Buy? Sell? Hold?
Is The Clash's famous "Should I Stay or Should I Go?" running through head? Or are you conjuring up Apocalypse Now, when Marlon Brando mutters "the horror, the horror", thinking surely he meant watching one's stock portfolio decline in value?
Fear clouds judgment, causing us to sell when we should hold and remain in cash when we should buy. Jim Grant, founder of Grant’s Interest Rate Observer, notes in his most recent newsletter: “We human beings only say we like to buy low and sell high. Our every instinct is to do the opposite. Rock-bottom prices only seem low in retrospect. At the time, they seem frightening because of the very reasons they are cheap.”
How should an individual investor think about their stock portfolio in these times? The most important mindset is to remember: your stock portfolio represents ownership in actual businesses, and your long term performance will depend on the performance of those businesses.
Start first with your existing holdings. The fact that a company's stock price has gone down does not mean that your investment thesis--the reason you bought the stock--is wrong. Warren Buffett's investment in The Washington Post is worth 100 times (not 100%, 100 times!) what he paid for it. But after his initial purchase, the shares declined by 45%. Had he sold then, he would have a realized loss equal to 45% of his investment and an opportunity cost loss of 100 times his money!
Your investment thesis also is not wrong because we are headed into a recession, even if it proves a deep one. While a weak economy might not have been top of mind when you bought the stock, the reality was and is that recessions continually occur. Good companies not only survive, they often are better businesses after weak competitors have been culled or bought.
That said, selling may make sense if: 1) A dispassionate analysis suggests that your initial understanding of the company's economics is incorrect, and it is not an attractive business to own; 2) The company is unlikely to weather the current economic environment. In a few months, we will start to see consolidation across numerous industries: strong companies buying their weaker competitors. The buyers will reap the benefits of current stock prices, not the owners of stock in the weak competitors forced to sell; 3) You have found a better investment opportunity (and perhaps can utilize the tax benefits of selling at a loss).
How do you decide when and what to buy? The "when" is impossible to answer: there are no examples of stock pickers who have sustained a track record of timing the precise highs and lows of markets. Stocks should be purchased when they are cheap according to the company's long term prospects, and worldwide equities already are on sale. Much of the recent dramatic stock market declines are due to deleveraging--either owners have to sell to pay back borrowings, or fund managers have to sell to meet redemptions. Those sellers haven't decided that the companies in their portfolios are poor, they simply have to sell. That's, at least, a very good time to think about buying.
What about the argument that a bargain isn't a bargain if it will be a bigger bargain tomorrow? The best one can do is estimate how long the buying window is likely to be open--perhaps you guess six months, perhaps eighteen if you expect a mild depression--then buy stocks each month during that period until the amount you want to invest is deployed. This won't guaranty that the market does not go down further after your purchases, or that it jumps and you miss the best prices; in fact, almost certainly one of those two will occur to some extent. But it is the optimal approach.
If you've read this far, you're probably ready for a stock pick. Here are two very conservative ones: 1) Buy Berkshire Hathaway (BRKA), if the stock bounces below $110,000 per share, as it has on occasion recently; 2) If your portfolio needs more exposure outside the US, buy Third Avenue Value Fund (TAVFX). In both cases, you are partnered with money managers, Warren Buffett and Marty Whitman, who have a brilliant, multi-decade track record and who have a substantial personal investment in these vehicles.
Dave Shryock
October 28, 2008
Posted by: DaveS on Oct 27, 08 | 11:50 am | Profile