Tuesday, November 25, 2008

Strategy during crisis investment II

Part II

Market chaser — a loser
On the contrary, there are also certain groups of investors who always chase the market. They get excited whenever the market runs. They are overwhelmed whenever the bull is in town and they tail behind the bull. When the bull is gone and the bear returns, they become fearful. They hide at home and cuddle whatever balance they have in their savings.

“The public buys the most at the top and the least at the bottom.” — Bob Farrell’s Rule No 5

As a whole they put in more money during the bull market than in the bear bottom. Some even cut lost after a substantial fall in prices. In a way they “buy high and sell low”, whereas the basic rule of investment is to “buy low, then sell high” — a simple investment tenet understood by most people, but not being widely practised. Although we may not know where the bear bottom is, buying in a down market may still lead to losing money. This is definitely true. As long as the purchase is not at market bottom, it may still result in losses for the time being. This is likely to be a short-term loss but compensated by a probable long-term gain. Even if we cannot time the market perfectly, we are definitely better off to “buy low and sell high” then to “buy high and sell low”.

Prices fell but value intact
Presently stock prices have fallen sharply. Banks are trading at 1x book value, property stocks sold at 50% discount from net asset value, utility stocks trading at single-digit price-earnings ratio providing an earnings yield of more than 10% net of tax and there are many good stocks trading at dividend yield of 2x bank interest rates.

While prices have fallen off the cliff, the values of these companies are still very much intact. The present financial tsunami in the US has its impact on many Malaysian companies. It will cause a slowdown in our economy and affect earnings over the next one to two years. But isn’t this part of business risk? Established and proven companies have weathered this many times as in the past and they will eventually end up bigger and stronger.

Prices may fall but the value of a good company is still very much intact. The value of a company comprises the brand name, business contacts, the team of suppliers, the network of clienteles, the internal management control, the technical skills and etc.

Warren Buffett is busy buying
Warrant Buffett, the second richest man in the world who makes his fortune from stock investment, is busy buying undervalued companies. He sees the value and he also sees prices detaching away from the intrinsic values. He said: “I haven’t the faintest idea as to whether stocks will be higher or lower a month — or a year — from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turn up.”

Although we may not be able to imitate exactly what he is doing, we can still follow some of his investment strategies. There are a few strategic moves that he has employed in the current financial crisis:-

• He is able to buy those shares which he likes in the past at a huge discount to the net worth, which means his safety margin at this point is very good.

• He aims to hold the investments for several years for huge profit margin as he is unlikely to sell for a small profit.

• He does not rush in to buy, he is very selective on the stocks he bought.

• He buys gradually. Thus far, he only uses about half of the cash balance in Berkshire Hathaway, his flagship company.

While others witness the collapse of banks in the US and wonder which one will be the next to fall, Buffett discovers many cheap buys. When Alan Greespan said this is a once-in-100-years financial crisis, Buffett believes this is a golden opportunity to accumulate undervalued stocks for his collection.