Healthy and Sickly

Taken from Mary Buffett's The New Buffettology

Warren has discovered that to take advantage of the market's pessimistic shortsightedness, he must invest in companies whose economics will allow them to survive and prosper beyond the negative news that creates a great buying opportunity.

To do this Warren has to make sure that the company in which he is investing is not only intrinsically sound enterprise, but also has the economic ability to excel and earn fantastic profits. Warren isn't interested in the traditional contrarian investor approach of bottom picking.

Only by selectively picking the cream of the crop is he able to recover, but continue upward.

Think of it this way.

You have two racehorses. One, called Healthy, has a great track record with lots of wins. The other, called Sickly, has a less-than-average track record.

Both catch the flu and are out of action for a year.

The value of both shrinks because neither is going to win any money this season.

Their owners, intending to cut their losses, offer them up for sale.

Which would you want to invest your money in? Healthy or Sickly?

Healthy is clearly the best bet. First of all, you know that Healthy is usually a strong horse. Not only does Healthy have a better chance of recovering from the flu than Sickly does, he has a better shot at winning races (and making you tons of money) once he does!

Even if Sickly recovers, the horse will more than likely remain true to its name and get sick again and again. The return on your investment will be Sickly's health - poor.

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Make sense?

So when a stock get bashed down.. do make sure that the stock's underlying business economics is still healthy. If one chooses a stock whose business is showing poor health, like clear deterioration in business fundamentals, then it is very likely the return of investment will be but poor!