Buying Opportunities for Warren Buffett

How does Warren Buffett define buying opportunities?

In her first book Buffettology , Mary Buffett wrote..

Warren believes that the technical mechanics of the stock market can create situations that will whipsaw security prices regardless of the underlying economics of the business. Buffett believes this irrational economic behavior can create situations that present excellent buying opportunities for the practitioner of business perspective investing, ie investing in excellent business selling at the Less Price.

This is slightly different than individual business aberrations or general business cycles created buying opportunities. This technical mechanics phenomenon is a quirk in the stock market infrastructure that occurs because of the ways and methods that securities are bought and sold. And combined with certain investment strategies such as portfolio insurance and index arbitrage, the stock market is always exploited in which the stock of an individual business becomes nothing but a commodity. Demand for the stock is then not driven by business values or economics but its demand is determined by the direction and rate of speed at which the price level of the whole market changes.

In which, this infrastructure problem can be the depature point of mass hysteria, in which people experience a great loss of wealth for no apparent rational reason, for they often panic and this selling their securities and staying on the sidelines until the market stabilizes. The panic exacerbates the severity of the situation, a situation that offers an opportunity for one to practise business perspective investing.

In a perfect world all the information about a particular company is interpreted and defined by two different stock market philosophies, in which one is short term oriented whilst the other long term. They, in turn, determine the market price for the stock of that company. Since the short term strategy is the dominant force in the marketplace and so will dominate the force that determine's the stock's price. And this is where the long term business perspective gets his or her buying opportunity.

In short, there are large forces at work that buy and sell huge amount of securities. And they couldn't care less about the economics of the businesses that they are buying or selling, for they treat as a commodity itself. And when to go bonkers, that is doing the total irrational things, like the stock market crash of 1901 and then the famous Black Monday of 1987, this always create wonderful opportunities in the stock market. And so it will happen again and again and again. Fools and greed go hand in hand which creates a field of opportunity for the rational.

In her other book, The New Buffettology , Mary Buffett spoke of the buying opportunity again, telling the tale of Benjamin Graham's Mr.Market again.

Benjamin Graham introduced Mr.Market to Warren. (see page 34)

Mr.Market had an interesting personality trait that some days allowed him to see only the wonderful things about the business. This, of course, made him wildly enthusiastic about the world and the business's prospects. On other days, he couldn't see past the negative aspects of the business, which, of course, made him overly pessimistic about the world and the immediate future of the businesses.

Mr.Market also had another quirk. Every morning he tried to sell you his interest in the business. On days he was wildly enthusiastic about the immediate future of the business, he asked for a high selling price. On doom-and-gloom days, when he was overly pessimistic about the immediate future of the business, he quoted you a low selling price hoping that you will be foolish enough to take the troubled business of his hands.

One other thing, Mr.Market doesn't mind if you don't pay any attention to him. He shows up to work every day - rain, sheet, or snow - ready and willing to sell you his half of the business, the price depending entirely on his mood. You are free to ignore him or take up on his offer. Regardless of what you do, he will be back tomorrow with a new quote.

If you think that the long-term prospects for the business are good and would like to own the entire business, when do you take Mr.Market on his offer?

When he is wildly enthusiastic and quoting you a really high price?

Or when he feels pessimistic and quotes you a very low price?

Obviously you buy when Mr.Market is feeling pessimistic about the immediate future of the business, because that's when you get the best price.

Graham added one more twist. He thought Warren that Mr.Market was there to benefit him, not to guide him.

You should be interested only in the price that Mr.Market is quoting you, not his thoughts on what the business is worth.

In fact, listening to his erratic thinking could be financially disastrous to you. Either you will become overly enthusiastic about the business and pay too much for it, or you become overly pessimistic and miss taking advantage of Mr.Market's insanely low selling price.

Warren says that, to this day, he still likes to imagine himself being in business with Mr.Market. To his delight he has found that Mr.Market still has his eye on the short term and is still manic-depressive about what businesses are worth.

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.

Mary Buffett continues by telling the story of the two racehorses. Healthy and Sickly.

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.

And when put into business perspective, Mary introduces the reader the two categories of business. The healthy, durable-competitive-advantage business and the sick, price-competitive businesses.

Warren separates the world of businesses into two categories: healthy, durable-competitive-advantage businesses and sick, price-competitive-commodity businesses.

A company with a durable competitive advantage usually produces a brand-name product or occupies a unique position in the marketplace that allows it to act like a monopoly. If you want this particular product or service, you have to purchase it from the company and no one else. This gives the company the freedom to raise prices and produce higher earnings. These companies also have the greatest potential for long term economic growth. They have fewer ups and downs they possess the wherewithal to weather the storms that a shortsighted stock market will overreact to.
A price-competitive-commodity business manufactures a generic product or service that many other companies produce or sell and they competes for customers solely on the basis of price.

And some of the most common characteristics of a commodity business mentioned by Mary Buffett in her earlier book, Buffettology, are these companies operates on low profit margins, they have a low return of equity, lack of any brand-name loyatly, the existence of many similiar producers of the same product, excess production capacity of the same product in the same industry, eratic historical profits, and in some cases the profitability depends on the management utlization of its assets such as plant and equipment and not on such intangible assets as patents, copyrights, and brand names.