Investment Lessons We Can Use: II

Previously posted: Investment Lessons We Can Use

Here is another posting which I thought was rather educational, one that we can learn and profit from.

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I agree that averaging down is a scary thing. When you buy a stock like you buy a business (which means price is only one small component of your overall analysis) and the price falls-- what I do is ask myself "if the business is failing"? A falling stock price may be a sign of danger as other savvy investors see flaws with the business model, increasing competition (usually seen as narrowing profit margins), etc. Or, sometimes it is an over-reaction to what you believe is a temporary setback, like rising commodity prices.

If, after raising your skeptical antenna, you continue to believe your business is on track to continue its long term growth and build shareholder value... than the proper (if corageous) thing to do is buy more shares at the now more attractive price. After all, it is the same business you previously liked at a higher price.

If, on the other hand, your heightened skepticism results in some important questions needing answered-- maybe about intensifying competition or rising raw material costs-- you might want to sit back and wait and study further. But, cut loss on rumors and whims isn't likely to make you wealth. Often, you will be selling into weakness with the irrational crowd without confirming any business weaknesses. A cut-loss system, or any other system that doesn't require careful analysis and thought, is not very wise and not very FA-ish.

An example... Warren Buffett accumulated shares of the Washington Post during the 1970s recession, and bought more during a newspaper union employee strike. He saw these as temporary troubles, while others were cutting losses. He is now up more than 10-fold. He bought American Express during troubled times, he bought Geico Insurance when it was in trouble too. He looked at the falling share prices in each case, and decided to buy more, because he believed the businesses were sound and their troubles temporary. He was usually right.

Most important aspect of FA... be careful you only buy good businesses at fair prices (our 8-step screen, built on Mr. Buffett's wisdom). If you get this right, you eliminate most worries about cutting losses. Step 2... remember Ben Graham's advice... "Never buy a stock simply because it has risen sharply in price or sell one because it has fallen sharply in price. The opposite advice would be wiser."

Sage

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Comments:

1. The average down issue.

Recently, the past couple of months, I had witnessed many so-called good stocks falling down hard. For me, I think it's more important to distinguish if there are indeed real changes in the business economics. To simply brush it off and proclaim as poor market sentiments and over-reaction would be rather unhealthy in a less than matured market such as ours. And to simply average down without truly understanding what is happening is simply suicidal.

2. Buffett and Washington Post and Amex.

Yes Warren Buffett was right because these 2 companies had a very strong competitive advantage in its business. Washington Post had a monopoly-like business because it dominated the media business in the Washngton area. Amex is Amex is amex! So one needs to understand why Buffett did not cut-loss. These 2 companies had extra-ordinary strong competitive advantage. Do compare with the companies locally. Do they really have the same edge at all??? Are they even close? If no, then it's never quite the same as what Buffett did!