Warren Buffet has often stated that he learned his investment philosophy from a man named Benjamin Graham
Author of the Intelligent Investor
A famous Graham quote, which I feel is rather fitting right now is, “In the short run, the market is like a voting machine–tallying up which firms are popular and unpopular. But in the long run, the market is like a weighing machine–assessing the substance of a company.”
Last week’s 400 point drop in the Dow Jones
After last week’s 300 point drop in the Dow Jones followed by a subsequent 100 point decline the next day, folks are naturally asking if its “time to get out” of the market?
If you read the newspaper or watch shows like CNBC, you will hear 3 main reasons why stocks supposedly fell:
- The Argentinian government defaulted on their bonds
- Conflict is brewing in places like the Ukraine, Israel, and Iraq
- S. GDP grew by 4% in the 2nd quarter and good economic news = bad stock market news because if the economy grows then the Federal Reserve can stop buying bonds, thus ending their Quantitative Easing program
The first question you are probably asking is which one of these explanations is accurate? I would suggest probably some combination of all 3, though it doesn’t really matter. The stock market is like any other capital market, it’s driven by supply and demand. Whatever the cause, when there are more sellers than buyers, prices go down; this is what happened last week. For a variety of reasons, there were more sellers than buyers and as a result, prices came down.
The questions that any investor should be asking themselves are as follows:
- Are my investments diversified or concentrated? Diversified would mean one’s eggs are spread across many baskets; concentrated would mean one or two large holdings or sectors dominate their investment portfolio.
- Am I going to be forced to sell any of my investments in the next 1-5 years? Between sources of income, cash positions, and bond allocations, do I have enough money to cover my expenses and any emergencies over the next 5 years? If yes, I will not be forced to sell any of my stocks during that time. If no, I am no longer a long-term investor (for at least a portion of my investments) and should consider moving towards short or mid-term investments.
- Can I resist the temptation to over-react and sell when stock prices have fallen? If I can ignore this temporary decline in prices, and maybe even buy more stocks when prices are low, then volatility is at best my friend and at worst neutral. But if I cannot ignore this temporary decline in prices and plan to over-react and sell, I might as well sell now while prices are still high.
With the purchase of any business, there is a close association between price and value.
The stock market is no different; you are investing in a business and paying a price that should reflect the value of the company. In the short term, price and value can be mismatched. Sometimes price exceeds value and we have a crash, like the dot.com crash where companies that had no profits were trading at huge valuations. At other times value exceeds price, like in March of 2009 when the stock market had bottomed and world-class companies were selling at rock bottom prices.