Hope. It can kill a portfolio. The more rational, cold, and calculated you are in your investing, the more confidence you can have in your portfolio. Each emotion you introduce only digs you further into the hole. You can hold a company because you love their products; but, you better be sure that the business is generating enough cash to keep those products rolling off the lines.
Sometimes, hope is enough and things pan out the way investors wish they would. And sometimes, hope makes people lose money.
Discussing Berkshire’s 1994 USAir position, Buffett discussed the problems and difficulties facing the airline and what it meant for Berkshire stockholders. Berkshire was losing money with USAir and the airline’s value was delicately balanced between being fully restored…or declaring bankruptcy.
Buffett admitted that the airline had a long road ahead of it, and then went on to say:
Whatever the outcome, we will heed a prime rule of investing: You don’t have to make it back the way that you lost it.
The point? Just because you lost money on a company that lost value doesn’t mean you have to wait for that company to grow again. When it comes to your money, put it where you will get the most value. There is more value in a money market than in a company that is declining in value. It’s better to earn 5% interest in cash than to lose another 10% of value, hoping that management turns things around.
Price follows value. The longer you hold a company, the more clear that becomes. Why hold stock in a business that will lose value for the next three or four years? Instead, put your money into a growing company, and wait until after the “turnaround” happens.
Filed under: How to Think About Investing
Imagine this scenario:
1. You bought a stock, you realized you overpayed 2 years later. (value has dropped since, in FCF)
BUT…
You know the business has laid the foundation for future growth despite sagging economy.
2.This growth will manifest in increased operating margins from
1)inevitable price hikes 2)exploding demand
and will ultimately lead to higher CROIC (compared to an acceptable 14% during saggin economy)
The question is: Would you feel safe in HOLDING your position knowing you may have overpayed by as much as 25%?
I’d love to hear your POVs
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In Joe’s Walmart post, he talks about how even if you bought at a cheap price in the early years, sometime after the first 5 years you would be down about 50% of your original investment, and you would be thinking that your investment is definitely more valuable than that. After another few years, you hit the break even mark, after all those downs you still seriously think walmart is undervalued. Another few years ago by, walmart is realized and gives you an annual return of 33% per year on your original investment (numbers off the top of my head) but you get the idea.
If the value of your business drops below what it is trading at, that’s when it’s time to sell, because the best you can do is hope that someone else will pay a higher price than you for the business. Over time, price follows value so that means you would be speculating if you held on. If there is still a margin of safety (albeit not as big as when you first bought), you can consider holding on or you can look for better opportunities. It can be a holding spot until you see a better opportunity.
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Interestingly, though, Buffett held on to the investment until he got bailed out with a profit in 1997. But I agree with you, his system is all based on BUYing cheap. And if the purchase was wrong, even the master found it tough.
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