Focusing On The Calendar Year and Markets
January 7, 2008 | Joe Ponzio | about: AEO / AMLN / JNJ / TRB / WMT
Welcome to 2008 all. I am going to spend the next day responding to all of the comments from the past two weeks. Let’s get to the heart of the matter: What is going to happen in 2008? It is a question I have been hearing for the past three weeks, and is worth answering.
Here we go: Great businesses will grow; bad businesses will shrink; stock prices will follow in the long-term. Of course, when I say that, people respond with things like that’s no help or obviously or the likes. We all know that…so why can’t we believe it? And more importantly, why can’t we invest accordingly?
First things first, forget the calendar year. What will make 2008 different from 2007? Or 1997? Or 1967? When it comes to the stock market, the answer is a resounding nothing! The stock market will still be a place to buy and sell businesses – overpriced and underpriced companies, good and bad businesses, large and small operations.
Where is the economy going? The election?
Are we headed for a recession? Depression? What will the election mean to our portfolios? It doesn’t matter! If you are a short-term trader, these questions require a lot of thought and strategy. If you own businesses – businesses with moats that generate a ton of cash – you don’t have to worry. We’ve lived it (some of us, at least) and our businesses have thrived.
The Cold War. The Gulf War. 9/11. The Iraq War. Federal funds rates from 1.79% in 1955 to 16.39% in 1981, back to 4.79% in 2006. 6-month CD rates from 4% to 15% back to 5% over 40 years.
You ain’t seen nothing
In the last 40 years, over a period of six months we’ve seen the Dow drop as much as 32+% (1974) and run up as much as 48+% (1975). Great – but that was 30 years ago. Right – but it was also down 29+% (2002) and up 34+% (1999).
And yet, businesses continued to grow. As Buffett says:
You go to bed feeling very comfortable just thinking about two and a half billion males with hair growing while you sleep. No one at Gillette has trouble sleeping.
Do you own businesses run by management that can’t sleep when interest rates are on the rise? Are your companies largely successful because there is a Republican President? Will the next President’s party make or break their success?
What is 2008?
And that leads to the point of this discussion: Don’t focus on the calendar. Whether it is October of 2007 or January of 2008, the people at your company will be going to work every day to try and make you money. So long as they are banging away at their keyboards, ringing up sales, mixing chemicals, etc., they are working to make you more money. Your businesses aren’t likely to explode – for better or for worse – in just a few months or quarters. It will take years, and if you buy, hold, and sell on that premise, you’ll do very well.
Forget January. Forget 2008. Forget the stock market. Buy businesses and let time reward you for your good decisions.
My AEO stock is down and the markets are tanking!
But what about American Eagle Outfitters? The stock is at $18 and change! And it may go lower – a lot lower. Is it a good business? I think so. Are people still shopping at AEO’s stores? Yep. Is management still trying to reduce expenses, grow revenues, and generate more cash? You bet. Did you buy it hoping to make a quick profit? I didn’t.
When you buy an underpriced business, it may take years for the markets to correct their mistakes. Fortune smiled on us when JNJ and Wal-Mart ran up just weeks after I showcased them. The Tribune arbitrage play was meant to be a 3-week 10% profit. The fact that Amylin is down 23% since my July 26th cautionary post is a function of mere market fluctuations.
The stock market will do a lot of crazy things. It has always been that way; it will always be that way. Had you bought AEO in September of 1994, you would have seen your position slashed by some 80% over the course of the next year and a half. And had you held? A handsome, 13-year 22% average annual return at today’s price.
The market fluctuations are gut-wrenching. That’s why you have to ignore them. If not, you’ll drive yourself nuts and start making some really terrible moves.
If it works for Warren…
Buffett has been profiting from and holding stocks through the craziest, scariest, and wildest markets for more than 40 years. Think today’s markets are bad? You ain’t seen nothing compared to what he went through.
Price follows value. Maybe not today. Maybe not in 2008. But it does.
Now, let’s make some money the intelligent way and invest like real business owners/silent partners!
Excellent post!
Quick question for you though. I read through your 4-part post %u201CCalculating The Value Of A Business.%u201D I was wondering if you had spreadsheets to demonstrate the example you use in calculating the Johnson and Johnson intrinsic value. Also, if you have spreadsheets of other examples in the past, I would love to see those as well. I just want to make sure that I%u2019m making decisions using the correct data.
Thanks.
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All true – theoretically. In the real world, Joe 6 Pack has limited capital; certain goals to reach in a limited timeframe and there are opportunity costs to holding while the market (and companies) are going down. Besides, J6P is married and his wife doesn’t understand the ‘Buffett method’ and ‘margin of safety’ and ‘intrinsic value’ and screams bloody murder when the retirement monies/kid’s education fund goes down the drain. Sometimes, it pays handsomely to sit on the sidelines while the economy goes to hell in a handbasket. That way, you will get many great companies to choose from (as opposed to the 1-2 in a “normal” mkt) which will allow you to better deploy your capital or buy ‘brand’ names at a lesser margin of safety. Your opportunity cost of holding will be less (meaning that the beaten down great company will rebound quicker). Finally, your wife will understand purchases of Colgate or McDonalds as opposed to some obscure company that may have unbelievable cash flow and great margin of safety. Your overally yearly return may be lower (over the long term) from buying ‘brand’ companies as opposed to the obscure company that Buffett and other disciples are buying but your wife will love you and you won’t qts your own purchases. When all is said and done – value investing is easy. “Holding on in the real world” is tough, very tough.
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Focus on what you can control – buy great companies selling below their intrinsic value.
Anytime you feel like doing anything else, re-read this great buffett piece:
http://www.valueinvesting.de/en/superinvestors.htm
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M Williams: Check out the JNJ post – the spreadsheet is at the end.
Babui: No one said this game was easy. In fact, nerves can kill a portfolio. I’ve seen it happen too many times. If Joe 6 Pack has certain goals to reach in a limited timeframe, he may want to consider not being in the markets. If that timeframe is, say, retirement in 5 years, J6P needs to remember that he’ll have another (hopefully) 20 years of investing after retirement.
Limited capital is not a major obstacle. So long as you have at least $1,000 (though preferably at least $5,000), you can invest in companies. When staring retirement in the face, $200,000 or $500,000 doesn’t seem like enough to be “playing” in the markets. To that I say, “Right!” All the more reason to strategically invest in underpriced companies and let time do its thing.
And if the spouse’s nerves are directing the portfolio, Joe 6Pack needs to run from the markets as fast as he can – at least until he can convince Mrs. 6Pack to understand investing beyond the daily swings.
Over the long-term, if the short-term swings are too scary, consider an index fund and individual bonds.
David: Thanks for that great article. I posted it elsewhere a while back, but still a great refresher!
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Great Post! I have been reading your blog for a while and I like how you summed up most of your standing of the stock market and Buffett’s ideology into one post. I agree that many people get hooked on price without understanding what it means to own a great company.
Look at Apple, they have a mighty good moat around them. Even though their market share isn’t big they still dominate at what they do. Not because of the buzz that surrounds them, but rather of their innovative and easy to use products with a great business strategy in place.
http://www.boringmarket.com
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