A week ago, I received an email from a reader who asked why Akamai Technologies (Nasdaq: AKAM ) -- a stock I've followed closely for some time -- has been falling in price in recent months. My answer, quite simply, was that I had no clue. No one has that kind of crystal ball, especially over the short-term. (And, yes, that includes you, Mr. Technical Analyst.)
But the question stuck with me. It got me wondering why we, as investors, so often ignore price until we are holding shares. By then, of course, it's too late. I should know. I bought Amazon.com (Nasdaq: AMZN ) in late 1999 because there were plenty of reasons to believe the company would someday transform itself from a rebellious Rule Breaker into a very profitable Rule Maker. Heck, even TIME thought so, naming CEO Jeff Bezos its Person of the Year that December. I bought, without giving a single thought to the price at which I was buying. Whoops.
Bubble, bubble, toil, and trouble
Of course, now we can say that Amazon's share price was more bloated than a blimp covering Monday Night Football. We've got the benefit of hindsight. But you could have known back then, too -- if you took the time to construct even a thumbnail valuation. Here are the numbers I pulled from Amazon's annual 10-K filing for 1999:
- 326.753 million diluted shares.
- $1.639 billion in sales.
On December 27, 1999 -- the day Bezos appeared on TIME's cover page -- Amazon's stock closed at $81.13 per share, for a total market value in excess of $26.5 billion. At its height, Amazon.com was trading for a stratospheric 16.2 times sales. That the company has boosted revenue by more than 33% annually since hasn't been anywhere near enough to generate positive returns for investors. Indeed, the stock is down nearly 50% over that period.
Don't buy great companies
The lesson here ought to be obvious: Great businesses may not make for great investments. In fact, they often don't -- unless they are priced correctly. That's so important I'll say it again: Even a great business like Amazon can be a poor investment if you overpay to become an owner.
Back in 1999, I failed to understand that in the short term, stock prices are influenced primarily by supply and demand, which are in turn often influenced by speculation and hype. But over the long term, stocks tend to achieve an equilibrium; a fair value, if you will. Achieving sustained market-beating returns -- even with Rule Breakers, I'll contend -- requires that you not only understand this principle, but also that you buy stocks that have been mispriced in the short term relative to their long-term value.
The flea market investor
A wonderful book by John Train called Money Masters of Our Time profiles some of the best minds in the history of investing. Naturally, Berkshire Hathaway (NYSE: BRKa ) (NYSE: BRKb ) chairman Warren Buffett is on the list. My admittedly limited understanding of his approach leads me to believe that he has more in common with the Fool who shops at Wal-Mart for groceries than he does with the Wall Street investment banker who goes blind staring at spreadsheets. (Please pardon the oversimplification if you're reading this, Mr. Buffett.)
Certainly the cheapskate routine has worked for him; he's generated greater than 20% compound annual growth over 40 years. Yet his approach appeared worn during the dot-com bubble. Indeed, some openly mocked Buffett. It wasn't warranted. I researched Berkshire's 1999 and 2000 year-end 13-F filings -- including both the initial and amended documents -- and it appears Buffett's team bought 14 stocks during the heady days of 2000. Of those, six remain in the portfolio today, including Moody's (NYSE: MCO ) , which has done very well.
We know because we can calculate Berkshire's approximate cost basis for the position. Buffett listed all the data necessary in his very handy 2004 annual letter to shareholders (PDF file). According to that letter, at the end of last year, Berkshire had 24 million shares of Moody's stock, which it bought for $499 million, or roughly $20.79 per stub. The stock split 2-for-1 this summer so the share count has since doubled. With the stock trading for $50.74 per stub as I write, Berkshire's stake has grown in value to $2.4 billion. That's close to a five-bagger in five years.
The bear hug: Your portfolio's moat
The stock market isn't perfectly efficient. If it were, Warren Buffett wouldn't be the Warren Buffett we know today. Nor would we routinely witness the carnage that befalls the stock of an otherwise stellar company guiding to lower-than-expected quarterly revenue or earnings. Yet we do. And therein, Fool, lies your opportunity.
Buying well -- that is, with a huge discount to intrinsic value or real growth prospects -- can protect returns during even the worst of markets, as Buffett proved. Call it a bear hug for your portfolio. And, no, you needn't be a billionaire genius to employ the strategy. All you need is discipline and a few good tools. Philip Durell, chief analyst for Motley Fool Inside Value, has the tools if you're willing to supply the discipline. He's piled up 14 investing lessons covering everything from return on invested capital to discounted-cash-flow analysis. That's one reason why he's beating the market by nearly seven percentage points as I write today. Access to his approach, and his 28 past and present picks, is yours free. Right now. Just take a 30-day trial to Inside Value.
Looking for even more on value investing? Look no further:
- Remember the four critical errors you must avoid.
- The numbers tell only part of the story when it comes to value stocks.
- Trash digging is sometimes good for your portfolio.
- Know the three magic words that can juice your returns significantly.
Fool contributorTim Beyershopes he never becomes overvalued. Tim owns shares of Akamai. You can find out what is in his portfolio by checking Tim's Fool profile, which ishere. Amazon and Moody's are Motley Fool Stock Advisor recommendations; Akamai is a Rule Breakers pick. The Motley Fool has an ironcladdisclosure policy.