True Investors Welcome Volatility

While most academics like to equate volatility with risk, I hold a different view. To me, volatility should be viewed with enthusiasm. It gives the true investor the opportunity to buy and sell great businesses at attractive prices. Business-oriented investors who view investing as the opportunity to acquire ownership stakes in excellent companies will find that volatility is an investor's best friend.

More opportunities
My approach to investing is rather simple: Look for good companies selling below intrinsic value and hold onto them for a long time. However, it's important to remember that investing also has to be sensible. If a stock you acquire happens to appreciate rather quickly and no longer seems fairly valued, take advantage of the volatility to sell it and allocate your capital to another undervalued security. Likewise, if volatility results in a declining stock and your methodology is sound, then you either buy more of an even better value or sit tight while the gap between market price and intrinsic value narrows. Any way you slice it, greater market volatility leads to more potential opportunities for the enterprising investor.

One should not incorrectly equate market volatility with market timing. Using volatility in an attempt to buy at the bottom and sell at the top is a good way to erode your capital. Anyone who was buying housing and mortgage-related securities in the last year is paying an expensive price today. Instead, an investor should welcome volatility on a stock-by-stock basis. Companies like Countrywide Financial (NYSE: CFC  ) and NVR Inc (NYSE: NVR  ) have seen their stock prices tumble hard, and for good reasons. But in the long run, it may be wise to keep a close eye on companies in these battered industries.

A 16-year annualized return of 0%
Warren Buffett, who is synonymous with the phrase "my favorite holding period is forever," has admitted that maybe he should have sold Berkshire Hathaway's (NYSE: BRK-A  ) (NYSE: BRK-B  ) position in Coca-Cola (NYSE: KO  ) at the height of the market boom in 1999. Coke was trading near $70 a share at one point, with a P/E multiple of about 47 -- twice the P/E of the S&P. Coke is one of the finest companies on the planet, but the excessive market volatility of the late 1990s offered investors a unique selling opportunity.

An investment in the Dow Jones index during the 16 years beginning in 1966 and ending in 1982 would have been worth about the same amount at the beginning and the end of that time period. Hovering around 1,000 in 1966, the Dow remained around 1,000 in 1982. Any dividends earned had been wiped out by inflation during that time. Yet during that 16-year period occurred one of the most opportunistic buying opportunities in the United States. Taking advantage of the volatility, Buffett began gobbling up stocks in 1974 (he had been out of the game since about 1969, when he shuttered his partnership). In 1970, dismayed with the high stock prices, Buffett remarked, "I feel like a sex-starved man on a desert island."

Yet in 1974, excited about the exceedingly low levels of stocks, Buffett remarked, "I feel like a sex-starved man in a harem filled with beautiful women."

In 1974, the buy-and-hold Buffett we know today was selling "stocks he'd bought at three times earnings to buy those selling at two times earnings." During the six-year stretch between 1976 and 1980, Berkshire Hathaway had an annualized rate of return of more than 60%! Volatility is indeed an investor's friend.

Very recently, Buffett announced that Berkshire has divested its entire stake of Chinese oil company PetroChina (NYSE: PTR  ) . The $500 million or so Berkshire invested a few years ago was sold off for about $3.5 billion. While some speculate that the sale was because of pressure from shareholders and activists upset with the parent oil company's activities in Sudan, Buffett has specifically stated that the sale was value-based. Considering the extreme volatility in the emerging markets, specifically China and India, and the fact that PetroChina's market cap has doubled in mere months to a staggering $400 billion-plus, it appears Buffett is once again selling when others are greedy.

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