If you've felt the stock-market decline of the past 12 months, you're not alone.
It's been rough out there. Some two-thirds of all publicly traded companies on our major U.S. exchanges are down in the past year, according to Capital IQ data. UAL (NASDAQ:UAUA), parent of United Airlines, has seen rising oil prices help drive its stock down more than 60% over the past year. Slowing consumer demand pushed Circuit City's (NYSE:CC) shares down more than 80%. Taking the cake, though, is housing-plagued Freddie Mac's (NYSE:FRE) 90% stock-price decline!
That's some scary stuff. It's easy to get discouraged in times like these. Moreover, behavioral finance studies have shown that investors often flee the scene of a scary market. Whenever I think of investors dumping their stocks, I think of Peter Lynch.
In his classic One Up on Wall Street, Lynch writes about the "mirror test" -- questions every investor should ask herself before even considering buying a stock. One in particular strikes me as the most important:
Do I have the personal qualities it takes to succeed?
This is the most important question of all. It seems to me the list of qualities ought to include patience, self-reliance, common sense, a tolerance for pain, open-mindedness, detachment, persistence, humility, flexibility, a willingness to do independent research, an equal willingness to admit mistakes, and the ability to ignore general panic.
When investing is more about temperament than tickers
With Lynch's "personal qualities" in mind, let's cut through all the darkness of today's market and look to the light by remembering three core rules:
- Patience pays.
- Pessimism brings opportunity.
- Keep it real.
Let's take a closer look at each of these three points.
Be patient
Tom Petty had it right when he sang "the waiting is the hardest part." That's because many investors are too eager to buy and sell. They like action and they want their returns now. That shouldn't be surprising -- after all, we are programmed to look for the "sure thing" now, not wait for the uncertain "bigger thing" tomorrow. Investors are better off turning that around and waiting for the best bargains, as they can generate the biggest returns with the least amount of risk.
Again quoting Lynch:
Some have fancied themselves "long-term investors," but only until the next big drop (or tiny gain), at which point they quickly become short-term investors and sell out for huge losses or the occasional miniscule profit. It's easy to panic in this volatile business.
Take advantage of opportunities
Shelby Davis had it right when he said, "You make your best money in bear markets. You just don't realize it at the time."
Difficult times bring on bear markets, and many investors start selling stocks. Sometimes they sell for good reasons, like when a business has become damaged. Sometimes they sell for the wrong reasons, which can cause the stock price to go below company value.
Starbucks (NASDAQ:SBUX) is a good example. It is closing stores and slowing store openings, and surely you've read the headlines speculating on whether consumers will continue to shell out for high-priced coffee. The sentiment these days seems to be solely negative; indeed, I believe Starbucks is trading for a bargain price because the market is failing to see how much cash Starbucks can generate over the next five to 10 years.
Keep it real
In his most recent shareholder letter, Bill Miller quoted Warren Buffett as saying "I'm a realist."
That may be an obvious point: Be a realist. Yet it's tough to stay rational and realistic during times of extreme volatility -- for instance, have you seen the roller-coaster ride Elan (NYSE:ELN) has been on recently?
But pessimism can create opportunity.
Early in 2000, the market thought McDonald's (NYSE:MCD) had lost its way. And with prices as low as they were, it thought the damage was permanent. The stock has increased almost five times in value since those dark days. That great company wouldn't have gone on sale without the pessimism, and only rational investors could recognize the value during those difficult times.
Of course, the key distinction is to be a realist, not an idealist. If you can be objective in your analysis and conservative in your estimates, you'll likely stay out of the latter camp.
Practicing what we preach
Those three rules are easy to say but hard to follow.
In my work on our real-money Motley Fool Million Dollar Portfolio service, I strive to practice what I preach. No one's perfect, of course, but we're excited to be long-term investors. In fact, some of the pessimism I described above has allowed us to scoop up shares of great companies like Starbucks and Best Buy (NYSE:BBY) at attractive prices.
We'll be living those three rules as we seek out some of the great companies that are now on sale. Our Million Dollar Portfolio service invests $1 million of the Fool's own money in a portfolio made up of "the best of the best" of Motley Fool newsletter recommendations. I encourage you to learn more about how to gain access to our service, including the companies we're buying and the ones we're eyeing. Just click here to tell us where to send all the details.
David Meier is associate advisor for Million Dollar Portfolio. He does not own any of the stocks mentioned, but he does own a tablet PC. The Motley Fool owns shares of Starbucks and Best Buy, which are both Stock Advisor and Inside Value recommendations. The Motley Fool takes its disclosure policy very seriously.
