U.S. equity-market investors are navigating through choppy waters. The availability of credit and liquidity makes the investing world go round, yet the tap is running dry very quickly. In a story I wrote a few days ago, I gave one example of why the credit market is in such turmoil and why the worst may still be coming.
Nonetheless, the market has experienced turbulent times before, and it will experience them again. And that's OK, because markets have to go through periods of self-cleansing. Beginning in 2000, for example, Mr. Market began cleaning out Internet and other tech companies that weren't even generating positive cash flow, much less net income. What's more, for the most part, Mr. Market got it right during that purge. A lousy company that once traded for $50 was not a bargain at $2 a share, but rather still overvalued once you closely examined the fundamentals.
Yet Mr. Market did get a little too emotional with some businesses that didn't warrant taking such a hard hit. Consider Apple (NASDAQ:AAPL), which was changing hands at around $33 a share in February 2000, only to see its shares decline to less than $8 by December. The stock did split 2-for-1 in June 2000, and the dilution probably exacerbated the decline. Yet for the next couple of years, Apple's share price hovered around the $8-$12 range. Anyone too emotional to withstand the pain of watching the stock price drop some 75% sold out and now probably feels even more pain, with those same shares exchanging hands at around $175.
No pain is more gain
I have long said that successful investors exhibit certain traits that are crucial to beating Mr. Market: sound search strategies, independent thinking, and patience. On top of those traits, the really great money managers feel no pain or emotion when it comes to stock prices -- or, to be more specific, when it comes to watching their stock prices decline substantially.
That doesn't mean the prudent investor won't reassess intrinsic value after a substantial decline in stock price, to see whether Mr. Market's action holds any merit. But if you truly understand that a stock's price volatility is not the same as the risk in a business, you are a lot less likely to let emotion dictate your investment decisions. The principal reason for Berkshire Hathaway (NYSE:BRK-A) chief Warren Buffett's success is his innate ability to eliminate all emotion from his investing decisions. Before he makes any investment, he makes sure he knows the company cold. That way, when a stock goes down by 20%, Buffett knows there's no cause for alarm and instead sees as an opportunity to buy more stock at a cheaper price.
Right now, the credit market is wreaking havoc on stock prices. Daily 52-week-low lists are littered with the stocks of banks and a host of other business. For the most part, these securities deserve the current valuation they command. Too many businesses traded sound business judgment in favor for quick profits. And many of them have caused their shareholders irreparable damage.
Yet in the midst of all this carnage, some solid companies are reaching very attractive prices, too. That means there are some excellent opportunities available. Just remember that in our current market environment, you will not buy at the bottom, and you could see things remaining volatile for months or even years.
The proof is in the pudding
We all know about Buffett's advice to "be greedy when others are fearful and fearful when others are greedy." That's how he found great success with American Express (NYSE:AXP) during one of the worst times in the credit card issuer's history. For a contemporary example of feeling no pain when it comes to investing, look at Mohnish Pabrai, a Buffett-inspired value investor with a seven-and-a-half-year net annualized return exceeding 25%.
During most of that period, Pabrai has observed that immediately after he buys a stock, it tanks and immediately after he sells, it shoots up. So what explains his stellar performance? He exhibits no emotion toward those stock-price movements! When he bought Universal Stainless (NASDAQ:USAP) several years ago at around $15 a share, the stock was trading for $5 several months later. Yet Pabrai didn't flinch. And he would eventually more than double his money on the investment. The same thing happened with Tesoro (NYSE:TSO). After an average buy price of $7.63 a share in the summer of 2002, the stock was trading at $2.80 by the fall. Two years later, he sold the stock for around $15. He experienced similar situations with Frontline (NYSE:FRO) and Sunrise Senior Living (NYSE:SRZ) as well.
If you had given Pabrai's portfolio to an emotional investor, the results would have been much worse. To succeed in this game, remember that you have to take advantage of Mr. Market's emotional mood swings -- not the other way around.
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