Weathering the Market

During the past few days the market has been going haywire as a result of the recent drop in the Dow Jones Industrial Average. Investors have been in a panic and are wondering what caused the decline, where they should put their money, and what’s going to happen next. They’re talking about oil and gas pricing, gold investing, politics, elections, and many other topics. Anything that could possibly be a cause or solution is in the news. This is a very typical reaction from the market and despite how much is written about the way value investing is conducted, the fear ensues. Let’s look at this for a moment.

As value investors, we take a bottom up approach on researching a potential investment and determining if it is something that we should add to our portfolio. This means that we first take a look at the company and the economics of what makes it a great business. Does it have a stable revenue model? Does it have a runway for growth and scalability? Does it have an economic moat? Learning these things about an investment can shed some excellent light on how resilient it can be to market swings. And, this resilience is definitely something that will help investors endure a storm.

Don’t get me wrong here… it is important to pay attention to the macro economy and the markets around the world for many reasons, but if nothing, at least such exposure will help us grow in knowledge and wisdom and maybe find the next great investment idea. But if you’re able to find a great business and are a disciplined value investor, then swings in the market shouldn’t worry you. In fact, they should excite you.

I always love giving the example of Proctor & Gamble. P&G makes a variety of products but they have a heavy weight in the consumers staples industry. They make things like toothpaste and toilet paper. These are products that everyone uses and will continue to use regardless of what is going on in the market. This is an example of economic resilience. So why does a company that is apparently resilient to economic downturns get affected by these swings? Well, that is because the market, and by definition the investors in the market, aren’t rational. As soon as something goes wrong and someone starts selling, everyone else starts following. They may be following for good reasons but then the uneducated and emotional investors follow for reasons of fear. And so, a good resilient company is abnormally trading low and irrationally cheap. I love this! Sometimes we sell greed… and now, we are buying fear!

This isn’t an easy task to do because it requires discipline and emotional control. So what should an investor do when something like this happens? Well, your first action should to revert to your Dream Team. A Dream Team is a list of companies that you hold on a waiting list. They are companies that could potentially be a great investment. They exhibit all of the qualities of being something that you would add to your portfolio, however they just simply aren’t priced correctly yet. Market anomalies are great opportunities for companies that are overvalued or valued at par to fall into your margin of safety and buying range. So start tapping into your Dream Team. The second thing to do is to evaluate the holdings that you already have. Are they still a good investment? Maybe now they are even cheaper then they were when you initially purchased them. If that is the case, and your portfolio allows it, you may want to consider purchasing more of them. This action has the potential to substantially lower your ACB (adjusted cost base) – the average cost of your holdings.

Value investing is as much an art as it is a science. Market conditions determine which method is used more heavily and at which moment. But one thing that is important is that a great company will always prosper and a value investor must have the discipline to endure.

I’m curious to see how the Robo-Advisors, new age Quants, and Algorithmic Trading packages fair out during situations like this.