Tuesday, May 30, 2023

Buffett – Don’t Buy Stocks Just Because They Are Undervalued

Buffett, like many other great investors, tends to be very discriminating—he avoids the temptation to buy a stock that looks attractive at the moment. Any stock can potentially be a value if the price is right, but Buffett doesn’t allow himself to be fooled into buying stocks because they are undervalued.

Eventually, each of the 10,000 or so US-listed stocks, including the Qualcomms and Oracles of the world, will trade at low valuations, but only a small fraction of the 10,000 companies offer attractive long-term growth prospects. Most have weak fundamentals or a history of irregular growth and should be avoided. Many others will provide periodic trading gains and then slump when the investment community tires of their stocks and seeks short-term gains elsewhere. As you hone your stocks over time, you’ll eventually whittle down your short list to a few dozen candidates to buy. Then, you can zero in on this list and buy them all at once as their prices drop to favorable levels.

Buffett believes that you should avoid the temptation to buy a stock just because you have the cash. More often than not, a heavy wallet invites mistakes. As of early 1999, Buffett had more than $35 billion in cash and bonds in Berkshire Hathaway’s investment portfolio. He was content to hold this large sum, equivalent to the total annual output of dozens of smaller countries, indefinitely until he could find a suitable price to buy the companies. In contrast, most investors feel a psychological need to put their loose change to work almost immediately. Instead of patiently waiting for their favorite stocks to decline, they buy shares of low-quality companies without wasting time to study their fundamental qualities.

Buffett avoids this trap by identifying all the stocks he wants to buy over the next several years and buying them all at once, but only when they drop to an attractive price. If the shares do not immediately fall to the desired price, he takes no action. He knows that the odds favor a drop in price sooner or later. In the interim, it will turn its attention to other desired companies whose prices may have already fallen to attractive levels.

To help you practice the taking-strike method, you should keep a list of your possible stock prices. The list should include the maximum price you would willingly pay for the company today. Post this list in a convenient place and check it from time to time.

The obvious advantage of warehousing stock is that it forces you to be cautious. Before buying, you must determine a fair value of the company, which means studying the enterprise. Investing some time in valuations proves that your chances of buying prematurely will be greatly reduced. Buying companies this way also allows you to build the portfolio you really want and keeps you from adding unnecessary stocks because you have idle money. Furthermore, the method harnesses your impatience and – most importantly – ensures top performance as you would pay more for any company.

You should update your checklist from time to time to make sure that your target values ​​are reasonable. If a company has lost growth prospects, the original purchase price you set may be too high. Conversely, if the company’s fundamentals improve, the stock may not retrace to your buy level again. In such cases, you should reevaluate the company to determine whether it is truly worth the higher share price.

The point is that when you don’t have to invest, you don’t think you should. Once you gain confidence in picking your own stocks, you will naturally make fewer and fewer buy-sell decisions. Being a successful investor gives you the advantage of holding a 20-game lead over the second-place team in September. You can keep the bat on your shoulder and take strikes indefinitely as it will not change the outcome of the season.

Add your favorite stocks to the inventory.

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