Last week I read an article by fellow SA writer Tim McAleenan which highlighted several quotes from the great Warren Buffett to make you a better long-term investor. I found this article to be both entertaining, useful, and I believe it was an interesting read. Therefore I decided to write a similar article; but with quotes that can help you become a better value investor.
I consider myself to be a value investor which is neither long nor short-term investing: But rather an investment paradigm that I use to find cheap stocks compared to fundamental growth. Warren Buffett is perhaps the most well-known value investor to ever live, and his charismatic witty personality has become a trademark throughout his many years of investing. Buffett is known for his "cool head" and ability to remain calm when fear and panic are the only emotions within the market that are present. Overall, Warren Buffett is a man of wisdom, but has the common sense to profit from his wisdom by not over thinking the market and downplaying the events that cause "normal investors" to panic and sell for loss.
"Never invest in a business you can’t understand."
The first Buffett quote is simple but straight to the point. I'll be the first to admit there are several companies within the market that I don't understand, nor do I think I could. Some are even large companies such as those who operate through the cloud or various semiconductor companies whose operations are beyond my scope of knowledge. And although some investors may look down on this fact I believe it's both normal and important to identify.
There are thousands of companies being traded in the market and it's impossible for you to know every detail about each one. However, when you invest in a company you must be knowledgeable of its operations which are why some believe you should only invest in companies who make products or provide services that you use. This belief or strategy makes sense because the last thing you want is to be holding a stock while it's falling and you don't even know why. Therefore listen to Buffett and don't invest in a company that you can't understand.
"There seems to be some perverse human characteristic that likes to make easy things difficult."
The statement above is by far one of my favorite quotes of all-time because there is simply no way to argue its truthfulness. In case you haven't noticed, every time the market's down you will hear CNBC, CNN, or Fox attempting to explain some factor that's pushing the market lower. Or if a stock falls without any significant developments we always have to find a reason for why the loss may take place. This quote, and these examples, is very important to remember, because although a stock may drop lower it doesn't mean the company's any different than what it was the day prior.
We as humans are psychologically programmed to search for answers and find reasons for why an event occurs. Our curiosity has led to our advancements and our ability to learn from the past and evolve as a species. However, as a value investor it can be damaging to your potential gains. Because it clouds your judgment and results in making investment decisions much more difficult than what it has to be. Therefore, instead of making "things" more difficult you should attempt to be logical and view the world of investing with simplicity.
“If a business does well, the stock usually follows.”
Our quest for answers usually leads us to second-guessing ourselves and unable to think logical about a company's future. Two of my favorite companies are General Motors (GM) and Ford Motor Company (F). Both of these companies have lost more than 35% of its value over the last year despite higher sales and a strong sales forecast for the next three years. These stocks have fallen as a result of fear and our obsession with Europe or the events that may transpire in the coming months within Europe. And although Europe is a big piece of the puzzle for the auto industry its economy has been weak for quite some time yet the auto industry has continued to excel.
According to Buffett, if a business does well the stock will usually follow. I believe this quote to be correct and should be an important rule for all value investors to follow. Because regardless of how low the market drops as long as a company continues to fundamentally improve the fundamentals will eventually reflect through stock performance. And you can return very large gains by simply buying when the technicals push a stock lower and waiting for the fundamentals to reflect as gains.
"The business schools reward difficult complex behavior more than simple behavior, but simple behavior is more effective."
I have written on several occasions that I believe my greatest asset was choosing psychology as my field of study, rather than business. I always took business classes but earned both my undergraduate and graduate degrees in the field of psychology. I am thankful because of what Mr. Warren Buffett said in the above statement which basically means that investors are taught, or trained, while in college to completely dissect a company or invest with such great detail that common sense is lost in the process. In my opinion, Buffett is using the words "simple behavior" to replace "common sense" which is exactly what upper level business education classes try to replace with complex behavior, or formulas of investing.
“Beware of geeks bearing formulas.”
My theory on what Warren Buffett was saying during the "business school" comment above is proven to be somewhat accurate with the statement "Beware of geeks bearing formulas." Buffett has always been an investor who emphasizes on simplicity and common sense with a basic understanding of fundamentals and a good grasp on the state of the economy. Therefore, he warns investors of "geeks" or those who use their "knowledge" as a way of replacing the most important investment tool of all; common sense!
“I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years.”
The best way to explain this quote and relate it to investing in value is to use Buffett's investment in Bank of America (BAC). Now of course, there will be some to argue that the BofA investment was more of a publicity stunt and that he never would have bought into the company if not for the dividend, and other benefits. However, Buffett invested a large amount of cash, $5 billion, into a very volatile company.
At the time, and even now, there were many who called this investment ignorant or a mistake because of the questions surrounding the banking industry and more specifically Bank of America. These people will argue that future regulations will be too high for the company to remain profitable or that the company still faces several large lawsuits. However, as Buffett stated, he's not investing in tomorrow, or next month, he's buying on the assumption that the market could be closed and re-open in five years. And if that were to happen then it's very likely that Europe won't play such a large role in our markets and that BofA, which is trading at less than 35% of its book value per share, will be trading 3x higher according to its fundamentals. Buffett's had some good investments over the years and I believe that because of the undervalued money center banking industry that his investment in BofA may be one of his best yet, once the panic and fear within the market subsides.
My final Warren Buffett quote is "Wide diversification is only required when investors do not understand what they are doing." It simply means that you don't have to follow the leaders in order to be successful in the market. You can find your own way and your own strategy and be successful. Warren Buffett is an investor that we should all strive to imitate and attempt to learn as much as we possibly can about identifying and purchasing stocks when they present value.
Value is everywhere in this market, therefore I will conclude with a few stocks that you may want to consider in order to invest like Buffett. And with each of these stocks ask yourself if its loss is a result of fundamentals or if its derived from panic or fear within the market. And then finally ask yourself if the market were to close tomorrow would these stocks open higher or lower in five years?
- Regions Financial (RF) is a small regional bank that has fallen with the financial sector but has little or no exposure to sovereign debt along with significant fundamental improvements during the last four years. During its last quarter the company posted $155 million in net income compared to a loss of $155 million year-over-year; and improved its revenue by 45.90% during the same period. Because it's a small regional bank, with a market cap of just under $5.5 billion, the company has very little exposure to the economic concerns that have plagued the financial market over the last year. In my opinion, RF is a victim of association and has only traded lower because of it being a part of the financial sector along with its financial struggles in previous years. However, the company's much improved and trades with a remarkably strong debt-to-assets ratio and is well positioned for future growth with a significant amount of cash.
- Citigroup (C) has lost 34% of its value over the last six months and now trades at just 50% of its book value per share. Unlike Regions, Citigroup does face the harsh economic conditions of the global economy and its heavy exposure to European debt and the euro zone has created fear among investors causing the stock to decline. However, the question to ask is where will the stock trades in the next five years? I don't believe this is a good short-term investment because more volatile days are most likely ahead. However, as a long-term investment it's very possible that this company could return very large gains because the company's simply too large to fail.
- Corning (GLW) is widely considered to be one of the most innovating companies in the sector of technology. Yet it's lost 30% of its value over the last six months and trades at just 6x earnings after the demand of its display segment stalled with falling TV sales. However, the company's making its presence known as it shifts from TV's to phones and tablets; and has created a much stronger, yet clear, product: Gorilla Glass. Despite the struggles in its display segment the company grew revenue by nearly 30% during its most recent quarter. And has experienced incredible growth within its other segments which consist of new technologies to carry this company into the next era of Corning. Therefore, with such an encouraging future along with a solid past is it realistic to believe that this stock will continue to trade with such a low valuation?
- Caterpillar (CAT) has posted a 3 month gain of 33% yet still trade with a 13.50% loss during the last six months; and is trading at just 13.5x earnings. The company's growing remarkably fast despite several segments of the construction business lagging. A large reason for its 40% year-over-year growth has been its expansion into emerging markets which is just getting started. I believe the stock has substantial upside potential over the next five years because once the housing market recovers and people begin to build both residential and commercial property this stock will trade much higher.
- Apple (AAPL) hasn't traded lower during the last six months but it does trade under 15x earnings despite revenue growth of 40% and earnings growth of 53% year-over-year. Some have suggested that there are simply no more investors willing to buy shares in the company; or that its shares are too expensive. However, Google (GOOG) is growing at nearly half the rate of AAPL and is trading with a P/E ratio of nearly 23. Technology stocks tend to trade off momentum and I anticipate very large gains once the earnings for this company are announced for the upcoming year. Apple is expected to enter the TV space in 2012; some believe it will implement a dividend; it just broke its own records with sales of its new iPhone; and additional devices such as an iPad 3 are expecting to be released in 2012. Therefore the immediate future of AAPL along with the long-term future of AAPL appears promising. And I don't have any doubts that it will be trading much higher five years from today.
The five examples of value hardly scratch the surface of value that is present within the market. Because of strong selling there are many stocks that have fallen despite fundamental improvements because of speculation. I believe that now is the time to capitalize on the value within the market; and purchase stocks that have fallen but should be trading higher. You shouldn't take my word on it -- but rather read the words of wisdom from the most successful investor of our generation -- and I believe that your perspective will be changed which will result in much higher profits once you invest in value.