The Right Time To Root For Lower Stock Prices

 |  Includes: BDX, BRK.B, IBM, JNJ, KO, PG
by: Tim McAleenan Jr.

Warren Buffett set off an interesting side debate about long-term investors in his recent letter to shareholders of Berkshire Hathaway (BRK.B) stock when he mentioned that he will be "rooting" for the share price of his IBM (IBM) investment to go down while the company engages in significant share buybacks over the coming years. Since announcing this, many investors have debated whether or not it is proper to "root for" the stock price of their investments to decrease in value. While how we "root" for our investments probably will not affect their performance, it does inform our general approach to investing that comes to define our investing philosophy.

First of all, I can say that I agree with Buffett's comment 100%. If I am in the accumulation stage for a particular investment, I would absolutely love nothing more than to see its share price decline. Why can I say that with such confidence? Because I have one clear thought that drives my approach to long-term investing: I want to buy the greatest amount of future look-through profits at the lowest possible risk-adjusted price. For instance, I'm looking at establishing a DRIP account with Becton Dickinson (BDX) in the near future so that I can build up a growing position in the medical device giant. Right now, I find the price very attractive at $75 per share, and each share represents $5.47 in earnings. I'd love it if the price fell to $70. I'd get to lay claim to the same amount of earnings for a lower price. That excites me. As long as I'm a net buyer of a company, I want to pay as low of a price as possible for each share of the stock.

Now I do want to issue one important caveat: Not all share price declines are equal. For instance, let's say that I bought 100 shares of Johnson & Johnson (JNJ) stock at $64 per share. Right now, each share represents about $3.48 in annual earnings. If the share price falls to $50 due to the finicky emotions of investors, then that's great. I'm going to love the share price decline, and add to the position so that I can fulfill my goal of buying the largest amount of future profits for the lowest price. But- and this is the crucial part- if the share price declines due to the deterioration of earnings and fundamentals, then I am not excited about the share price decline at all. In fact, I'd quickly be approaching "I-just-made-a-bad-investment" territory. If Johnson & Johnson falls to $50 per share because Tylenol is getting destroyed by competition and it only looks like the company is going to generate $2.00 in annual earnings for the next five years, then the share price decline spells bad news for my investment. This distinction plays a large role in whether to "root for" price declines or not.

When the conditions are right, seeing a falling share price for blue-chip superstars like Coca-Cola (KO) and Procter & Gamble (PG) is great news for investors. That's because it provides the opportunity to buy a greater amount of future profits in companies that have very high earnings quality. And that's why it's important to look at our goals to determine how we choose to interact with the market. If we plan on adding to a position and the share price falls without any corresponding deterioration in the fundamentals or our general thesis statement about the company, then we should thank Mr. Market for the opportunity to buy shares of a company that we want (at a better price than we originally bought it) or at the very least, enjoy the benefits of more favorable dividend reinvestment if applicable.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.