Here’s a great article by Gary Smith at MarketWatch. Smith, the author of “Money Machine: The Surprisingly Simple Power of Value Investing” illustrates how market volatility provides great opportunities for value investors saying:
“In fact, stock market volatility is a value investor’s best friend. Stock prices fluctuate far more than justified by the underlying fundamentals, in that the volatility of stock prices is much larger than the volatility of the dividends, earnings, and cash flow that determine the intrinsic value of stocks. This is not a problem for value investors — it’s an opportunity. If stock prices didn’t fluctuate wildly, investors would not be able to buy stocks at bargain prices and sell stocks at inflated prices.”
Here’s an except from that article:
The stock market is down. Now it’s up. Now it’s down again. Prices are zigging and zagging and volatility indexes are surging. Is it time to push the eject button?
Many are saying this bull market is over. It was fun while it lasted, but now investors should bail out. Sell everything, even if means paying large capital gains taxes, because stock prices may drop lower — much lower.
After last Monday’s rout, a friend told me: “I’m going to sell all my stocks, I can’t afford to lose any more money. I’ll get back in when the market recovers.” He is not alone. It is hard to control desire and emotion. Humans, being human, trade too much, trust hot tips, chase trends, and are caught up in speculative bubbles and fearful panics — buying after stock prices rise and selling after they fall.
‘The market will go up and it will go down, but not necessarily in that order.’
J.P. Morgan
J. P. Morgan once said that, “The market will go up and it will go down, but not necessarily in that order.” Yep. We all know that stock prices fluctuate, sometimes by small amounts and, other times, by large amounts, but nobody knows the size and timing of these oscillations in advance. That is precisely why value investing is so powerful. It doesn’t depend on predictions about price fluctuations.
In fact, stock market volatility is a value investor’s best friend. Stock prices fluctuate far more than justified by the underlying fundamentals, in that the volatility of stock prices is much larger than the volatility of the dividends, earnings, and cash flow that determine the intrinsic value of stocks. This is not a problem for value investors — it’s an opportunity. If stock prices didn’t fluctuate wildly, investors would not be able to buy stocks at bargain prices and sell stocks at inflated prices.
My friend’s strategy of selling after prices fall and buying back after prices recover is backwards. All that short-sighted plan does is lock in losses. Someone who sells after a drop and buys back after the recovery guarantees that they sell low and buy high. If you own a stock that has a price of $100, sell when the price drops to $80, and buy it back when the price returns to $100, you’re out $20 a share. Unless you know that the price will never, ever go back to $100, it is better to hold on to the stock than to sell at $80.
The same is true of the stock market as a whole. Getting out after the market drops and getting in after that market recovers is a really bad idea unless you are certain that the market will never recover.
In May 1932, with stock prices at their lowest level in this century, Dean Witter sent this memo to his company’s brokers and management: “All of our customers with money must some day put it to work — into some revenue-producing investment. Why not invest it now, when securities are cheap? Some people want to wait for a clearer view of the future. But when the future is clear, the present bargains will have vanished. In fact, does anyone think that today’s prices will prevail once full confidence has been restored?”
Bargains are not going to be found when investors are optimistic, but when they are pessimistic. In Warren Buffett memorable words: “Be fearful when others are greedy and greedy when others are fearful.” For value investors, volatility is our friend.
To be sure, the current market environment does not offer a buying opportunity of a lifetime, like in September 2002 or February 2009. But now is a good time to be in the market, because stocks are likely to be a profitable investment over the long run.
The U.S. political situation is a mess, but the country’s economy is doing just fine. The unemployment rate is 4.1% and the rate of inflation is under 2%. Thirty-year Treasuries TMUBMUSD30Y, +1.53% yield 3.1% while the 10-year Treasury TMUBMUSD10Y, +1.27% yields 2.8%. The S&P 500 SPX, +1.49% dividend yield is just over 1.8%. This is still a wonderful time to be a stockholder.
Even if dividends only grow by slightly more than 1% a year, stockholders will do better than bondholders in the long run. If dividends grow at their historical 5% rate, stockholders will clobber bondholders. An investment of $100,000 in bonds earning 3% annually will grow to $134,000 after 10 years and $181,000 after 20 years, while an investment of $100,000 in stocks earning 7% a year will be worth $197,000 after 10 years and $387,000 after 20 years.
You and I don’t know what stock prices are going to be tomorrow, or next week, or next month, but we can say with great confidence that the U. S. economy will grow bigger and much stronger over the next decade. Stock prices, accordingly, will be much higher then — and investors who stayed invested and reinvested dividends will be glad they did.
Gary Smith is the Fletcher Jones Professor of Economics at Pomona College and author of “Money Machine: The Surprisingly Simple Power of Value Investing.” (AMACOM, 2017)
You can read the full article at MarketWatch here.
For all the latest news and podcasts, join our free newsletter here.
Don’t forget to check out our FREE Large Cap 1000 – Stock Screener, here at The Acquirer’s Multiple:
