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ValuePicksOnly (76.37)

BE THE NEIGHBOUR!!! (Mr. Market and How To Handle Price Drops)

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February 07, 2008 – Comments (2) | RELATED TICKERS: AAPL

Every self respecting value investor should be familiar with the Mr. Market principle invented by Benjamin Graham. It's a fictional character who is synonym for the manic behaviour we find on the stock markets. One day he is extremely positive about the future and is willing to pay a lot of money for a share in a company, while the next day he might be pessimistic and wants to sell his share for a bargain price. This characteristic is contagious, but it is way more profitable if you can use these extremes to your advantage: buy when Mr. Market is pessimistic and sell when he is optimistic!

2 TYPES OF PRICE DROPS

If you look at the markets that way, you can to devide stock price drops in 2 categories: 1. price drops caused by manic, irrational behaviour and 2. price drops caused by fundamental changes of the company. It is important to be able to make these distinctions, because the first one can offer you a great buying moment, while the second type of pricedrop can change a business in a bad way.

SELLING STOCKS WHEN PRICES DROP

DO NOT DO THIS!!! Unless a type 2 price drop has occurred and the company's value has dropped significantly. This is why you should only buy good, stong and healthy company's at good prices. If you did that and a price drop occurs without some fundamental reasons, you should keep the stocks untill the price recovers and starts moving towards it's fair value.

I never quite understoot why people sell as soon as a price drops. Look at Apple (AAPL), which dropped 40% from it's high: bad stock price development: YES. Bad company: NO. The price drop of Apple is irrational and exaggerated, and this presents a good buying opportunity. 

SIMILIARITIES BETWEEN A HOUSE AND A STOCK

Let's say you just bought a house. After a lot of searching and researching you've finally found your dream house in which you intend to live for a long time. It's a solid house which is still in a good state. It has proven itself in the past by surviving many tropical storms. The current owners have always taken good care of the house and did everything they could to keep the house in tip-top shape. So, fundamentally this house looks great.

Now the only thing left is: which price am I willing to pay for this great house? After some more research and comparison you agree to buy the house for $400.000.-. You always want to be up to date with the latest news so you read the newspaper everyday before you go to work. Everyday when you arrive at your mailbox, your neighbour will be there too and everyday he tells you he wants to buy your house...peculiar little fellow.

The first day he is willing to pay you $350.000,-. You tell him:"no, thanks", get your newspaper and get on with your day. The next day the same thing happens, but now he is only willing to pay you $300.000,-. You frown once, wish him a good day and start eating your breakfast.

This keeps on going untill after 2 weeks he is only offering you a mere $100.000,-...AND YOU ACCEPT THE OFFER BECAUSE YOU ARE AFRAID THAT TOMORROW HE WILL OFFER YOU EVEN LESS!!!

Now doesn't that sounds crazy to you that you sell your $400.00,- house, in which you intended to live for a few years, after only 2 weeks for only a fraction of the price you bought it for?! Well this is exactly what happens on the stock markets!

IMPORTANCE OF A SOLID PORTFOLIO

If you've got a solid portfolio full of strong company's bought at good prices and an investment horizon of a few years, short-term market drops aren't a good time to sell your entire portfolio.

Those familiar with our "businesspartner" Mr. Market, know that stock prices tend to exaggerate in both directions. Using those exaggerations to your advantage can make you some serious return on your investment- although the absolute tops and bottoms can't be predicted.

After a huge market drop like we have seen in the past weeks/months, after the last houseowners have sold their house to their neighbours, there will be an opposite movement of prices; up, that is. One tip: BE THE NEIGHBOUR!!!

And they both walked back inside satisfied, after emptying their mailboxes, and started eating their breakfasts...

 

Disclaimer: I am not responsible for any losses of money or the like because of the usage of the above mentioned methods and tips. You hold full responsibility over your own actions. And I do not own stocks in the AAPL.

2 Comments – Post Your Own

#1) On February 07, 2008 at 11:27 AM, mickeyc21 (30.94) wrote:

Nice advice for normal times. We are not in normal times and the market has gone exactly sideways for the last 6-7 years and will do so for approximately the next six to seven years.

I do respect the patient buy and hold style but it is entirely innapropriate for the market (long term) that we are in.

The God of value investing Warren Buffett is on record recently (sorry don't have source - you'll have to do the research) as saying that stocks will have NO GROWTH for over a decade. Buffett is NOT buying on dips with very few exceptions. He is buying and flipping Chinese dot coms, trading currency and buying junk debt from railroads. He is not trading remotely like the cliche of the Warren Buffett trader. Wonder why? Think he might know something you don't? Absolutely he does.

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#2) On February 07, 2008 at 1:43 PM, ValuePicksOnly (76.37) wrote:

Thanks for your comment Mickey, but we have a difference in opinion at some points.

We are currently in perfectly normal times, although many will argue. Recessions are normal and even necessary in any economic cycle. OK; the subprime crisis isn't normal, but not every sector is affected by it. Crisis' like these, caused by 'bubbles', just happen once in a while. In 2001 we had the internet-bubble and now we have the subprime-bubble...A big bull market followed after the internet-bubble collapsed, I think you can learn a lot from the past...

And you say the market has gone sidesways the last few years?! Look at this S&P500 chart: It went from 800 to 1600 in 5 years, that's 100% gain in 5 years! I do not think you can call that a sideways movement...

And stocks will have no growth over the next decade? Well, if Buffett says so...But who cares?! There are company's trading far below what they are worth at the moment, even if you take into account 0% growth in the coming years! So there is still money to be made.

But I do agree that Buffett's strategy is changing. Not that that's something new, because it always has! He is trading far different now, then he did when Berkshire was just starting out. The ability to adapt his strategy to new circumstances is what makes him one of the best investors of all time. We should try do be as adaptive as he is, but there is nothing wrong to start out with a proven foundation.

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