Buying Stocks in a Flourishing (Dangerous) Market
Nothing "erks" me more, as an investor in individual stocks, than times when everyone feels like a star investor. Given the stock market's run over the past 6-12 months, just about anyone could close their eyes, through a dart at a board full of stock ticker symbols, and end up with a winning portfolio. Of course, it is difficult to deny the pleasure of checking your stock portfolio and seeing an abundance of the color green. For me, however, despite the initial giddiness of seeing green, this also raises questions.
There is a fine line, when considering buying stocks, between maintaining caution with a value investment approach and being so overly cautious that great opportunities fly on by. Recently I was interested in pulling the trigger to buy an entry position in Yahoo!, but was teetering back and forth; when the market seems to be doing so well that nearly everything is reaching new highs, I immediately become cautious. In the case of Yahoo!, I missed out at a purchase price of $27-$29, with the stock now above $34 within a relatively short period of time. While this can be frustrating, if you are more concerned over the price of a stock rather than confidence in the condition and fundamentals of the business, it is probably a good sign to hold off buying a stock.
The important thing for long-term investors to remember is this: a sound business is a sound business. Short-term price swings will usually mean very little in the grand scheme of things. For instance, I would have been wise to hold all of the Netflix position I purchased in 2007. Today I can hardly recall what were then dramatic 10%-20% price swings that occurred around Netflix's earnings reports. An individual investor today, however, would now appreciate holding Netflix through the volatility whether or not they purchased the stock at $19 or $23 in 2007.
In the short-term a 20% price swing can be difficult to stomach, just as it can be dreary to hold a stock that doesn't seem to be doing much of anything over the period of a few years. Sometimes we can forget that no stock is detached from a business; every stock represents ownership in a business. In order to maintain a consistent perspective, especially in times of questionable or volatile short-term movements in the market (which occur quite often), it can be helpful to treat each investment as a business, not just a stock. A simple but important distinction, at least for me.
Of course, long-term investors should not completely ignore the movements of the market or the price of stocks. A helpful approach in today's market, when many stocks are at all-time highs and you have a leery purchase finger, can be to purchase smaller entry positions in businesses with sound fundamentals, a strong management team, and other positive attributes in key areas. Start building or expanding your portfolio with small and attainable entry positions. Tom Engle (TMF1000) teaches this approach, which is a simple tool to build a diversified portfolio of strong businesses regardless of where the market's short-term irrationality might be placed.
My investment experience, which is reaching its ninth year since I started investing when I was twelve years old, is still relatively limited. Reflecting on my investment decisions has confirmed much of the above for me. Too often I let short-term volatility (in either direction), rather than focused concentration on the business fundamentals, dictate my investment decisions. Over the long-term, short-term volatility does not mean a whole lot. I don't hear of many people fretting over whether they invested in Coca-Cola in 1950 or 1951. In the end, business fundamentals are what count.
Just some musings on a Monday evening...