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MarketWise, July 28, 2002 by Will W. Woodard, III Finding Value in an Oversold Market "It's not until the tide goes out that you discover who's been swimming naked" – Warren Buffet Warren Buffett is one of my heroes. The billionaire investor, chairman of Berkshire Hathaway (NYSE: BRKA, BRKB) and spiritual leader of a group of investors that encompass some of the money management world's true greats, is plain-spoken, frugal, understated--a real "underpromise and overdeliver" type of guy. The wisdom of his perspective has allowed me more than a few "A-Hah" moments. When "the Oracle of Omaha", as Buffett is known, made the above comment, he was addressing the pitfalls of using margin leverage (borrowing to increase purchasing ability) in the stock market, but his words ring true throughout the free-enterprise universe. Especially-relevant insight, I feel, can be applied to current US equity market conditions. At its heart, a free enterprise society's markets will match supply with demand as efficiently as the flow of capital will allow. The decade of the 1990's was a period of especially robust demand within the US economy, so throughout the world supply was created to meet the demand. Supply finally caught up to and passed demand--thanks in part to a series of interest-rate hikes by Chairman Alan Greenspan's Federal Reserve Board Open Markets Committee. The rate hikes squeezed the flow of capital in an attempt to minimize the possibility of inflation, and it worked--but it threw the US economy into recession, too. An unintended consequence of the recession and economic slowdown, however, is that demand still has to catch back up with supply, or, alternatively, the economy must work off the accumulated oversupply and adjust to lower demand going forward. Either of those scenarios may take some time to accomplish, and the equity markets, driven by corporate earnings, may tend to lag while that process occurs. Mr. Buffett's observation has been furthered by the explosion of a market bubble in telecommunications and technology. In a nutshell, the boom times sucked in a lot of investment capital, and that capital was put to work in high-quality (and not so high-quality) ventures of all types throughout the burgeoning high-tech economy. When the organic growth of those ventures slowed due to lagging demand, accumulated oversupply, a slowdown in business capital expenditures, and worries about a recession, many debt-laden companies were caught by surprise. Some resorted to increasingly-deceptive accounting in an attempt to keep the good times (and the earnings growth, and the stock's share price)going. That is why there are a few notably-visible corporate derrieres on the stock pages these days, exposed by greed, doubt, and the historic low tide of a two and one-half year-long bear market. None of this should really surprise us as investors. As long as there has been free enterprise there will be those that push the system, venturing further and further out on the risk-continuum tree branch in search of return. Some will inevitably go too far. The market has decided to speed up the matter of sorting out the details by punishing the stock price of any company that it perceives to have taken undue risk, whether the company actually TOOK the risk or not. (Never mind that the market historically rewards prudent risk-taking behavior!) This makes for unsettling times, but (here's where it gets good) the uncertainty also creates significant opportunity. As a contrarian, a value investor, and someone who loves buying things when they're on sale, I am getting excited. Everywhere you read it's "doom gloom world coming to an end" stuff. Nobody wants anything to do with stocks--it's all real estate, or gold, or the Euro, or (fill in the blank of current hot investment idea). Now, I'm all for diversification across asset classes--in fact, it is one of the hallmarks of prudent investment management--but, let me tell you, friends--chasing the hot sector is a sure way to pay too much. When nobody wants anything to do with an asset class (like stocks as of late July) smart investors are going to be doing some sniffing around. Like your parents said, (pun intended) stock up when things are on sale! In the current market environment, thought, it's not quite as easy as picking up the Seamark flyer and knowing you need ribeyes. Here are some guidelines that can help your search for an appropriate investment buy: 1. Know what you need: Take inventory of your current portfolio. Are you adequately diversified? Fashion a "watch list" of stocks or funds in sectors that are appropriate for your situation but not currently represented in your holdings. Focus on leadership and expense management, and avoid the current "hot" investment idea. 2. Decide on your investing time frame, and set sell points if appropriate: Are you buying for the long haul or making a trading purchase? If it's a long-term buy, you may be willing to ride out a price drop. Trading plays, on the other hand, should have pre-determined sell points. 3. Buy quality: This is not the time to be buying the weak sister in a sector. Focus on only the best--the best-capitalized, the best managed, the companies with a sustainable competitive advantage. 4. Average in to your positions: Once you've identified a likely company or mutual fund, don't just throw all of your available capital at it. Spread out your buys over a period of weeks or months. Dollar-cost averaging, as this is known, will help to protect you from buying too high, as you'll automatically purchase more shares when the per-share price is down. 5. Use charts: Technical analysis (TA) is the use of price/volume charts to help identify and interpret market behavior. Professional money management firms take TA very seriously, and its application can add significant value to the investment portfolio management process. I use technical analysis in conjunction with fundamental equity and market analysis to identify market trends and target appropriate buy and sell points for a stock, index, or sector. 6. Get an impartial second opinion: If you're not sure of what your portfolio should look like and/or would really rather not worry about it, consider getting some help. Talk to a fee-only financial advisor, (disclosure: that's me!) evaluate your goals and risk tolerance, and develop a plan. A fee-only advisor will not be swayed by commission payouts and will be able to look at your situation without bias. There are several excellent Internet sites (disclosure: I am a member of all of these organizations) that offer guidelines for selecting a financial advisor including the Financial Planning Association ( www.fpanet.org ) , the Motley Fool ( www.fool.com ) and The American Association of Individual Investors ( www.aaii.com) (subscription site) Specifically, the AAII offers a very good worksheet for selecting an advisor or planner; email me at will@darecapital.com and I'll send you a copy. Good investing, Speaking of charts, let's look at the three major indices:
Will W. Woodard, III, CFP® "Clients and Friends Newsletter" is published monthly by Dare Capital Management and is free of charge. To subscribe, send your email address to will@darecapital.com and put "subscribe newsletter" in the subject line. All of the foregoing is commentary for informational purposes only. All statements and expressions are the opinion of Will W. Woodard, III and Dare Capital Management and Advisory, and are not meant to be a solicitation or recommendation to buy, sell, or hold securities. Dare Capital Management and Advisory is registered in the State of North Carolina as a Registered Investment Advisor Firm. The information presented herein and the company's web site has been obtained from sources believed to be reliable, but its accuracy is not guaranteed. The security portfolio of Dare Capital Management and Advisory may, in some instances, include securities mentioned herein and/or on the company's web site. Positions in securities mentioned will be disclosed at the time of publication and may be subject to change at any time without further notice. Estimates, assumptions and other forward-looking information are subject to the limits of forecasting. Actual future results may vary for many reasons. |
