The three most important words in investing

Reported by Bruce Jackson, The Motley Fool.
Tuesday, September 13, 2011
Topics in this article:
Asx,Cochlear,Csl,Fortescue Metals ,Karoon Gas Australia,Lynas Corporation,Mesoblast Limited

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Mark BourisMyths bustedHome loans can seem a bit complicated and overwhelming. But it doesn't have to be. Mark Bouris clears up some common misconceptions.

Stay firm. Don’t let volatile share markets shake you off course, writes The Motley Fool.

Aren’t you glad you slept through this?

It’s the chart of the S&P 500 in the U.S. overnight Monday.

The extreme share market volatility continues unabated. After slumping another 1.6%, the S&P 500 recovered in the last 90 minutes of trade to close up 0.7%.

The VIX index, otherwise known as the fear index, hit 43, before closing flat at 38.6. During most periods of crisis, the VIX has peaked somewhere in the 30s or 40s.

Ten years ago, in September 2001, it hit 44. In November 2008, it climbed as high as 81 (that’s extremely unusual) before quickly declining. In calmer times, it reverts to the teens. The VIX has only spent 3% of its time above 40 over the past two decades, and its average has been just 19.

Long stocks

It looks like a good time to be short volatility. Or in other words, long on stocks.

But you’ve heard that before from The Motley Fool. You’ve probably heard it so much now you’re immune to the message.

We won’t apologise for being repetitive. Perhaps it’s sinking in. At least some people seem to appreciate our message. We recently received this email from Belinda…

I just found your website, and it was completely refreshing.

I get so depressed reading the papers these days; it was nice to see some common sense in your ironic company name.

As a financial planner myself, sometimes it’s hard to remain confident when you’re telling people now is a good time to invest. The psychological hurdle seems to be a big one!

Thanks, Belinda.

If you want doom and gloom, you’ve come to the wrong place.

That said, don’t get us wrong. We are optimists. But we’re also realists. We realise the global economy, and particularly Europe, has some challenging times ahead.

Europe on the brink

Greece remains on the brink of default, something that could have ripple effects through the entire European banking sector. And if you thought that was bad, don’t even think about what could happen if Italy can’t raise 14.5 billion euros of debt scheduled for repayment on September 15 – just 2 days away, and counting.

Still, that’s a drop in the ocean compared to the 1.9 trillion euros of debt — more than Spain, Greece, Ireland and Portugal combined — Italy is laden down with.

No wonder then Wilson Asset Management portfolio manager Chris Stott says in the Australian Financial Review

“Clearly, global macroeconomic matters are going to dominate over the next few months. I am expecting a tough period for stocks, and (the Australian share market) will definitely test the lows of 3750 again.”

Wow.

“Definitely” is such a definitive word.

Clueless, and comfortable

You’re unlikely to see The Motley Fool use such language. We’re not fence-sitters, but when it comes to predicting the movements of the markets, we’re clueless.

Instead, we focus on finding the best ASX shares trading on the share market. Investing nirvana is being able to buy great companies when they are cheap. And if the S&P/ASX 200 does slump back to 3750, we’d likely be staring at a whole host of opportunities.

The three most important words in investing

Mind you, yesterday’s voluntary product recall from Cochlear (ASX: COH), “the most reliable” maker of hearing devices, proves investing is no walk in the park. One of Australia’s few truly world class companies, Cochlear now faces a major battle to re-build its reputation. Expect sales, and profits, to suffer, in the near-term at least.

These ‘left-field’ events are virtually impossible to predict. Still, investors in Cochlear are suffering, the shares plummeting 20% yesterday.

Their mistake? It can be summed up in 3 words…

“Margin of safety.” Warren Buffett calls them “the three most important words in all of investing.”

Based on its growth prospects, Cochlear had been trading on a price to earnings ratio of over 20. At such a relatively pricey valuation, it left little room for error, whether that be a revenue miss, an earnings miss, or a left-field event, like a product recall.

No sure thing

In investing, nothing is a sure thing. Even the most astute investor can get burned by the market’s whims, or by the unexpected. A satisfactory margin of safety gives you the next best thing, and a value investor always demands it from his or her investments.

Unfortunately, it will likely take some time for Cochlear’s shares to recover. This is no quick-fix situation. Often share price falls like this are recovered gradually, not in a hurry. And also, we wouldn’t be surprised to see the shares drift lower in the weeks and months ahead. Buyers today may be able to pick up a world-class company at a reasonable price, but shouldn’t expect near-term fireworks.

Crazy cheap

Speaking of margin of safety, Motley Fool Investment Analyst Dean Morel has discovered a small tech stock trading at a crazy cheap price.

We like ferreting about in the small-cap space, where solid companies with decent growth prospects are simply ignored or over-looked. You may not find the next CSL (ASX: CSL), Fortescue Metals Group (ASX: FMG), Lynas Corp (ASX: LYC), Mesoblast (ASX: MSB) or Karoon Gas (ASX: KAR), but you will find some hidden gems that could turbo charge your portfolio.

If you are looking for more small-cap investing ideas, check out The Motley Fool’s new report 2 Safe Ways To Play The Commodities Boom. Click here to request your free copy today.

26/07/2014 17:07Sydney, Australia. 26 July,2014
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