I will often be asked: “Why should I spend six years to make my money when I can buy small stock X that went up 432% last week, or buy Apple which zooms up from time to time, and be done with it?”
There are a lot of ways to make money in the stock market. Everyone finds a way that suits their temperament, their tolerance for risk, and their adrenaline level. Beyond that though, I have to ask you: How much are you willing to pay for nothing.
Any time that you buy a stock in excess of its fair market value, that is what you are buying.
All stocks have a fair market value. The calculation of it can vary a bit, but it basically is what the company is worth between what it owns, has in cash on hand, and what it owes. Take all the profits losses, assets and liabilities and divide by the number of shareholders, and that’s what the company is worth at the end of the day.
This is the core of any stock’s financial gravity. Stock prices orbit around that gravity. When they get too high or too low, market forces, usually value vultures on the low end and speculators shorting the price of the stock on the high end.
Any time that a stock passes its fair market value, if you buy at that price, you are buying a bet that the fair market value of the stock will grow into your stock price. The person selling it to you is selling it at a premium, because they are making a bit of money off of your desire to hold that stock at a premium.
The space between the fair market value and the premium that you pay, though is just speculative air. This is where companies and balloons have something in common: When you let the air out, they drop like rocks.
Take Apple. Great company. Heavily traded. Billions in cash in the bank in reserves. I wouldn’t touch it with a 10 foot pole at the prices that it has been it, because they’re always in excess of the company’s fair market value. It trades on emotion, and people’s appreciation for the product, not the appreciation of its value. It has had an incredible run, but it is also based on the cult of one person: Steve Jobs. If he becomes sick or dies, this is not a Berkshire-Hathaway where they can reach down and pull up someone with the showmanship skills as well as the technological and social savvy.
There are large substantial companies that take a beating from investors and then are left bleeding on the sidelines. McDonalds hit it during the mad-cow era, even though they didn’t suffer from mad cow disease. Coca-Cola had management issues that caused a run out of their stock for a few years. Neither of these companies was on the verge of going out of business, but both offered huge, sheltered upside. When the golden arches were trading for 20-22% below their fair market value, your real minimum upside was at least 20-22% return if you bought at those levels.
Because we know that greed always tends to overheat stocks to greater than their intrinsic values, because investors join the wave late, the real upside brought the stock back to previous levels about 20-30% over fair market value, providing you with a 65% return.
Now, because I’m not a huge believer in the rapid growth that we’ve seen in years past, you also have a dividend paid out by these companies as they heal, which can add anywhere between 2% to another 7-9% to your upside.
Sparrows soaring through their day trades and their momentum plays like to tell you that we value vultures don’t make the kind of big money that they do.
I would point you to XEC, which, if purchased at the bottom of the barrel in the 2008/2009 melt-down, is up 168%. Most of the stocks in non-banking areas purchased in that down cycle more than doubled. The bank stocks, which still have rabies and black plague to most investors, are, ironically, though, the first sector to heal itself quicker. Once confidence levels improve in their information stream, those stocks will also see a rebound from the bottom that is profound.
These turn-arounds are not in hours or days, but weeks and even years. Still, when you receive dividend payouts and appreciation, and you can average 16-20% a year over the life of that investment, or even just 8-10% in some cases, you’re still growing steadily, with far lower risk than our sparrow friends encounter.
That’s why patience pays.
The Genius Guide to Value Investing 