In a recent article I wrote about how I am looking for REAL cheap stocks. By doing some minor searching I am finding a ton of bargains, but not real bargains that I would be conferable holding for a period of time. The reason I bring up the above Warren Buffett quote is due to mistakes I have made this year along with several bloggers. I believe this is one, if not, the main reasons investors under perform the markets.
If you have been following the blog throughout the year, I can easily slice the year in half and show the public two different ways of managing an investment portfolio.
1st half
The first half of the year was almost 100% automated with stocks chosen from the magic formula website. The only prerequisite that I required was that a company have a healthy balance sheet and some earnings. Sprinkle in a couple of non-magic formula stocks and WHALA! we have a portfolio that was ahead of the S&P 500 by a couple of percentage points.
2nd half
I had more time on my hands so I made a decision to move to a more researched and focused portfolio.Keep in mind this is at the exact time markets are selling off. I made big bets and lost big. I will go into details in another post, but to keep it short and simple, I made big bets and lost big.
WHY!!!!
Why did I lose big? The stocks appeared cheap. One of the lessons I have learned this year that will stick with me for the rest of my investment career can be best described by Warren Buffett’s obesity quote:
You don’t need to know if a person weights 250 or 400 pounds to see that they are fat- Warren Buffett
I see this happening all over the blogosphere. A blogger finds a stock, reads a couple of 10-Q’s, 10-K’s, conference call,etc… The blogger then does a DCF trying to pinpoint growth and discount rates. The stock plummets and then he/she is left scratching his/her head as to why the stock is falling considering the amount of analysis in the growth and discount rates used. The analysis and growth rates are sometimes right, but sometimes if one in fact looks up and away from the DCF models, one will notice the stock is indeed a fat pitch or not. Below Batman and Robin explain what I mean.
Charlie Munger (Berkshire Hathaway’s vice chairman) said, “Warren talks about these discounted cash flows. I’ve never seen him do one.”
“It’s true,” replied Buffett. “If (the value of a company) doesn’t just scream out at you, it’s too close.”
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Very true. I can also boast that I’ve made some pretty stupid decisions with companies that appeared cheap but were really value traps.
Conversely, the companies that were truly truly cheap, I missed out because I was thinking it wasn’t cheap enough.
It’s also funny how the companies that are not cheap with my DCF calculations are actually the ones that are the cheapest and with the best prospects.
Very insightful points…I also agree that DCF and value stock analysis has its traps. I discovered that in this depressed economy that lots of stocks are cheap by price ratios, but many are companies that have their current assets overvalued. For example, commodities companies that have inventory that is no longer worth as much as when their book value was calculated in the past. Another wrinkle in the equation is when earning estimates are too high, and were not appropriately decreased, thus giving the illusion of a low P/E ratio. Essentially, it does not matter how much a company’s assets are worth, if because of the down economy, there is no demand for their products.
It show just how much influence Graham had on Buffett. That saying was a variation of what Graham said in Security Analysis.
“To use a homely simile, it is quite possible to decide by inspection that a woman is old enough to vote without knowing her age or a an is heavier than he should be without knowing his exact weight”