A particular Warren Buffett quote reminds me that doing nothing is good:

“”I call investing the greatest business in the world because you never have to swing. You stand at the plate, the pitcher throws you General Motors at 47! U.S. Steel at 39! and nobody calls a strike on you. There’s no penalty except opportunity lost. All day you wait for the pitch you like; then when the fielders are asleep, you step up and hit it.”-Warren Buffett

With 14% cash on hand, its tempting to get into some positions. Especially Microsoft which has been climbing the magic formula list this past week as it hits new lows. I continue to tell everyone I know that the magic formula has to be among the most undervalued books/sites/investing system around. Where else can I find a screen that looks for great businesses at a discount. Its only a matter of being patient and sticking with the system. For many years studies have proven that low P/E’s outperform the market, but investors/speculators continue to invest in companies that are trading at sometimes catastrophic P/E’s. Companies with high P/E’s are usually dangerous in this type of market as analysts expect companies to deliver outstanding numbers. What happens next? The company delivers great numbers (usually double digit growth ) but the stock gets pummeled (i.e. AAPL, GOOG,MSFT). How do low P/E’s fare during earnings season? Good. David Dreman highlights this in the book. Expectations for these companies are so low, no matter what kind of numbers the company reports, chances are a) a positive earnings surprise will make the stock soar (WFC)  or b) the news has been priced in already.

To keep from falling under the same frame of mind, I have decided to reinforce the idea that right now is the time to be patient, look for opportunities and not panic. To keep busy, I am re-reading the contrarian investing bible. The book might have collected a little dust, but the information is in a league of its own.

A common question among value investors is whether The Intelligent Investor and Security Analysis are worth reading? This question stems from the idea that both books have the perception of being “dated” and thus the information is irrelevant. Many of the companies mentioned in both books might not exist today, but the content on investments and investor behavior are relevant today as when they were first written. In fact, its scary to see how not much has changed in terms of Mr.Market and his wild mood swings. Since I do not have time to re-read The Intelligent Investor, I have spent my time reading  the two most important chapters in value investing, Chapters 8 and 20 of The Intelligent Investor.

What Warren Buffett has to say about the two chapters:

“If you follow the behavioral and business principles that Graham advocates- and if you pay special attention to the invaluable advice in Chapters 8 and 20- you will not get a poor result from your investments.” -Warren Buffett

Chapter 8 – The Investor and Market Fluctuations

“Every investor who owns common stocks must expect to see them fluctuate in value over the years”- p.195

“If he is the right kind of investor he will take added satisfaction from the thought that his operations are exactly opposite from those of the crowd” p.197 (early signs of contrarian investing)

“The investor who permits himself to be stampeded or unduly worried by unjustified market declines in his holdings is perversely transforming his basic advantage into a basic disadvantage.That man, would be better off if his stocks had no market quotation at all, for he would then be spared the mental anguish caused him by other person’s mistakes of judgment.”- p. 203

“Let us close this section with something in the nature of parable. Imagine that in some private business you own a small shares that cost you $1,00. One of your partners, named Mr. Market, is very obliging indeed. Every day he tells you what he thinks your interest is worth and furthermore offers either to buy you out or to sell you an additional interest on that basis. Sometimes his idea of value appears plausible and justified by business developments and prospects as you know them. Often, on the other hand, Mr. Market lets his enthusiasm or his fears run away with him, and the value he proposes seems to you a little short of silly.” -p 205

Chapter 20- “Margin of Safety” as the Central Concept of Investment

” We say that to have a true investment there must be present a true margin of safety. And a true margin of safety is one that can be demonstrated by figures, by persuasive reasoning, and by reference to a body of actual experience”  p.520

“Investment is most intelligent when it is most businesslike“- p.523

“To achieve satisfactory investment results is easier than most people realize; to achieve superior results is harder than it looks.”- p.524

Obviously, the quotes above are only a small sample of the brilliance of Graham’s writings. I could easily pull 20 quotes from each chapter. I highly suggest re-reading the two chapters to see how relevant the information is today as they were back when Benjamin Graham wrote them.Finally, the above  page numbers are from Jason Zweig’s edition of The Intelligent Investor.

First the link: Francis Chou
The article brings up an interesting point, a good amount of value investors are lagging the market. The first person that comes to mind is Bill Miller and I believe he is down 19%. Ouch. According to their first quarter shareholder letter, Dodge and Cox is down almost 12% (S&P 500 was down a little over 9%). There are various other value firms who are under performing the market. Have they lost their touch or is it a sign of the times? I believe it’s the latter. One thing about contrarian-value investors is we are usually early to the party and leave early as well. We hate crowds.Just about every “guru” underestimated the magnitude of the housing/credit crisis and their performance reflects it. Mohnish Pabrai and Bill Miller come to mind.

Value investing is a proven strategy that will continue to work in the future. Unfortunately, many of the value investors missed the commodity train and are lagging. In the 90’s, most value investors avoided technology and lagged behind growth and technology funds. Now, not only did they miss the commodity boom, but were early in financials. A double whammy. So what now? Start cherry picking bargains. As the article states, just about every retail business is undervalued. As a matter of fact, Chou mentions Office Depot. Sounds familiar? Not to brag but…… I I wrote about Office Depot wayyyy back on February 24. Anyone reading this blog at the time could have researched the company, watch the stock plummet 20% after “worst than expected earnings”, and buy the stock at $10.xx. The stock is still a bargain and any positive comment made about the economy will push the stock higher.

A particular quote by Chou caught my attention in which he states:

“Look at our long-term record. We have always bounced back.”

Value Investing always bounces back. America always bounces back. It is a matter of being patient and ignoring the current headlines. Andrewc left an interesting comment on a recent post (Gurus Loading Up On Healthcare Stocks) in which he states:

I like seeing how the “gurus” picks are completely different than what the media is buzzing about. All last summer the funds managers were guying natural gas when the talking heads said that was dead money. Now, with gas prices going through the roof and TV programs talking constantly about rising oil prices, you see very few new positions in the energy. They don’t follow the momentum- they already had there positions and are enjoying big profits. And while CNBC and others hype up CHK and others, the gurus quietly move to others areas of value, like Healthcare. Watching when the experts enter and exit positions keep me from getting caught in the herd.

In summary, that’s what contrarian-value investing is all about.
1. Go against the crowd.
2. Wait for crowd to realize they made a mistake
3. Sell to crowd at a significantly higher price

As stated in my response, years from now CNBC will be flashing headlines dealing with financials and retailers. As usual, here is a classic Ben Graham quote that helps out when the headlines news is causing doubt in security analyses

“You are neither right nor wrong because the crowd disagrees with you. You are right because your data and reasoning are right.”

One common characteristic of successful value investors is they take advantage of the lower stock price and increase their position(s). On the other hand, many investors will do the opposite and sell. Truth is, the stock market is a volatile animal. In a given month, a stock’s price can move up dramatically. But, it can also go down dramatically. A perfect example of how fast a stock can move is Office Depot (ODP). When I wrote about Office Depot, every consumer company was taking a beating as economists and analysts expected a slowdown in the economy. As a result, the whole office supplies industry, which primarily consists of Staples, Office Max, and Office Depot were depressed and hit the 52 week low list. Office Depot also landed on the Magic Formula List for stocks with a market cap over 2 billion. I wrote about Office Depot when the stock was trading at $13 and change. Soon after, the company reported earnings that fell short of analyst expectations and the stock tumbled about 20% to $10.XX. Talk about timing.

At this point in time, I could have written some lame excuse about how Office Depot has become a sell and avoid the stock at all costs. But, those who know me know that will never happen. The beauty about contrarian investing is even if a company reports horrible earnings it is a win win situation. Assuming the company reports a worst than expected quarter much of that bad news will be priced into the stock. On the other hand, if a company has a positive earnings surprise; you will see a nice pop. This was the case with Office Depot. In a matter of 2-3 weeks the stock has moved up more than 25% despite reporting declining revenue. Not bad eh? Anyone can gloat and feel like a genius when a stock is up, but can one watch their stocks go down 20% and not panic. In my opinion that is what separates the elite from the average.

Finally, a couple of years ago I found an interesting quote on volatility by Peter Lynch. I memorized it for situations like this. Who knows? It might help someone out one day.

When stocks are attractive, you buy them. Sure, they can go lower. I’ve bought stocks at $12 that went to $2, but then they later went to $30. You just don’t know when you can find the bottom. – Peter Lynch

Readers of this blog will notice that a couple of picks of mine have been in the dog house, while others have performed well in a choppy market. Unfortunately, for the casual web surfer who stumbles onto here, they will focus more on the stocks that have been down.More…