Process Is More Important Than Ever!

Date Added: January 23, 2019 | Comments Off on Process Is More Important Than Ever! | Filed under: Blog

All the past year we had been waiting for share prices to finally reflect the physical reality of the underlying business they represent given in some cases the continuing improvement and in others the excessive optimism in that physical reality.

At year end we found ourselves not only still waiting but also having to witness a general market correction primarily precipitated by the U.S. administration.

In my experience when the market corrects one of two things happens with the smaller less liquid esoteric type companies that we favour: – either market participants pass right over them in their desire to find liquidity and their prices are left pretty much unscathed, OR – relatively small selling has a big impact on their prices (especially if insiders hold most of the stock). I have seen both. I recall owning stocks like Loewen Group that didn’t flinch at all in the so called “Black Monday” market correction of October, 1987. But in 2018 we mostly saw the latter – perhaps because the corrective action has been less acute and dragged on.

It is an often-quoted fact that if a security falls by say 50% in price, it requires a subsequent 100% gain in order to simply break even. If the mark-down is market-related rather than due to adverse company news, an investor selling such a security at that time adds a new risk to his capital: the marked-down security has to be replaced by another security with +100% potential in order to break even. In trying to do so and given the magnitude of the challenge, this investor will often be tempted to gamble on what is currently said to be the “most attractive” or “most promising” investments – unfortunately investments usually already over-priced. This could well add a second risk: a security purchased at a price above its intrinsic or business value may never recover to that market price. Proper value investing is what mitigates this second risk: if a value investor calculates that the fair value of a business is $8-10 per share and he is able to buy that business at $5 per share, a subsequent market-related decline in price to $2.50 would mean two things: 1) that it is almost certainly temporary- as long as the value of the business remains well above its market price, and 2) that it is a wonderful opportunity to buy more of that bargain at this further discounted price.

Remember that business value, based in physical reality, generally fluctuates to a much lesser degree than does market pricing. 

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