Finding Bargains and Patient Opportunism
Previously, we discussed the book contents in relationship to psychological pitfalls in investing, cycles and the market pendulum, risk and attitudes towards risk, price and the relationship between price and value. The following two chapters deal are sort of “how-to” chapters, in the sense they inform us as to find bargains in the markets, and where to look for bargains, and they also tell us about the value of patient opportunism in markets.
The Most Important Things is…….Finding Bargains
The process of intelligently building a portfolio consists of buying the best investments, making room for them by selling lesser ones, and staying clear of the worst.
The first step is usually to make sure that the things being considered satisfy some absolute standards. It’s not unreasonable to want to emphasize assets that fall within a certain portion of the risk spectrum. In other words, there can reasonably be some places investors won’t go, regardless of price.
The starting point for portfolio construction is unlikely to be an unbounded universe. Some things are realistic candidates for inclusion, and others aren’t. The next step is to select investments from it. That’s done by identifying those that offer the best ratio of potential return to risk, or the most value for the money.
The process of investing has to be rigorous and disciplined. Second, it is by necessity comparative. Whether prices are depressed or elevated, and whether prospective returns are therefore high or low, we have to find the best investments out there.
Our goal isn’t to find good assets, but good buys.Thus, it’s not what you buy; it’s what you pay for it. The tendency to mistake objective merit for investment opportunity, and the failure to distinguish between good assets and good buys, get most investors into trouble.
What is it that makes price low relative to value, and return high relative to risk? Unlike assets that become the subject of manias, potential bargains usually display some objective defect. Bargains are often created when investors either fail to consider an asset fairly, or fail to look beneath the surface to understand it thoroughly, or fail to overcome some non-value-based tradition, bias or stricture. Generally, the greater the stigma or revulsion, the better the bargain.
First-level thinkers tend to view past price weakness as worrisome, not as a sign that the asset has gotten cheaper.
A bargain asset tends to be one that’s highly unpopular. Fairly priced assets are never our objective, since it’s reasonable to conclude they’ll deliver just fair returns for the risk involved.
A good place to start is among things that are: • little known and not fully understood; • fundamentally questionable on the surface; • controversial, unseemly or scary; • deemed inappropriate for “respectable” portfolios; • unappreciated, unpopular and unloved; • trailing a record of poor returns; and • recently the subject of disinvestment, not accumulation.
The necessary condition for the existence of bargains is that perception has to be considerably worse than reality. Investment bargains needn’t have anything to do with high quality.
We’re active investors because we believe we can beat the market by identifying superior opportunities. It’s obvious that investors can be forced into mistakes by psychological weakness, analytical error or refusal to tread on uncertain ground. Those mistakes create bargains for second-level thinkers capable of seeing the errors of others.
The Most Important Thing is …… Patient Opportunism
There aren’t always great things to do, and sometimes we maximize our contribution by being discerning and relatively inactive.
Patient opportunism—waiting for bargains—is often your best strategy.
You’ll do better if you wait for investments to come to you rather than go chasing after them.You tend to get better buys if you select from the list of things sellers are motivated to sell rather than start with a fixed notion as to what you want to own. An opportunist buys things because they’re offered at bargain prices. There’s nothing special about buying when prices aren’t low.
This is one of the hardest things to master for professional investors: coming in each day for work and doing nothing.
It’s essential for investment success that we recognize the condition of the market and decide on our actions accordingly. The other possibilities are (a) acting without recognizing the market’s status, (b) acting with indifference to its status and (c) believing we can somehow change its status. These are most unwise.
investors needn’t feel pressured to act. They can pass up lots of opportunities until they see one that’s terrific. One of the great things about investing is that the only real penalty is for making losing investments. There’s no penalty for omitting losing investments, of course, just rewards. And even for missing a few winners, the penalty is bearable. Missing a profitable opportunity is of less significance than investing in a loser.
The motto of those who reach for return seems to be: “If you can’t get the return you need from safe investments, pursue it via risky investments.” You simply cannot create investment opportunities when they’re not there. The dumbest thing you can do is to insist on perpetuating high returns—and give back your profits in the process.
The truth is, there’s no easy answer for investors faced with skimpy prospective returns and risk premiums. But there is one course of action—one classic mistake—that I most strongly feel is wrong: reaching for return.
Trying to earn aggressive returns not only doesn’t ensure that you will achieve them but also increases the likelihood that by making increasingly risky investments you will incur losses and fall far short, exacerbating your problem.
High valuations can often go higher and last for longer than expected, continually frustrating disciplined and patient value investors. To wring high returns from a low-return environment requires the ability to swim against the tide and find the relatively few winners. High-return environments, on the other hand, offer opportunities for generous returns through purchases at low prices, and typically these can be earned with low risk.
The absolute best buying opportunities come when asset holders are forced to sell, and in those crises they were present in large numbers. Usually, would-be sellers balance the desire to get a good price with the desire to get the trade done soon. The beauty of forced sellers is that they have no choice. They have a gun at their heads and have to sell regardless of price. The difficulties that mandate selling—plummeting prices, withdrawal of credit, fear among counterparties or clients—have the same impact on most investors. In that case, prices can fall far below intrinsic value.
The key during a crisis is to be (a) insulated from the forces that require selling and (b) positioned to be a buyer instead. To satisfy those criteria, an investor needs the following things: staunch reliance on value, little or no use of leverage, long-term capital and a strong stomach.