Review & Outlook

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Buffett on Market Downturns

26 August, 2015 by Ben O'Brien in Commentary

Though the market has bounced back today, the Dow and S&P are now solidly in correction, a pullback of more than 10% from July highs. Who do you turn to for insight in times of market panic? It can be tempting to turn on CNBC. But that may be the worst thing you can do because much of the media (especially cable news) thrives on stirring up the frenzy during uncertain times. After all there’s nothing better for financial TV ratings than a market downturn.

One of the best people in my opinion to listen to in times of market panic is Warren Buffet who has shepherded his company Berkshire Hathaway through all sorts of up and downs for fifty years, growing it from a troubled New England textile mill into one of the largest global conglomerates. Buffett does not appear on TV to provide his two cents when the market is in a panic, however, he has written a great deal of  insightful material on his long experience in investing. Recently, I’ve been reading a collection of Buffett’s Berkshire Hathaway annual shareholder letters which, though most were written many years ago, has turned out to be a fresh and timely answer to the current market panic.

One of the pieces of advice that stuck with me as applicable in the current market is to focus mostly on the game on the field and not the scoreboard. The scoreboard of course is the market with its constantly fluctuating prices. The game on the field though, is the operating results of the underlying businesses, things like corporate earnings and cash flows. Companies have an intrinsic value, which is the value of the projected future cash flows discounted back to the present. During a panic, stock prices (the scoreboard) become unhinged from intrinsic values. But in the long run the scoreboard always gravitates back towards reflecting what’s going on on the field–the value of the cash flows. By keeping track of company operations and cash flows, you are less tempted to sell, seeing that companies are still chugging along, selling their goods and services even while the macroeconomic picture looks grim.

Buffett does not however, just say that in a market downturn you should grit your teeth and wait it out, but rather he says that the long term investors should actually welcome a market downturn as a discount buying opportunity. He writes:

A short quiz: If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef? Likewise, if you are going to buy a car from time to time but are not an auto manufacturer, should you prefer higher or lower car prices? These questions, of course, answer themselves.

But now for the final exam: If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the “hamburgers” they will soon be buying. This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.

This is, of course, contrary to our human nature. But even if you can’t quite bring yourself to “rejoice”, as Buffett says, you can try to cultivate this contrarian perspective. It will at least keep you from panicking and help you to stay the course.