#8 Investing 101: What's the right time to buy?
You should learn stop freaking out and start loving crashes.
When do you shop for your winter clothes?
If you are like everybody, chances are great that you go shopping for winter when you realize that the weather is getting too cold to venture out with your thin jacket.
If you want to succeed as an investor, you can’t afford being like everybody else.
Right time to buy winter clothes is just when we exit the winter season. The demand subsides fast, shops launch sales to get rid of their inventory and winter clothes become irrelevant, only to become relevant again next year.
That’s when you do your shopping. You shop for the next year.
Buying stocks is not that different from shopping in a department store. When you think about shopping, you may find three types of discounts:
Market wide discount: Days like Black Friday.
Sector specific discount: Late summer sales in clothing when we are to enter winter.
Brand specific discount: Huge discounts to sell the inventory of unpopular products.
These are when you can get the most value for your money. The stock market is no different. It also has its sales, promotions, campaigns etc…
This is not a post about how you can find great businesses and or how you can value stocks. We have already discussed them in previous issues of this series.
This is about when you can expect to see them at gross discounts so you can buy at magnitude and make money when the sale is over and they are in demand again.
So, let’s cut this short and dive directly to the meat of this!
1. Black Friday = Market Crashes
You know how Black Friday is in America.
You go to a store and you don’t look much, pretty much everything is at discount and you buy whatever you can. People don’t think they are buying an inferior product just because it’s cheaper today than yesterday.
No.. Exact opposite, they literally fight to get their hands on some items on sale.
Market crash is Black Friday for stocks.
Pretty much everything goes down. Those that were elevated go down even further; what was cheap becomes even cheaper.
However, there is one fundamental difference between a market crash and Black Friday: People hate it.
They avoid buying stocks in market crashes as strongly as they want to buy anything in Black Friday.
The psychology behind this is flawed:
People see the physical items and when they go on a sale, they don’t think it’s now inferior. They are just happy that it’s cheaper now.
However, when stocks go down, they suddenly think they are inferior now. After all, people who wanted them yesterday, are not wanting them today. There has to be something wrong… Right?
Wrong!
It’s counterintuitive but the market crashes mostly happen because everything was so good, the economy was so strong and expectations went off the roof! Once the actors in the economy can’t meet elevated expectations, people get disappointed and think like it’s the beginning of the end.
As Howard Marks says success carries within itself the seeds of failure.
Just imagine you were a tennis player who won all the tournaments you attended. And suddenly, you lose one because you got complacent, you simply didn’t want to win enough. What would other people tell though?
“The sign that he passed his peak.”
“Beginning of the end for his career.”
“His talent is not unmatched anymore.”
Would these inferences be fair? You would know they are not. You would know you simply didn’t want enough but the reaction would be devastating. It would be way worse than it would be if you were a player who occasionally lost.
That’s what happens in most of the market crashes.
People suddenly start thinking that we have reached a peak and nothing could be better, only way is down.
This is where you find high quality companies at gross discounts.
In market crashes, intelligent investors are the rational buyer who buys in Black Friday sales knowing that the goods didn’t automatically become inferior just because the price dropped.
He looks at the fundamentals and if there is no reason the business shouldn’t make as much money or more next year, he buys, knowing the quality hasn’t changed.
if you internalize this thinking, you can make unbelievable amounts of money in the market crashes, as Buffett explains here:
All you need to do is to buy businesses whose fundamentals haven’t changed and they will keep making more money.
“It’s hard,” you probably think now “how am I supposed to do that?”
Well, just conduct a thought experiment and ask yourself whether the crash will change how people buy the products of a business in the long-term. If you can say “no”, it’s the right company to buy.
Let me give you an example:
This guy created the wealthiest town in America: Quincy, Florida.
Pat Munroe
Pat Munroe was a banker in Quincy, Florida in the 1930s. In the depths of the Great Depression, he realized that people were spending their last pennies to buy Coca-Cola from the vending machines in town.
He was a smart guy. He quickly realized that if people were spending their last pennies to buy Coca-Cola then:
The business should be recession proof.
People would buy even more when the crisis is over.
He bought as many Coca-Cola stocks as possible and convinced his neighbors to do the same.
Result? The town generated 67 Coca-Cola millionaires, thanks to Pat Munroe. Many descendants of the original millionaires are still holding onto their shares.
Quincy, Florida.
Market crashes are the best times to buy stocks. It’s just like buying the clothes for summer in the depths of winter at dead prices.
Most people can’t act because they think everything could go spiraling down and the financial world could come to an end. This is like not buying summer clothes fearing that winter would never end.
It doesn’t happen. The financial world has never ended before and recovered from all the past crashes:
Will there be a day where the market won’t recover and the financial world will end? It’s possible. But, if the financial world ends, nothing would be important. There would be no escape so it’s not a reason not to buy.
After all, the sun will swallow the world one day and there will be no more summers and winters, but it won’t be important anyways.
2. Sector Specific Sale = Industry Wide Recession
Not everyday is a Black Friday when everything goes on sale at the same time. Sometimes, there is a sale just in shoe stores.
There could be many reasons: We may be going into summer and people don’t want shoes, they want slippers; or a trend changes and a brand comes with a new design of shoes and the classical shoes lose relevance temporarily until the trend turns.
In business, we call it a ‘industry recession’ where an industry suddenly shrinks, deviating from the trend.
There could be many reasons: Structural problems in the industry might have created trust problems in customers, the goods in the industry might have become too expensive as a result of macro events etc…
Let’s give some examples:
When the Fed raises interest rates to tackle inflation, mortgage rates also go up and people don’t want to buy homes as much as they used to. The industry slows down or even shrinks.
When banks went bankrupt in the Great Recession of 2008, people withdrew their money from banks and didn’t want to transact with them because they had lost trust.
In 2020 Covid led a great industry-wide recession in the travel industry because people were living under lockdown.
These were great times to buy strong companies in those industries that were poised to quickly recover post recession such as Dr. Horton, JP Morgan, Bank of America, Marriott etc..
Let’s go back to 2008…
Everything was falling apart, people were losing their jobs, banks were going bankrupt and there were no buyers for foreclosed houses…
The crisis erased $16.4 trillion of household wealth.
At the depth of the crisis, Buffett wrote his famous piece titled “Buy American, I am.”
While everybody was avoiding stocks, especially bank stocks, he bought. He invested $5 billion in Goldman Sachs, helping it survive. Though he exited that position completely in 2020, Goldman Sachs stock increased 7x since he bought in the crisis.
Another example?
In the early 1980s, the US auto sales stagnated and pent-up demand rose quickly, Legendary investor Peter Lynch, seeing the increasing pent-up demand, allocated some 10% of his portfolio to car manufacturers. His Chrysler position more than tripled in the next few years.
Let’s go to the more recent past…
In 2020, everybody thought the Covid would last for at least 5 years. Travel and hotel stocks got heavily sold off.
Booking stock plunged to $1,100 per share from $2,100 per share.
If you looked at its balance sheet, in 2020, you would have seen that the company had $11 billion in equity and just $5 billion in long-term debt.
If your equity can pay your debt and you are still left with another $5 billion in the bank, you can’t go bankrupt. That business was strong enough to weather any storm, you could have invested in it and waited for it to play out. That position would have made 5x in 4 years.
In sum, industry recessions are great times to pick the strong companies in the industry that can weather the storm. Once the recovery starts, those companies will be the first ones to skyrocket and you would have bought them at a gross discount.
You just need the stomach.
3. Brand Discount = Company Specific Problems
We all do some nasty stuff, we are human. That could be significant or harmless.
On my part, I am guilty of chocolate addiction. I remember my parents had to cut my stipend so I wouldn’t buy chocolate. The addiction was reaching unhealthy levels and they were just trying to protect me. I was just a child, I didn’t understand and I didn’t care. So, at night, I would sneak into their room while they sleep and steal some pennies from their pockets so I could buy some chocolate the next day.
Some people, however, can scam people pretty big and steal their life savings. Some people, on the other hand, have problems not because they did some big nasty stuff but because they are victims of them.
Not all of those stories end the way they started. People who have done pretty nasty stuff can correct themselves and make up for it in the rest of their lives. Victims may not stay vulnerable forever, they can recover and live a pretty good life.
Human life is unpredictable because humans are unpredictable.
The wonder kid in high school doesn’t always end up successful, an introvert doesn’t always stay behind the curtains.
Yet, despite the fact that we are well aware of this aspect of human life, we are still so obsessed with the linear development of corporate life.
That’s impossible.
Corporate life is much like human life, with many ups and downs, happy moments, disappointments etc… Because it is made by humans and run by humans.
Just like humans, they sometimes do nasty stuff, knowingly or unknowingly.
When humans do such things, he gets shamed but we also ask the question “can he recover from this?”
If the answer is yes, we try to rehabilitate that person. If he recovers, that’s a win.
It’s exactly the same in corporations. When corporations do nasty things, they get hammered down by investors, they dump the stock.
At that moment, we ask the question: “Can it recover from this?”
If yes, it might be worth taking the shot. If it recovers, that’s a big win.
Bill Ackman’s Chipotle investment is an amazing example of this.
He started buying Chipotle in the second half of 2016.
Before he started to buy, Chipotle got hammered down because it had been discovered that there were food safety issues in its operations.
What did Ackman do? He asked the question: “Can it recover from this?” 👇
He figured out that almost all chain restaurant brands have had food safety issues some time in their lifecycle and most of them solved this problem and survived. Why wouldn’t Chipotle?
This was a firm specific problem. It did some nasty stuff unknowingly. Stock got down 50%. He bet that it could solve these problems as they weren’t material.
Result? He made billions.
Sometimes companies don’t do nasty stuff, sometimes they are victims too.
In 1963, American Express basically got scammed and it nearly destroyed its equity pool.
American Express had a subsidiary company that lent to businesses against collateral in physical inventories. One of the businesses it lent to was Allied Crude Vegetable Oil Refining Company. It had collateralized its salad oil inventory.
In 1963, American Express got an anonymous call and the guy on the other side of the phone told them that the oil containers were mostly filled with seawater. The small volume of salad oil naturally floated on top of the water and the fraud had thus gone undetected when the containers had been inspected.
The company was supposed to have $150 million in olive oil but it only had $6 million! After the discovery, American Express stock fell 50%.
Buffett spotted the opportunity.
He asked “Can the company survive this?”
The answer was yes because despite losing some equity the earning power of Amex was intact as its main business was traveller’s checks was rock solid. It had 66% market share.
He bought $20 million worth of American Express, 5% of the company.
Result? His American Express position was his first big hit. This company today is worth $200 billion.
Lesson?
Firm specific problems are normal. When you spot them, look at the company and try to understand whether its earning power is intact. If the problem is not about its core business or its getting disrupted, then chances are great that it can survive.
Once you are convinced that it can survive, you have to bet while the market dumps.
This is how you make some real money.
🏁Conclusion
Great companies rarely trade at a discount.
Great companies, by definition, are rare and those rarities tend to shine and make themselves known. Thus, when everything is great, the market won’t give them to you at attractive prices.
You have to know when you should attack.
Great companies get discounted mainly in three situations:
Market crash.
Industry recession.
Company specific problem.
In all those cases, the key to successful investing is to understand whether the company has durability, whether it can endure the storm.
How do you do that?
Look at the balance sheet to see whether it has any risk of bankruptcy.
Look at the industry to see whether it’s becoming irrelevant anytime soon.
Look at the core business to see whether it’s intact despite operational problems.
If you decide that there is no risk of bankruptcy, the industry will be here 20 years from now and the people will resume buying the products of the company once it corrects the problems, then you should bet.
And you should bet big!
Whether it’s winter clothes or undervalued stocks, the key is recognizing cyclical patterns and acting when others aren’t. Timing, patience, and a long-term perspective can turn moments of irrelevance into opportunities for outsized returns. Great post!
Hi
Thank you so much for this
According to this analogy what is your view about the Intel , Can it survive?