Surviving Mkt Volatility with Buffett’s Strategies



By Goddy Egene, 06.27.2010 


The performance of the nation’s stock market had given hope to investors in the first quarter of 2010 when it posted a year-to-date (YTD) growth of 24 per cent. Compared with a decline of 34 per cent recorded in first quarter of 2009, many investors were encouraged that 2010 would be better than the previous two years (2008 and 2009). The positive trend was maintained in the month of April but the following month (May), witnessed some lull – leading to a decline.



The volatility has persisted since then and the market is heading for another decline at the end of this month (June). With just two days to the end of the month, the Nigerian Stock Exchange (NSE) All-Share Index has already depreciated by over 3.2 per cent this month.Operators and many investors had expressed confidence that given the performance of quoted companies, especially the more-than-expected results by the banks after making huge provisions for bad loans, the positive trend would be sustained for a longer period.



However, some brokers contended that the high volatility is being witnessed because total confidence is yet to return to the market, while the issue of margin loans overhang is affecting the recovery of the market. They also pointed out that many investors saw the growth recorded by some equities in the first quarter of the year as an opportunity to lock in profits and reduce past losses.One of the brokers specifically linked the latest onslaught of the bears on the market to the lull caused by banks’ preparations to close their books for the half year ending June 30, 2010.



He said: “As you are aware, the end of the second quarter is fast approaching and banks are preparing to close their books. Whenever this happens, it affects the performance of the stock market because the banks are among leading buyers of shares in the market either directly or indirectly. Besides, the issue of margin loans is   still there. Some of the banks are still putting pressure on debtor-stockbroking houses to repay and this is currently affecting the level of trading in the market,” the stockbroker said.



No doubt, many investors, mostly those with short-term tendency, are worried by the downtrend in the market. But investments experts believe investors playing the stock market ought to have gotten used to its fluctuation and volatility. Noting that stock markets by their nature, fluctuate, they explained that the ability to read the market accurately  and take advantage of the opportunities  is what separates real investors from pretenders. They cited Warren Buffett- the famous American investor, who became a billionaire by investing in stocks. Despite global market crises over the years, 80 years old Buffett, who bought his first shares at age of six, remained a successful stocks investor. 



Hence, many financial analysts said that instead of panicking, investors should adopt some of Buffett’s investment strategies so as not only to be able to survive stock market volatility but also become successful investors.It has been discovered that in times of economic decline he rarely changes his long-term value investment strategy during stock markets downturn. In fact, he stressed that it is always profitable to regard down markets as an opportunity to buy good companies at reasonable prices.



Buffett’s Investment Philosophy


Buffett has a set of definitive assumptions about what constitutes a “good investment”. These focus on the quality of the business rather than the short-term or near-future share price or market moves. He takes a long-term, large scale, business value-based investment approach that concentrates on good fundamentals and intrinsic business value, rather than the share price. 



Buffett looks for businesses with “a durable competitive advantage.” What he means by this is that the company has a market position, market share, branding or other long-lasting edge over its competitors that either prevents easy access by competitors or controls a scarce raw-material source. Employing a selective investment strategy and using his investment criteria to identify and select good companies, he can then make large investments (millions of shares) when the market and the share price are depressed and when other investors may be selling.In addition, he assumes the following points to be true: The global economy is complex and unpredictable; the economy and the stock market do not move in sync; the market discount mechanism moves instantly to incorporate news into the share price; the returns of long-term equities cannot be matched anywhere else.



Buffett’s Investment Activity


Buffett’s company is known as Berkshire Hathaway and it has grown into  investment industries  covering Insurance , Soft drinks, Private jet aircraft, Chocolates, Shoes, Jewellery, Publishing, Furniture, Steel, Energy, Home building. These industries where he has investments vary widely – leading to the question of the common criteria, he uses to separate the good investments from the bad ones.



Buffett Investment Criteria 


It has been said that Berkshire Hathaway relies on an extensive research-and-analysis team that goes through reams of data to guide their investment decisions. While not all the details of the specific techniques used are made public, the following 10 requirements are all common among Berkshire Hathaway investments. Firstly, the candidate company has to be in a good and growing economy or industry. It must enjoy a consumer monopoly or have a loyalty-commanding brand. It cannot be vulnerable to competition from anyone with abundant resources. Its earnings have to be on an upward trend with good and consistent profit margins.  The company must enjoy a low debt/equity ratio or a high earnings/debt ratio. 



It must have high and consistent returns on invested capital. The company must have a history of retaining earnings for growth.  It cannot have high maintenance costs of operations, high capital expenditure or investment cash flow.  The company must demonstrate a history of reinvesting earnings in good business opportunities, and its management needs a good record of accomplishment of profiting from these investments and lastly the company must be free to adjust prices for inflation.   



The Buffett Investment Strategy


Buffett makes concentrated purchases. In a downturn, he buys millions of shares of solid businesses at reasonable prices. However, he does not buy the shares of technology companies because he doesn’t understand their business or industry. During the dotcom boom, he avoided investing in tech companies because he felt they hadn’t been around long enough to provide sufficient performance history for his purposes.And even in a bear market, although Buffett had billions of dollars in cash to make investments, in his 2009 letter to Berkshire Hathaway shareholders, he declared that cash held beyond the bottom would be eroded by inflation in the recovery.



Buffett deals only with large companies because he needs to make massive investments to garner the returns required to post excellent results for the huge size to which his company, Berkshire Hathaway, has grown. His selective contrarian style in a bear market includes making some large investments in blue chip stocks when their stock prices are very low. And it is assumed that  Buffett might get an even better deal than the average investor because of  his ability to supply billions of dollars in cash infusion investments earns him special conditions and opportunities not available to others. His investments often are in a class of secured stock with its dividends assured and future stock warrants available at below-market prices.



Buffett’s strategy for coping with a down market is to approach it as an opportunity to buy good companies at reasonable prices. He has developed an investment model that has worked for him and the Berkshire Hathaway shareholders over a long period. His investment strategy is long-term and selective, incorporating a stringent set of requirements prior to an investment decision being made. Buffett also benefits from a huge cash “war chest” that can be used to buy millions of shares at a time, providing an ever-ready opportunity to earn huge returns.



The following, which are some of his quotes, may also be of good guide when investing in stocks. “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price. I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years.  Only buy something that you’d be perfectly happy to hold if the market shut down for 10 years.”






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