Last week was quite a roller coaster for international share markets and that rippled through the ASX with the S&P200 opening Monday at 5147 points, dropping to 4929 on Tuesday and then ended the week on Friday at 5252 – it was all over the place. Investors were nervous on news from China, oil and Europe one minute, which would drive prices down and then the next minute bargin hunters would jump in and drive prices back up again. At the end of the day however if you are a long-term value investor last weeks craziness doesn’t really matter. Here’s some tools I use to help me stay calm when the investment markets are going crazy.
It is so easy to get caught up in the hype of what is happening moment to moment in the markets, especially if you have your own hard earned savings invested in them. They can change so fast and there is so much information and contradicting opinions out there these days that it can be overwhelming to try and keep up with it all – so I don’t even try.
Whenever the markets get crazy the first thing I do is step back. I remember my priorities and look from a wider perspective.
Here’s a practice I find helpful:
I do not try to ‘trade’ the stock market and profit from the short-term up’s and downs, so why would it be beneficial for me to look at the markets that closely? Instead what I’ll do is look out as widely as I can at the long-term historical price charts of Indexes and individual companies. By doing this I am quickly reminded that each movement is but a ‘blip’ in the big scheme of things. This practice helps me puts it all in context and gives me perspective. When looking from a wide angle view like this I am less likely to make an irrational decision based on a short-term movement.
Focus on Fundamentals
Now that I have slowed down, stepped back and calmed the nerves by putting the short term movements into perspective, I next focus on the fundamentals of my individual investments and potential investments. Just because the price of an individual companies shares have dropped 10% in a day doesn’t always mean that the earnings capacity of that company have been eroded by that same 10%. When you focus on the long-term fundamentals of individual companies in detail such as: Return on Equity, Return on Retained Earnings, EPS Growth, Debt to Equity, Brand Strength and Competitive Advantage you can more or less ignore what price the market is quoting you. Because if the long-term fundamentals are strong, more often than not I have found that the share price over the long-term will look after itself.
Focus on Value
I see two completely different numbers when looking at individual companies to invest in – the price the market is quoting me second to second and the underlying value I believe the company is worth – the later doesn’t change nearly as much as the former. The price that the market is quoting day-to-day can at times become massively un-hinged from what I believe a company is valued at.
If I have focused on my fundamental analysis and am confident in the valuation that this analysis has brought me to the conclusion of, all a falling price is to me is an opportunity to buy an asset at a discount. Holding your nerve and buying at times like this is not always an easy thing to do, but if it was easy everyone would do it. I believe this is one of the main key points that can differentiate you as a great investor.
Be Careful with Debt
If I have bought a companies shares at a price that I believe is cheap and yet they continue to fall lower I am not really fazed and more often than not I will actually happily buy more parcels of shares to take advantage of the cheaper price. Again, if I have the fundamentals and valuation right I am able to do this confidently and I can just ignore that my initial investments are currently at a loss on paper – because I have determined that over the long-term the market will correct itself once the fear and pessimism subsides.
However, if I have used too much debt to make my investment purchases I am not able to do this as the equity of the shares my margin loan is using as collateral is being eroded and hence my Loan to Value Ratio (LVR) may be getting closer to the level at which my bank will issue a margin call – meaning I may need to sell shares at a loss to pay down the loan if I can not front up sufficient cash. So I am always very careful to ensure I keep a large margin of safety built into the LVR of my Margin Loans. Not doing this can very quickly become an investors undoing.
If I ensure I have my arse covered with my research and that I keep my borrowings under control there is no reason for me to see market crashes as anything more than the potential for an exciting opportunity to purchase shares in solid brands and companies at a discount to their underlying value. So, if all of your ducks are in line during market crashes and during times of volatility this practice of learning to stay calm and make rational decision can actually turn out to be very profitable.
Enjoy the ride!