price-vs-value-together-planning

Buying stocks when prices are high

“…the risk of paying too high a price for good-quality stocks – while a real one – is not the chief hazard confronting the average buyer of securities.  Observation over many years has taught us that the chief losses to investors come from the purchase of low-quality securities at times of favorable business conditions.”

The Intelligent Investor, Benjamin Graham, Chapter 20, p. 516, Harper, 2006

 

Benjamin Graham, the father of value investing, often wrote about a stock’s margin of safety.  He believed in buying stocks when their prices were low compared to their intrinsic value.  This allowed for profit when the market eventually revalues the stock to its fair value.  It also gives the buyer some leeway in case the company does not do well, and it’s value drops.  His star student was Warren Buffett.

Over the last several years, I have marveled at how the stock market continues to climb, when everyone (it seems) believes it is overvalued.  Would Benjamin Graham or Warren Buffett buy in this high-valued market?

In a recent interview with Bloomberg radio, Buffett says he is.  Watch it here.

We learned yesterday that Berkshire Hathaway recently took $4 billion from its $100 billion in cash and bought JP Morgan stock.

Eric Rosenbaum of CNBC writes an interesting article about it today.  Read it here.

In his article, Eric lays out some reasons why…the financial sector is valued lower than other sectors right now…Buffet loves JP Morgan CEO Jamie Dimon…etc.

He also brings attention to a view Buffett has expressed in the past:

“…the easiest way to gain confidence that the market is not overvalued is if two conditions are met: “Interest rates remain at or near present levels or go lower, and that corporate profitability in the U.S. stay at the present — or close to the present — levels,”

“If the two conditions are met,” he said, “I think it’s not overvalued. And if either of the conditions is breached in an important way, I think it will turn out to be overvalued.”

Eric goes on to say that stocks are at peak earnings power right now, and interest rates are going up.  Both measures that Buffett has said could indicate the market is overvalued.

But Buffett is still buying stocks!  What are we to make of this?

My view is that Buffett is showing us that stocks are a long-term investment, and the long-term rewards are high relative to bonds.  There are good buying opportunities even when the market is overpriced.  He is looking for quality companies and trying to buy them as cheaply as possible.

A few lessons from this for advisers like me, who spend a lot of time talking to clients about the market:

  1. Know what your goals are and what is important to you.  A fee-only adviser can help you discover what is possible and develop a financial plan for goals that are within reach.
  2. Invest with your goals in mind.  Short-term goals should not be funded with stocks.
  3. Quality stocks can be bought at any time, even at relatively high valuations.
  4. No one can predict what will happen to stock prices in the short-term, but we have great evidence that over the long-term stocks provide very good returns compared to other investment choices.

Are you ready to talk about how your investment management? Call or email us today!

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