Monday, 8 May 2017

A sound mental approach towards stock fluctuations (5): Market Declines and Unsuccessful Stock Investments

Market declines and unsuccessful stock investments

In the case of market declines and unsuccessful stock investments, there is a vital difference here between temporary and permanent influences.

The price decline is of no real importance:
  • unless it is either very substantial - say, more than a third from cost - or 
  • unless it reflects a known deterioration of consequence in the company's position.

In a well-defined bear market, many sound common stocks sell TEMPORARILY at extraordinarily low prices. 

It is possible that the investor may then have a paper loss of fully 50% on some of his holdings, without any convincing indication that the underlying values have been permanently affected.

The Price can be Extraordinary in a Recession or Bear Market

In the business recession and bear market in the past, there were times, an outstanding business was considered in the stock market to be worth less than its current assets alone - which means less as a going concern than if it were liquidated.  That price was extraordinary.

Why?  The reasons maybe many.  
  • The reasons were justified in some.   
  • Yet, in some, the reasons were exaggerated and eventually groundless fear; 
  • while others were typical of temporary influences.

An example:  

An investor bought ABC in 1987 at say, 12 times its five-year average earnings or about 80.  The share price declined to 36 soon after. 

What was the implication of the share price to him?  
  • We cannot assert that the decline to 36 was of no importance to the investor.  
  • The investor would have been well advised to scrutinise the picture with some care, to see whether he had made any miscalculations.  
But if the results of his study were reassuring - as they should have been - he was 
  • entitled to disregard the market decline as a temporary vagary of finance, and,
  • unless he had the funds and the courage to take advantage of it by buying more on the bargain basis offered.

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