Market Fluctuations as a Guide to Investment Decisions (2) - Timing or Pricing

Stock Brokers and the Investment Services

As a matter of business practice (or perhaps of thorough-going conviction), the stock brokers and the investment services seem wedded to the principle that both investors and speculators in common stocks should devote careful attention to market forecasts.

The investor can scarcely take seriously the innumerable predictions which appear almost daily and are his for the asking.

In many cases, he pays attention to them and even acts upon them.  Why?

Because he has been persuaded that it is important for him to form some opinion of the future course of the stock market and because he feels that the brokerage or service forecast is at least more dependable than his own.

This attitude will transform the typical investor into a market trader and will bring the typical investor nothing but regrets.



Timing in a Bull Market

During a sustained bull movement, when it is easy to make money by simply swimming with the speculative tide, he will gradually lose interest in the quality and the value of the securities he is buying and become more and more engrossed in the fascinating game of beating the market.

He begins by studying market movements as a "commonsense investment precaution" or a "desirable supplement to his study of security value"; he ends as a stock-market speculator, indistinguishable from all the rest.


Market Forecasting (or Timing)

A great deal of brain power goes into this field.

Undoubtedly some people can make money by being good stock-market analysts.

But it is absurd to think that the general public can ever make money out of market forecasts.

There is no basis either in logic or in experience for assuming that any typical or average investor can anticipate market movements more successfully than the general public, of which he is himself a part.


Timing and the Speculator

Timing is of great psychological importance to the speculator because he wants to make his profit in a hurry.

The idea of waiting a year before his stock moves up is repugnant to him.



Timing and the Investor

But a waiting period of such, is of no consequence to the investor.  

• What advantage is there to him in having his money uninvested until he receives some (presumably) trustworthy signal that the time has come to buy?
• He enjoys an advantage only if by waiting he succeeds in buying later at a sufficiently lower price to offset his loss of dividend income.

Timing is of little value to the investor unless it coincides with pricing, that is, unless it enables him to repurchase his shares at substantially under his previous selling price.

Market Fluctuations as a Guide to Investment Decisions (1) - Timing or Pricing

Common stocks, even of investment grade, are subject to recurrent and wide fluctuations in their prices.

Should the intelligent investor be interested in the possibilities of profiting from these pendulum swings?

There are two possible ways he may try to do this:

• the way of timing and 
• the way of pricing.

Timing

By timing, the investor try to anticipate the action of the stock market - to buy or hold when the future course is deemed to be upward, to sell or refrain from buying when the course is downward.


Pricing

By pricing, the investor endeavours

• to buy stocks when they are quoted below the fair value and 
• to sell them when they rise above such value.

A less ambitious form of pricing is the simple effort to make sure that when you buy you do not pay too much for your stocks.

This may suffice for the defensive investor, whose emphasis is on long-pull holding; but as such it represents an essential minimum of attention to market levels.


Pricing or Timing?

The intelligent investor can derive satisfactory results from pricing of either type.

If he places his emphasis on timing, in the sense of forecasting, he will end up as a speculator and with a speculator's financial results.

Intelligent Investor Chapter 8: The Investor and Market Fluctuations

Chapter 8: The Investor and Market Fluctuations

An investor must prepare both financially and psychologically for the fluctuations certain to occur in the market.

There are two ways an investor tries to profit from fluctuations:

1. Timing: Buy when you think the price will go up, and then sell once it goes up.
2. Pricing: Buy when the price is below fair value and sell once it reaches or exceeds fair value.

Consistent market timing is exceptionally difficult, as is evident by the countless market predictions and forecasts by industry professionals that differ from actual events by a wide margin. The variety of these predictions is great enough that an investor can make any move he chooses and find a prediction that supports this move.

Graham goes so far as to say it is absurd to think that the general public can ever make money out of market forecasting. There is no basis in logic or history to believe otherwise.

With regard to the pricing approach, Graham says that this is also extremely difficult to properly execute. Cycles often last for 5 years or more which causes people to lose their nerve and act irrationally. For example, in a prolonged bull market, people may fear being left behind, so they buy at the slightest indication of a bear market, feel vindicated as the prices escalate further, and then lose when the real bear market returns.

Also, any signals identified by experts to help determine whether this is a bear or bull market have been shown to be inconsistent in successfully identifying the position in the market cycle.

Conclusion: If you are banking on market fluctuations, you will not consistently perform well. Market fluctuations are not sound portfolio policy!

The intelligent investor uses a formulaic approach to determine whether stock prices have risen too high and he should sell, or prices have dropped significantly, and he should buy. Or, in other words, if he should alter the allocation of stocks to bonds in his portfolio (as per the tactical asset allocation policy that Graham discusses in previous chapters). The ideal approach is the rebalancing approach discussed in previous chapters (varying from 50-50 allocation to up to 75-25, and reviewing at set intervals throughout the year).

Business Valuation and Stock-Market Valuation

The stock market is paradoxical in that the highest grade stocks are often the most speculative because they gain great premiums over book value and are based more on the changing moods of the market and its confidence in the premium valuation it had put on the company in the first place. Thus, for conservative investors, they would be best to focus on companies with relatively low premiums placed upon them - a market rate no more than 1/3 above the net tangible-asset value.

However, a stock does not become sound because it can be bought close to asset value. The intelligent investor must also demand a satisfactory price-earnings ratio, sufficiently strong financial position, and the prospect of earnings being maintained over the years.

Intelligent Investors with portfolios close to the net tangible asset valuation of the underlying companies need worry less about stock market fluctuations than those who paid high multiples of earnings and assets. The intelligent investor should disregard the market price and not allow the mistakes that the market will make in its valuation to affect his feelings about the business. Do not let the market’s madness fool you into selling your shares at a loss - such a move requires reasoned judgment independent of the market price.

It is in this chapter that Graham creates the oft-cited Parable of Mr. Market. Essentially, you area private business owner. You own a share that you purchased for $1,000. Your partner is Mr. Market. Every day, Mr. Market quotes you a price for your interest and also offers to sell you his interest for the same price. Sometimes the quote is rationally connected with the business. On other days, it is clear that Mr. Market’s enthusiasm or fear has gotten to him, and the value he has placed is irrational. Graham says the Intelligent Investor would only let Mr. Market’s daily quote affect him if the Intelligent Investor agrees with the price (due to his own analysis of the value of the company), or he wants to buy from or sell to Mr. Market. Unless you want to transact with Mr. Market, you would be wiser to make your own analysis of the value of the company. If you want to transact, then you must compare Mr. Market’s value to the value you reached independently. This parable reflects the way a stock market investor should treat his relationship with the stock market.

Investment merit at a given PRICE but not at another

Investment Policies (Based on Benjamin Graham)

PRICE: is frequently an essential element, so that a stock (and even a bond) may have investment merit at one price level but not at another.

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Having selected the company to invest based on various parameters, the next consideration will be the price we are willing to pay for owning part of its business.

Price is always an important consideration in investing. At a certain price, the company can be acquired at a bargain, at a fair price or at a high price. Each scenario will impact on our investment returns.

We should ALWAYS buy a good quality company at a BARGAIN PRICE (margin of safety). This allows us to lock in our potential gains at the time of buying at a favourable reward/risk ratio. This maybe when the upside gain: downside loss is at least 3:1.

There maybe FEW exceptional occasions when we may be willing to pay a FAIR PRICE for a good quality company. This is often the case when a good quality company is fancied by many investors and is often quoted in normal time at a high price.

However, we should NEVER (NEVER, NEVER) buy a good quality company at HIGH PRICE, whatever its earnings and growth prospects maybe. To do so will not only diminishes our potential investment returns, but may even results in a loss of our capital due to the unfavourable reward/risk ratio.

Don't time the market, it is difficult. However, there will be time when the market is on sale and the prices of stocks are at a bargain and there will be time when the market is exuberant and the prices of stocks are high or very high.

The market will always be there and we should choose when to buy and when to sell. We should only buy a stock when the PRICE IS RIGHT FOR US and sell a stock when the PRICE IS RIGHT FOR US.


(What is market timing? Timing is a term that refers to investing by buying everything or selling everything on the basis of the (faulty) assumption that one can predict the market's next move. Attempts to time are common, but academicians and practitioners have concluded that success happens through luck only on occasions that are quickly reversed and very costly.)