Buffett, like many other big investors, tends to be very picky: he avoids the temptation to buy a stock that looks attractive at the time. Any stock can have potential value if the price is right, but Buffett isn’t fooled into buying stocks just because they’re undervalued.
Eventually, each of the 10,000 or so US listed stocks, including the world’s Qualcomms and Oracles, will trade at an undervalued price, but only a small fraction of the 10,000 companies offer attractive long-term growth prospects. . Most have poor fundamentals or a history of erratic growth and should be avoided. Many others will provide periodic trading gains and then languish as the investment community drifts from their stocks and looks elsewhere for short-term gains. As you refine your stock selection over time, you’ll eventually narrow your short list of buy candidates down to a few dozen. You can then focus on this list and buy them, one at a time, as their prices drop to favorable levels.
You should avoid the temptation to buy stocks simply because you have cash on hand, Buffett believes. More often than not, a small wallet invites mistakes. In early 1999, Buffett had more than $35 billion in cash and bonds in Berkshire Hathaway’s investment portfolio. He was content to keep this large sum of money, which was equal to the total annual output of dozens of smaller countries, indefinitely until he found properly priced companies to buy. On the contrary, most investors feel the psychological need to put their loose change to work almost immediately. Instead of patiently waiting for their favorite stocks to drop, they buy shares of lower-quality companies without taking the time to study their fundamental properties.
Buffett avoids this trap by identifying all the stocks he wants to own in the next few years and buying them one at a time, but only when they drop to an attractive price. If the stock does not immediately fall to the desired price, he takes no action. He knows that the odds favor a drop in price sooner or later. In the meantime, he will turn his attention to other desirable companies whose prices may already have fallen to attractive levels.
To help you practice the take strike method, you should keep a list of possible stock prices. The list should include the maximum price you would be willing to pay for the company today. Post this list in a convenient place and review it periodically.
The obvious advantage of stocking is that it forces you to be vigilant. Before you buy, you should determine a fair value for the business, which means studying the business. Spending some time testing for valuation will greatly decrease your chances of buying early. Buying companies this way also allows you to build the portfolio you really want and prevents you from adding undesirable stocks simply because you have money sitting idle. Also, the method takes advantage of your impatience and, more importantly, ensures superior performance because you will overpay for any company.
You should update your checklist periodically to ensure that your target prices are reasonable. If a company’s growth prospects decline, the original purchase price you set may be too high. Conversely, if the company’s fundamentals improve, the stock may not return to its buy level again. In such cases, you should re-evaluate the company to determine if a higher share price is really worth it.
The point is, when you don’t have to invest, don’t feel like you have to invest. Once you gain confidence in your own stock selection, you will naturally make fewer and fewer buy and sell decisions. Being a successful investor gives you the same luxury as having a 20-game lead over the second team come September. You can rest the bat on your shoulder and take strikes indefinitely because it won’t change the outcome of the season.
PUT YOUR FAVORITE STOCKS IN INVENTORY.