As a seasoned and grizzled veteran of the financial services industry for now going on 50 years, the most commonly asked questions I have received, and still do to this day, are: when to buy and when to sell a stock? Moreover, these very questions are the mother of how and why I have been labeled “Mr. Valuation.” You see, from my perspective, the answers to these important questions are directly linked to valuation, which is why so much of my work over the years has been on how to value a business. Therefore, in this context, the real question is how do you value a business?
For starters, the prudent investor must accept that you cannot value a business with perfect precision and therefore should not try. Instead, you want to have a range of valuations that are based on realistic assessments of what a business can produce on its shareholders’ behalf. Nevertheless, once you have a reasoned understanding of the value of the business then and only then can you make intelligent buy, sell or hold decisions. But once again, not with perfect timing but with prudent calculations offering a range of value that prudent investors can embrace.
Moreover, there are timeless principles of valuation that are rooted in sound fundamental analysis. Over the years, I have written about these timeless principles on numerous occasions. Consequently, instead of trying to reinvent the wheel, I have decided to refresh, update and repost some of my earlier work. In 2010 I published a series of articles on the principles of valuation. Over the course of the next several weeks, I will be presenting a new series of updated versions of those original works. This article will be the first in that series.
When to Buy, When to Sell
The two most important questions that investors in common stocks want answered are: When to buy, and when to sell?
As I alluded to in the introduction, I don’t believe that perfect answers to either question are possible. There are sound answers, prudent answers, and intelligent answers – but no perfect answers.
On the other hand, there often exists obvious times when a stock should be bought or sold. Thus, obvious buy and sell mistakes can be avoided by investors who understand the fundamental principles behind valuation. Prudent investors, through the application of intelligent research, can engage in a reasoned approach to finding the appropriate answers.
The main reason that perfect answers are not possible can be found in the classic Warren Buffett quote: “The fact that people will be full of greed, fear or folly is predictable. The sequence is not predictable.“
Buffett is speaking to the reality that the stock market can and often does temporarily miss-appraise stocks. During times of greed, the market is quite capable of overvaluing companies, sometimes to an outlandishly high level. When fear reigns, the market can significantly undervalue a company and keep it that way for an outlandishly long period of time.