How to Be Greedy When Others Are Fearful

fear dice

Warren Buffett, the Oracle of Omaha, is well known for his folksy quotes which help bring common sense to the topic of investing. Among the plethora of one-liners he has, the following is perhaps one of his most well-liked:

 “Be fearful when others are greedy and greedy when others are fearful.”

On the surface, this quote sounds reasonable and seems to represent what an investor should do in order to obtain a respectable return for the money he or she has invested. However, in practice, it may not be as straight forward.

In fact, my American colleague Morgan Housel had this to say about that particular Buffett quote:

 “Saying “I’ll be greedy when others are fearful” is much easier than actually doing it”

Morgan even lists this as the first of his 50 unfortunate truths about investing.

Why? Try this pop quiz!

Let’s take a look at the financials of a particular company (name to be revealed below) from 2006 to 2008 in the table below. It shows the changes in its revenue, net profit, and cash position for the years mentioned. So, take a look and let me know what you think.

2006 2007 2008 % change 2006-2008
Revenue* 622.9 523.7 456.7 -26.7%
Net Profit* 33.8 3.10 (99.4) -294%
Cash and Equivalents* 29.8 27.8 26.3 -11.7%

*Amounts are given in millions, S$

Source: company’s annual report; author’s calculation

If the developments of the numbers above look gut-wrenchingly bad, you wouldn’t have been wrong to think so. The company went from being profitable (on a net profit basis) to shockingly unprofitable. A snarky investor, back in 2008, might even remark that you would have to be really greedy to want this train wreck of a company.

However, that snarky investor may be surprised that the company’s stock price return from 1 Jan 2006 till 19 August 2014 is actually 115%. This remarkable return would have soundly thrashed the 6.3% return of the STI ETF (SGX:ES3), a proxy for the Straits Times Index (SGX:^STI), over the same time period.

How is that even possible? Tell me more.

Ironically, the best explanation may lie in another of Buffett’s quotes:

“In the business world, the rearview mirror is always clearer than the windshield.”

The truth is, while it sounds perfectly logical to be greedy while others are fearful, in practice, it is not as straight forward to do so. The numbers on the table represent the rearview mirror – it was the view in 2008 which was precise and clear.

To elaborate further, let me reveal the company’s name now.

The company in question happens to be OSIM International Ltd. (SGX:O23). For the case of the massage chair maker – in Buffett’s parlance – the windshield in 2008 had a view which was less clear, but far more positive. Here are some of the actions and things you could only see through the windshield for Osim International in 2008:

a) The company had acknowledged a business error in the USA (its Brookstone investment) and took a non-cash impairment for the losses incurred. Excluding the one-off charge, OSIM would have made S$15m in profits after tax in 2008 – an improvement over 2007.

b) OSIM’s uSpace Massage chair was awarded an Honourable Mention on the Red Dot Designed Award 2008 and Good Design Award 2008 from the Japan Industrial Design Promotion Organisation (JIDPO).

c) OSIM had adopted a leaner cost structure which helped it remain free-cash-flow positive – the company generated S$14m in free cash flow in 2008.

The changes made in 2008 ultimately paid off. As of the financial year ended 2013, OSIM clocked in an annual revenue of S$648 million and a net income of S$102 million. Its cash position on its balance sheet had also grown to S$73 million (while carrying minimal debt) as it remained free cash flow positive throughout for the most part between 2008 and 2013.

Foolish Bottom Line

Often, it takes a lot more than a keen eye for accounting (a rearview mirror) to act when others are fearful. In all fairness, even if we had spent more time looking forward (the windshield), it is still impossible to be correct all the time. It could well have turned out that OSIM International would not have survived or would have just remained stagnant.

But that takes nothing away from how we have learn to move forward while embracing “the things that are yet unknown” in the future in order to able to generate a respectable return. That is also to say, that whenever we make an investment, there is a degree of faith involved.

Perhaps, Peter Lynch, an investor as legendary as Buffett, summarized it best in his quote:

“Keeping the faith and stock-picking are normally not discussed in the same paragraph, but success in the latter depends on the former. You can be the world’s greatest expert on balance sheets or P/E ratios, but without faith, you’ll tend to believe the negative headlines.

What sort of faith am I talking about?

Faith that America will survive, that people will continue to get up in the morning and put their pants on one leg at a time, and that the corporations that make the pants will turn a profit for the shareholders”

I could not put it any simpler than this.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chin Hui Leong doesn’t own shares in any companies mentioned.