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Picking Stock In A Fiery Market

That is just plain dangerous. Why would anyone attempt something so audacious”, I said to the Indian gentlemen standing beside me.

It’s only dangerous if you don’t know what you are doing”, he replied with a smile.

I am referring to the fantastic feat of fire walking. Also known as Theemidhi, it was one of the many events organised by Singapore’s Indian community in the weeks ahead of Diwali.

I, along with hundreds of other eager spectators and many Hindu devotees, packed the Sri Mariammam Hindu temple on a warm Sunday evening to watch, at first hand, the bold and daring performance.

Science over the spectacular

The science that lies behind fire walking is, of course, well known. But the science does not detract, in any way, from the spectacular feat, as the fire walkers strode confidently over a four-metre pit of glowing embers in their bare feet.

But the knowledgeable Indian gentleman standing alongside me was absolutely right. Fire walking is only dangerous, if you do not know what you are doing.

Some people have likened the buying of shares in a volatile stock market to walking barefoot on a bed of hot ashes. But as legendary investor Jeremy Grantham once remarked: “Volatility is a symptom that people have no idea of the underlying value”.

Warren Buffett said something similar about risk, which is generally seen as a proxy for volatility. He said: “Risk comes from not knowing what you are doing”.

For many people, volatile markets could be a time for worry and distress. After all, it can be heart-breaking to watch the value of our investments take a hit.

Legends versus mortals

But as Peter Lynch once quipped: “A stock market decline is as routine as a January blizzard in Colorado. If you’re prepared, it can’t hurt you”.

He went on to say: “A decline is a great opportunity to pick up the bargains left behind by investors who are fleeing the storm in panic”.

That is easy for Peter Lynch to say. He is, at the end of the day, a seasoned investor. But what about us mere mortals – how do we go about differentiating between undervalued shares and rip-offs dressed up as bargains?

Aren’t we, like amateur fire walkers, going to get badly burnt, if we pick up the wrong stocks in a volatile market?

That can indeed be a dilemma. But it is not one that is insurmountable, provided we understand that cheap rubbish is still rubbish.

Walking on fire

The day I became a better investor – or as I prefer to call it, the day I learnt to walk on fire – was the day I understood the concept of intrinsic value. You see, every company on the stock market has an intrinsic value.

The value could be derived from the stream of dividends that we, as investors, enjoy by holding the stock. It could be the sum total of the company’s assets. It could also be the earnings that we, as investors, could reap over the long term, simply by owning the shares.

Trouble is, if you don’t understand the intrinsic value, then that could be tantamount to “playing poker without looking at the cards”, as Peter Lynch once joked.

But by recognising the concept of intrinsic value, we should be able to appreciate when shares have been unfairly punished. That is the underlying message behind Warren Buffett’s sage advice: “Be greedy when the market is fearful and be fearful when the market is greedy”.

He didn’t say buy any old rubbish and hope for the best.

Buffett also said: “Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it.”

Volatile times

The period for market volatility has begun. America has exhausted its supply of cheap money; concerns over Eurozone growth have come to the fore and China’s ability to properly rebalance its economy hangs in the balance.

But remember this: If a business does well, the stock eventually follows. In the short term, there is no correlation between a company’s success and its stock. But in the long term, there is a 100% correlation.

So focus on the long term and the 100% correlation, rather than what might happen from day to day.

And don’t, like some, be tempted to ditch stocks for cash at the first sign of disaster. As Peter Lynch once noted: “If total disaster strikes, cash in the bank is going to be as useless as stocks”.

A version of this article first appeared in Take Stock Singapore.  Click here now for your REE subscription to Take Stock -- Singapore, The Motley Fool's free investing newsletter, delivered straight to your inbox. Written by David Kuo, Take Stock -- Singapore tells you exactly what's happening in today's markets, and shows how you can GROW your wealth in the years ahead.

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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 Director David Kuo doesn’t own shares in any companies mentioned.