At the time of writing (2:41 pm), Singapore’s market benchmark, the Straits Times Index (SGX: ^STI), is down by 2.65% to 3,070 points from its close yesterday. At its current level, the index is also a painful 13.5% lower than its 52-week high of 3,550 points that was reached barely four months ago in mid-April. With plenty of red ink having been spilt, should investors be panicking? A falling stock market and how you should react Looking at a sea of red is not an easy or enjoyable task – trust me, I know. But here’s the thing, if you’re a long-term…
At the time of writing (2:41 pm), Singapore’s market benchmark, the Straits Times Index (SGX: ^STI), is down by 2.65% to 3,070 points from its close yesterday. At its current level, the index is also a painful 13.5% lower than its 52-week high of 3,550 points that was reached barely four months ago in mid-April.
With plenty of red ink having been spilt, should investors be panicking?
A falling stock market and how you should react
Looking at a sea of red is not an easy or enjoyable task – trust me, I know. But here’s the thing, if you’re a long-term investor, you should be rejoicing if stock prices fall. This is Warren Buffett on the topic in his 1997 Berkshire Hathaway annual shareholder’s letter:
“A short quiz: If you plan to eat hamburgers throughout your life and are not a cattle producer, should you wish for higher or lower prices for beef? Likewise, if you are going to buy a car from time to time but are not an auto manufacturer, should you prefer higher or lower car prices? These questions, of course, answer themselves.
But now for the final exam: If you expect to be a net saver during the next five years, should you hope for a higher or lower stock market during that period? Many investors get this one wrong. Even though they are going to be net buyers of stocks for many years to come, they are elated when stock prices rise and depressed when they fall. In effect, they rejoice because prices have risen for the “hamburgers” they will soon be buying.
This reaction makes no sense. Only those who will be sellers of equities in the near future should be happy at seeing stocks rise. Prospective purchasers should much prefer sinking prices.”
What to buy
So, the stock market’s recent malaise should be a prompt for us to start searching for bargains. But, that does not mean we should be indiscriminately buying stocks just because they have fallen in price – we still have to pay attention to the relationship between a stock’s price and the underlying intrinsic value of its businesses.
This raises the question: How can a company be considered undervalued? Here are a few ways:
- A company has strong potential to grow materially over the years and a high chance that it can achieve its potential. But, none of that is reflected in the company’s stock price.
- The market is so pessimistic about a company’s business that its stock is trading below liquidation value (the liquidation value is the value of a business which can theoretically be recovered after it sells all its assets and settles all its obligations).
Note that none of the reasons above involve what the stock market is currently doing or what is going to happen to the macro economy. This is because what the market and the economy will do is out of our control and often unknowable; as such, we should not let our investing decisions be led by them. We should instead be focusing our attention on things we can control and know with some degree of certainty (like the price we pay for a stock and the value of a business).
Benjamin Graham, an important figure in the world of investing, was believed to have expressed the thought that the stock market is a voting machine in the short run, but a weighing machine in the long run.
If you have been making prudent investing decisions, then the value of your investments would eventually still be weighed correctly. When the markets decline, we should be thinking of how we can take advantage of the situation, not run away in fear.
There are plenty of interesting things about stock market crashes to talk about. If you'd like to do so in person, come meet David Kuo and the rest of the Fool Singapore team on August 15!
The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore writer Stanley Lim owns shares in Berkshire Hathaway.