Last week, I had written about 15 surprising things regarding the investing world that I think every investor should know. These things come from my years of experience as a student of the investing game (10-plus years) and writer and analyst with the Motley Fool Singapore (over three). A few days back, a number of other surprising and important things about finance had jumped into my head. So, here are the 16th and 17th to add to my ever-expanding list: 16. How volatile even a company like Berkshire Hathaway can be. The U.S.-listed Berkshire is the conglomerate that’s currently…
Last week, I had written about 15 surprising things regarding the investing world that I think every investor should know.
These things come from my years of experience as a student of the investing game (10-plus years) and writer and analyst with the Motley Fool Singapore (over three). A few days back, a number of other surprising and important things about finance had jumped into my head. So, here are the 16th and 17th to add to my ever-expanding list:
16. How volatile even a company like Berkshire Hathaway can be.
The U.S.-listed Berkshire is the conglomerate that’s currently run by the super investors Warren Buffett and Charlie Munger. Both are long-time leaders of Berkshire; Buffet took over the company in 1965 and Munger joined in 1978.
Over the years, they have helped grow Berkshire by using the company’s capital to invest in the stock market and acquire other companies with attractive economic characteristics. And grow, Berkshire did. From 1965 to 2015, the company’s book value per share – a proxy for the firm’s real economic worth – had compounded at an astounding annual rate of 19.2%.
Given the investing prowess of Buffett and Munger (both men were also extremely successful fund managers prior to their Berkshire-related careers), it may be easy to imagine that Berkshire’s share price would be an oasis of calm in the stock market. But, that’s not true. In 2009, Munger said:
“This is the third time that Warren and I have seen our holdings in Berkshire Hathaway go down, top tick to bottom tick, by 50%.”
Munger’s statements that followed the above are crucial takeaways from the knowledge that even Berkshire Hathaway can have its volatile moments (emphases mine):
“I think it’s in the nature of long-term shareholding that the normal vicissitudes in markets means that the long-term holder has the quoted value of his stocks go down by, say, 50%.
In fact, you can argue that if you’re not willing to react with equanimity to a market price decline of 50% two or three times a century, you’re not fit to be a common shareholder, and you deserve the mediocre result you’re going to get compared to the people who can be more philosophical about these market fluctuations.”
17. Stocks can rise and fall like a roller-coaster ride despite there being hardly any changes to their business fundamentals.
This point is underscored by research that Yale University economics professor Robert Shiller had done in the 1980s.
Shiller had looked at how the stock market in the U.S. had performed from 1871 to 1979 and compared it to how it should have rationally performed if investors had hindsight knowledge of how dividends of U.S. stocks changed. The results are shown in the chart below, and they are fascinating.
The solid line you see is the stock market’s actual performance; the dashed line represents the rational-and-with-hindsight performance. Although stock prices in the U.S. had fluctuated violently over the 100-plus years under study, the actual fundamentals of American businesses – using the level of dividends as a proxy – had changed in a much less drastic fashion.
I think we had seen a similar dynamic play out during the Great Financial Crisis of 2008-09 as well.
Shares of stock exchange operator Singapore Exchange Limited (SGX: S68) had collapsed by over 75% from a peak of S$16.40 on October 2007 to a low of S$4.02 on March 2009. Investors who focused solely on the company’s stock price would think that a disaster of epic proportions had happened.
But, the bulk of the company’s stock price decline had been the result of a compression in its valuation multiple – from a price-to-earnings (PE) ratio of 41 at the peak to a PE ratio of just 12 at the trough, which works out to be a 70% plunge in the earnings multiple – and not a collapse in the firm’s business.
Oil rig builder Sembcorp Marine Ltd (SGX: S51) provides another good example. The company’s shares had sunk by 78% from peak-to-trough (from S$5.60 on October 2007 to S$1.23 on October 2008) during the crisis. Its PE ratio had nosedived by 79% from 38 to 8 over the same period.
The next time you see stock prices crash, don’t panic. Dig deeper beneath the surface. The underlying businesses may still be healthy and that is what’s most important over the long-term.
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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 writer Chong Ser Jing owns shares in Berkshire Hathaway.