Warren Buffett is known for many of his witty quotes and one-liners.
One of them states that “you pay a very high price in the stock market for a cheery consensus”, and for the longest time, the meaning of this statement had eluded me. When I started to understand more about expectations and valuations, that was when his statement automatically made sense to me. Let’s break down the quote to understand what he’s talking about and learn a few lessons from it.
A “Very High Price”
When investors pay a “high” price, it means, in essence, that they are paying for a lot of positive news developments to occur shortly. The “high” in this case refers to high valuations (such as price-earnings ratio, for instance) which bakes in a lot of optimism and expectations for good performance.
If the valuation is very high relative to what the company usually trades at, there must be some reason for this optimism and the investor should dig deeper to determine if there is any justification.
A cheery consensus in this context refers to everyone agreeing that something good is indeed going to occur. Investors may feel sanguine and confident about the company’s growth prospects and project this into the distant future, resulting in most, if not all, of the views out there being aligned and optimistic.
There is great danger here of groupthink occurring, and because of social pressure, no one has the inclination or guts to question the logic of seeing only blue skies ahead. A cheery consensus may, therefore, mask real risks and blind investors to the fact that all may not be right.
So, Should We Pay The Price?
The statement is, therefore, a warning for all investors to remain rooted and rational.
The danger of being swept away in a wave of optimism cannot be over-estimated, as it frequently occurs when everyone, from analysts to fund managers, seem to agree that a company can do no wrong. I would advise investors against purchasing shares in companies where there is excessive optimism which cannot be properly justified, as this may blind them to something negative which could occur and render their investment thesis invalid.
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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.