Wednesday, October 15, 2008

The New Buffettology: Chp 10: How Warren Discerns Buying Opportunities Others Miss

In addition to bull/bear market cycles, other events such as industry recessions, mistakes made by companies, structural changes and war can present situations to buy stocks cheap.

Industry recessions can present great opportunities to buy stocks in excellent quality companies. Find the best companies that are adequately capitalized during recessions as the weaker companies may go bankrupt. During an industry recession, all the companies get hurt, but the stronger ones will survive. It may take 1 to 4 years for the industry to recover. Warren purchased Capital Cities during an industry recession after the company announced they would not grow profits in 1990. The market hammered the stock down by 40% and then Warren stepped in to buy stock in the company.

Sometimes companies make blunders. Most of the time, when the market finds out about the mistake, it will mercilessly punish the stock price down. If you determine that the problem is reversible, then it can be an incredible time to purchase stock in a company that has a durable competitive advantage. Warren purchased stock in Geico and American Express after those companies had made individual blunders but when the problem was likely to be temporary.

Structural changes can include restructuring, reorganizing and divestitures (spin-offs). During these singular events, the market can often take an overly pessimistic view of the situation and lower the share prices accordingly. Warren purchased Costco after it reported negative earnings due to a restructuring cost.

Times of war represent uncertainty and result in falling stock prices. During war there is a lot of fear in the markets often market participants will sell-off stocks regardless of the quality of the companies. It is often possible to buy companies with durable competitive advantages at cheap prices during these times.

Bad news situations often result in buying opportunities for selective contrarians looking to purchase stocks in excellent quality companies.

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