Friday, November 28, 2008

Stocks Lose Money In Bear Markets...Or Do They?

It's no secret that value investors (including us) believe the market is overly optimistic when times are good, and far too pessimistic when times are bad. As a result, there are profit opportunities for those with a long-term outlook. But when we say long-term, are we talking decades, or just a couple of years?

Many believe the best way to play the market is to behave like it. Buy when things are hot, sell when they're cold. After all, in the "long-term" we're all dead. They point to "lost decades" in stock investing, such as the 1929 crash where the S&P did not recover its pre-crash price for 25 years.

Unfortunately, this is far too simplistic a viewpoint. While certain stocks undoubtedly matched the market, others did poorly and other blossomed. Those who can pick the stocks trading at discounts to their intrinsic values, and who do so recognizing that companies with low debt (including required payments such as operating leases) have the ability to survive, will do well.

Furthermore, looking only at S&P price points ignores the all-important dividend factor. When including dividends, the S&P index in 1952 was 4.5 times its price in 1928! Unfortunately, this stat never makes it into the headlines thanks to an inherent media bias towards sensationalism. (You can't blame them though...that's how they pay the bills!)

For more on this subject, Professor Dan Richards of the Rotman School of Business has written a terrific article here.

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