Price is what you pay, value is what you get
– Warren Buffett
The market for stocks goes above and below intrinsic value all the time.
Share prices are more volatile than cash flows. Share prices are more volatile than dividends too.
Even for large blue chip companies, share prices tend to be too volatile. This can be evident when reviewing P/E ratios over a given year for any company really.
For example, Apple (AAPL), has traded between a low of 164.08 and a high of 237.23 over the past 12 months. That’s a very high amplitude of over 40% in a given year for one of the largest and most widely held companies on earth, which is followed by so many analysts.
Those cashflows and the intrinsic value of the business did not move by 40% in a single year. It’s prices, driven by the fear and greed of market participants, which overshot on the upside and on the downside.
This presents you with some opportunity for the enterprising investor.
In general, it is probably better to buy shares in a good company when it is selling at a relatively cheap valuation.
However, most great companies tend to grow intrinsic value over time. That’s because they are able to grow earnings and dividends over time.
Hence, the risk is that the investor who waits for too long to acquire such shares at a discount may end up missing out on a lot of returns.
On the other hand, there is also the risk that the investor has unfortunate timing and ends up buying a little too high, after which he may have to experience some reversion to the mean over a period of a few years, which could end up testing their conviction.
A lot of value investing has tended to focus on buying low and selling high. I believe that once a good company is acquired at a good price, the job of the investor is to sit tight and let the power of compounding do the heavy lifting for them.
In the Words of Warren Buffett: “It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”
I believe that buying a great company at a decent price is a good strategy. In effect, it makes sense to acquire a great company at a P/E of 15, versus 20 or even 25.
However, if you do not invest at a P/E of 25, and waited for a P/E of 15 or 20 that never comes, you may miss out on a ton of compounding.
After all, the real wealth in investing comes from growth in earnings per share and dividends. Changes in valuation do tend to matter in the short-run ( 1 – 5 years), but their importance tends to diminish after a decade of investing.
As we have discussed before, investing is a game of trade-offs. The optimal path is to have the right margin of safety along those various trade-off paths.
Investing is part art, part science.
