We’re working off the assumption that everyone that reads this is familiar with Warren Buffett. But I bet far fewer of you can name “Canada’s Warren Buffett.”
Or, even more specifically, the new “Canada’s Warren Buffett.”
Indeed, for years the title of Canada’s Warren Buffett has been held by Prem Watsa, CEO and founder of insurance juggernaut Fairfax Financial Holdings Limited (TO:FFH).
Not only is the company he leads a big player in the insurance industry, like Buffett’s Berkshire Hathaway (NYSE:BRKb), his prowess on the investing side of the business is rather legendary.
Now, Mr. Watsa continues to garner significant respect. This isn’t necessarily a title that he’s lost, per se.
Rather, the new titleholder has come somewhat of the blue, ascending to these lofty heights one deal at a time.
We’re speaking of the CEO of Brookfield Asset Management Inc (TO:BAMa), a Mr. Bruce Flatt. And we’re going to lean on Mr. Flatt a little later on in this note for some prudent investment advice that we think is worth keeping close at hand.
You see, I communicate pretty regularly with hundreds, if not thousands, of investors across our Foolish advisory services here in Canada and my impression is that there’s a mood of significant frustration out there these days.
Heck, I’m frustrated!
And for the most part, the reason boils down to valuation.
Generally speaking, show me a great company and I’ll show you an expensive stock. Indeed, it’s rather easy for most investors to simply throw up their hands and say, “it’s too expensive to invest right now.” The thing is, there are a couple of major problems with that view.
One is that if you’re not investing, your money isn’t doing anything for you. In fact, rather than earning returns on your money, inflation will be chipping away at its value over time.
And though the theory may be to wait until market prices fall and invest then, that’s a strategy that’s easier said than done. That is, while it sounds wise to say – and certainly isn’t wrong – as with many things, the devil is in the details. Take it from me, as someone who’s biggest investing mistake was not investing nearly enough in the wake of the financial crisis.
If you’re waiting for markets to fall before buying, exactly how much does the market have to fall before you buy? 10%? 30%?
Or, perhaps like many investors, you’d set a certain valuation ratio at which you’d invest.
Again, this sounds good, but it can be problematic. Buying when everything is falling can be much harder than it seems. There is a strong behavioral bias against doing such a thing. Plus, when the market starts falling, there’s usually some upheaval and economic turmoil associated with it. That makes it far more difficult to buy.
And the trap an investor can fall into once prices start dropping is that they keep waiting for prices to be just a bit lower and then just a bit lower still. Or, they tell themselves that the prices are falling, but the deterioration of the economic situation makes it precarious to invest and worth waiting a bit longer “to see how things turn out.”
To make matters worse, if you haven’t invested by the time the rebound starts, you may see prices start to rise and think to yourself, “They’re surely not done falling, this is just a short-term movement before they start falling again.”
That’s 100% the scenario that befell yours truly after the financial crisis.
But as they keep rising, it gets ever more difficult to jump in, since it seems with each passing day that you’ve missed the opportunity.
In short, this ill-fated investor may find that the time never seems right to invest.
This said, it’s not wrong to prefer investing when prices are lower!
About the simplest stock-market truth you can find is this: All else held equal, when you invest at a lower price, your returns will be better.
So, I’m not saying you can’t wait until markets drop, or that you shouldn’t wait. I’m just saying that from a practical and psychological perspective, pulling that off is much harder than most people think.
What if you didn’t wait?
Of course, rather than waiting for the market to fall before you invest there’s also the option – to not wait.
That might not sound like a great plan at first. After all, I just said that, all else equal, investing at lower prices leads to better returns. The opposite easily holds: All else equal, investing at higher prices leads to lower returns. And we started above with the argument that valuations do look relatively high today.
Successful investing, however, is far more about shades of grey vs. black and white.
One way to deal with this is to simply be a “cost averaging” investor. That is, you decide that you’re going to invest in a broad basket of low-cost index funds and do that over time. Here, part of the strategy is to simply not worry about market valuations. You invest consistently, with the knowledge that you’ll sometimes end up investing when valuations are high, and sometimes when valuations are low. In the end though, it’ll average out.
Easy, peasy. And given the long-term nature of the market is to go higher, highly effective.
The other option is to invest in individual stocks, rather than the market as a whole.
When you go this route, rather than investing broadly – accepting the stocks that are overpriced as well as those that may be undervalued – you look for just the opportunities that, in your mind, the market may have missed.
Too good to be true?
Not so fast. Let’s now turn to Bruce Flatt who wrote this recently in a letter to Brookfield shareholders:
That these opportunities exist in the current economic environment may seem improbable; however, they always do, since the world is a big place and investors inevitably become overly exuberant in one sector or another. Finding great value investments in this environment requires the ability to look in the right places. It also requires us to work a little harder…
In other words, the opportunities are out there. You just have to look in the right places. And look hard enough.
Not every investor will want to do this because of the work that it requires. Which is exactly why these opportunities remain available for investors willing to put the effort in.
I might even argue that given the move to passive investing (Index ETFs and such) that’s occurred, fewer and fewer people are willing to put the effort in every day.
Great news for those of us willing to roll up our sleeves.
But how exactly should you start your search for the investments the market is missing?
I suggest keeping these three points in mind:
1. Consider smaller stocks. Big institutions move a lot of money around in the markets. Really small stocks are often not that useful to funds with a lot of money because they won’t have a big impact on the fund’s returns. So they often ignore these smaller companies.
2. Take note of things that “everybody knows.” More specifically, look for something that “everybody knows,” but that just isn’t true. (For instance that “all stocks are expensive right now.”)
3. Look beyond the top-level numbers. A company’s financials are important, but they only tell part of the story. If you don’t understand how the company achieved those numbers – whether good or bad – you won’t have a good understanding of whether it’s a good investment. And by looking beyond the numbers, you may be able to find opportunities that other investors are overlooking.
Iain Butler,
CFA Chief Investment Advisor
Motley Fool Canada
Disclosure: Iain Butler owns shares of Brookfield Asset Management. The Motley Fool owns shares of Brookfield Asset Management. The Motley Fool owns shares of Berkshire Hathaway (B shares).