Warren Buffett has profited greatly from sentimental markets. Here is the way!
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The stock market has been volatile in recent days due to increased country risks and uncertainty. Jittery markets can make investors jittery. But one investor who has made billions of pounds over the decades thanks to market sentiment is Warren Buffett.
How did you do it?
Focus on facts, not fear
One part of Buffett’s success has been separating the market’s interest from the underlying facts.
Most people know that Buffett has invested in it American Express (NYSE: AXP) over the past decades: Berkshire Hathaway continues to own the shares. Amex looks like Buffett’s classic stock market. It has a strong product, a proven business model and long-term profitability potential.
It also has risks too. Weakening US consumer confidence could lead to higher credit card default rates, hurting profitability.
But few people know today that Buffett bought when one risk was seen as the most significant in the market, which marked the stock of American Express accordingly.
That risk was a financial fraud involving vegetable oil that affected one of the company’s subsidiaries. Buffett correctly assessed that, since the company was not involved in fraud and the financial impact on it was manageable, the stock price crash had been avoided. He used it as an opportunity to buy.
Quality, always, and without exception
Sometimes, however, market downturns can make it difficult to separate fear from reality. Market downturns can be self-fulfilling, making businesses that were once strong and ultimately bankrupting them.
That happened to some financial services businesses during the 2007-08 financial crisis. Some were mismanaged companies but others were, arguably, in the wrong place at the wrong time.
Such market crashes have presented opportunity – but also risk. Buffett’s answer was a masterclass in why he became a millionaire.
He was asked to invest in Bear Stearns, then a major investment bank. He spent the whole night reading its annual report. He saw enough red flags from that alone to decide he didn’t need to spend any more time considering the idea.
That’s right: an annual report can be quite useful. For a small investor like me, that alone is a very important lesson in Buffett’s behavior during the crisis.
But another is his investment in it Goldman Sachsbecause it shows the way Buffett always prioritizes business quality.
Bottom fishing can be dangerous
That sounds easy enough. Who doesn’t love a quality business? The answer is: many investors!
At risk, as share prices fall, they may think that returns look better from a good business marked down to a lower price, rather than a good business at just an attractive price.
Buffett has been around long enough to know that quality is important and worth paying for. Realizing that there were opportunities and dangers in the financial sector that bombed in 2008, Buffett looked to sort the wheat from the chaff.
After working with Goldman for more than half a century, he made $5bn in selective investments and eventually made billions of dollars in profits.
As with calm markets, Buffett wasn’t looking for the cheapest looking stock to buy. He was looking to buy a large business at an attractive price – and he did.
