Opportunistic Investing    By A. Raj Kumar          May 16, 2008

                 Warren Buffett invests in high quality companies only when their stocks are trading at bargain basement prices.  He is also a patient investor with a (very) long-term investment time horizon.  Both of these principles go hand in hand and if you were to follow them with your own investments, they can make you very rich (just like Buffett)!

 

                 Let me explain what I mean and provide an example.  Currently, the stock market fears a recession.  Whenever there is an economic slowdown, sales and profits of many companies drop and consequently, they start to lay people off.  When people are afraid of losing their jobs, they cut back on spending and conserve their financial resources.

 

                 So the stock market fears that a recession (along with the high price of gasoline) will lead to a cutback in discretionary consumer spending.  Which companies get hurt when consumers slow down their spending?  Retailers, of course and guess which types of stocks have gotten clobbered since the beginning of last year? You’re right…retailing stocks like Best Buy, Home Depot, Lowe’s, Target, Staples, and Tiffany just to name a few.

 

                 Because Wall Street has a very short-term time horizon (typically just three to six months), they don’t want to own stocks that will perform poorly in the short-term.  So they have been dumping the retailing stocks.  Of course, for long-term investors like Buffett and me (and hopefully you!), these sell-offs create huge buying opportunities.  If we take a longer investment time horizon than Wall Street’s (let’s say 2 to 5 years), then we can take advantage of these so-called smart money managers.  We will buy high quality companies that they are dumping and sell it back to them five years later at much, much higher prices!

 

                 So here is our simple strategy: every year we buy cheap, beaten down and out of favor stocks of high quality companies with 20% (or one-fifth) of our portfolio and every year we should be selling stocks that we had bought five years earlier and that should have ideally appreciated by a couple hundred percent.  Thus, every year we are buying cheap stocks (buying low) and selling five-year old stocks that have appreciated (selling high).  By following this simple contrarian strategy, we will be adhering to the Single Best Investment Principle ever conceived: Buy Low and Sell High!

 

                 Now, let me add another layer of sophistication to our investment strategy.  If the companies we bought five years ago at bargain prices are continuing to perform well, then we should hang on to the stocks and not sell them.  By performing well I mean that the companies’ sales and profits continue to grow at a healthy pace (say greater than 10% annually or greater than analysts’ growth expectations).  If we keep the winners for a much longer time period (ten to fifteen years), then our potential appreciation can be in the thousands of percents.

 

                 For example, I bought Microsoft back in November 1993 and my cost basis is around $2.52; at Microsoft’s current price of $30 the stock has appreciated by almost 1,100% for me!  Every time Microsoft stock rises by $2.52, I make another 100% return!  The only way you can have a low cost basis on a stock is to hang onto it for a very long time; my Microsoft shares are over 14 years old.

 

                 What about Buffett?  How long has he held onto his stocks?  I don’t have the exact dates when he bought them but I can tell you the cost basis and the percent appreciation (as of 12/31/07) of three of his stocks:

 

                                                                    Cost Basis                                 Percent Appreciation                          When Bought?

                 Washington Post                       $ 6.37                                                      12,327%                                  in the mid-Seventies

                 Coca Cola                                   $ 6.50                                                      845%                                         1987 - 1988

                 American Express                    $ 8.49                                                      512%                                         in 1994

 

                

                 One of the nice advantages of long-term investing is that Uncle Sam subsidizes your gains.  If you sell a stock quickly for profit, then you have to pay capital gain taxes on it.  But if you keep the stock for 15 years, then Uncle Sam never got the capital gain taxes (since you haven’t sold the stock) and instead let you use that money to get additional gains.  So the federal government helps to subsidize the growth of your investment portfolio!  Buffett knows this fully well, which is another reason why he is a long-term investor and is reluctant to sell his stocks quickly.

 

                 Recessions come and go.  They are part of the economic cycle and they typically last for just six to twelve months.  This one too shall pass one day and the U.S. consumer will be back to his/her old addicted ways of shopping.  Retailing stocks, in my opinion, offer a terrific buying opportunity currently.  You may want to consider taking advantage of it.¨

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