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Paying a High Price for a Cheery Consensus
By Musicwhiz  •  April 20, 2009
[caption id="attachment_1601" align="alignright" width="173" caption="Photo by walknboston"]Photo by walknboston[/caption] Yes, those of you who saw the title are probably thinking it looks very familiar ! It was actually a quote from Warren Buffett when he mentioned that you “pay a very high price in the stock market for a cheery consensus”. I must admit yours truly was quite stumped when I first came across this statement and was wondering what it meant and what implications it had. Initially, I thought he was referring to paying high prices for shares of companies and thereby agreeing with what everyone thought about the company – a form of herd behaviour. Later I realized I was quite wrong when I was thinking about the stock market and the full meaning of this statement hit me like a bolt of lightning from above. In the context of this bear market, we can be considered to be experiencing one of the worst bear markets and recessions in at least the last 70 years. In fact, economists and market experts have termed this period as “The Great Recession” as many aspects mirror the Great Depression era of the 1930’s, with the exception of more globalization now, more co-ordinated stimulus efforts and more liquidity being pumped into each economy by respective central banks. Most investors have seen their portfolios literally melting like hot candle wax since October 2007 to the troughs seen in October 2008 and more recently, March 2009. Economists and government officials have gone on record stating that the recession does not seem to be lifting any time soon and there is a lack of clarity and visibility on how things will turn out. In Singapore, the MAS revised their GDP forecasts for Singapore for FY 2009 to a range of -6% to -9% (from -2% to -5% just a few months back). Exports are falling off a cliff and year-on-year GDP growth rate for 1Q 2009 has slumped 19% to make it the worst quarter since Singapore became independent. So what does all this news portend for the retail investor ? Well, for starters, Mr. Market has become very pessimistic and is willing to pay very low prices for most companies, be they good or bad. This is where the phrase comes in – we tend to pay high “prices” (i.e. valuations) for a cheery consensus (clarity and certainty). The words in brackets help to explain the sentence in the context of how it should be viewed. Valuations are low when there is a lack of clarity, companies are reported declining profits and analysts are scrambling to value companies based on Price-to-book, rather than Price-to-Earnings. This is because earnings have become so uncertain that a different metric must be used, they argue. Price to book is “safer” in that it assumes a more conservative stance with respect to a company’s book value, which is usually the liquidation value of a company after accounting for its assets and liabilities; rather than volatile earnings which can fluctuate from period to period due to the severe slump in consumption and lack of financing options for growing the business. Read more...
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By Musicwhiz
Musicwhiz who is in his 30s is educated in accounting and works in the investment line (but not in a bank, financial institution, brokerage or fund house). He has a have a full-time job and investing is his side-line as well as passion. Musicwhiz is a value investor and his technique is derived from the teachings of Warren Buffett, Benjamin Graham and Phil Fisher. He incorporate all aspects of their investing style, and modify his value investing style to the Singapore market.
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