Buffett – Don’t Buy Stocks Just Because They Are Undervalued

Buffett, like many other great investors, tends to be very discriminating-he avoids the temptation of buying a stock that seems alluring at the moment. Any stock can potential be a value if the price is right, but Buffett doesn’t allow himself to be fooled into buying stocks just because they are undervalued.

Eventually, each of the 10,000 or so U.S.-list stocks, including the Qualcomms and Oracles of the world, will trade at undervalued price, but only a small fraction of the 10,000 companies offer compelling long-term growth prospects. Most have poor fundamentals or an erratic growth history and should be shunned. Many others will provide periodic trading gains and then languish when the investment community tires of their stock and seeks short-term profits elsewhere. As you hone your stock picking over time, you will eventually whittle down your short list of buy candidates to a few dozen. Then, you can zero in on this list and purchase them, one at a time, as their prices fall to favorable levels.

You should avoided the temptation of buying stocks simply because you have cash on hand, Buffett believes. More often than not, a havey wallet invites mistakes. At the beginning of 1999, Buffett was holding more than $35 billion in cash and bonds in Berkshire Hathaway’s investment portfolio. He was content to hold this great sum of money, which was equal to the total yearly output of dozens of smaller countries, indefinitely until he found suitably priced companies to purchase. In contrast, most investors feel a psychological need to put their loose change to work almost immediately. Rather than patiently wait for their favroite stocks to decline, they purchase shares of lower quality companies without spending time to study their fundamental properties.

Buffett avoids this trap by identifying all the stocks he wishes to own over the next several years and buys them one at a time, but only when they fall to an attractive price. If the stocks do not fall to his desired price immediately, he takes no action. He knows that the odds favor a decline in price sooner or later. In the interim, he will devote his attention to other desirable companies whose prices may already have fallen to appealing levels.

To help you practice the taking-strike method, you should keep a list of your prospective stock prices. The list should include the maximum price you would willingly pay for the company today. Post this list in a convenient place and check it periodically.

The obvious advantage to warehousing stocks is that it forces you to be vigilant. Before buying, you must determine a reasonable value of the company, which means studying the enterprise. Putting some time into the valuation proves will greatly decrease your chance of buying prematurely. Buying companies in this manner also allows you to build the portfolio you really want and prevents you from adding undesirable stocks simply because you have idle money. In addition, the method harnesses your impatience and – most important- ensures top performance because you will be overpay for any company.

You should update your checklist periodically to make sure your target prices are reasonable. If a company’s growth prospects dwindle, the original buying price you set may be too high. Conversely, if the company’s fundamentals improve, the stock may not retreat to your buying level again. In such cases, you must reappraise the company to determine whether it is truly worth a higher share price.

The point is, when you don’t have to invest, don’t feel you should invest. Once you attain confidence in your own stock picking, you’ll naturally make fewer and fewer buy-and-sell decisions. Being a successful investor gives you the same luxury as having a 20-game lead over the second place team in September. You can rest the bat on your shoulder and take strikes indefinitely because it won’t change the outcome of the season.

PUT YOUR FAVORITE STOCKS IN INVENTORY.