WS: BUY STOCKS LIKE STEAKS

Christopher Browne is the President of Tweedy, Browne Funds, a U.S. based mutual fund group famous for its Graham/Buffett value investing approach. In his recent book, "The Little Book of Value Investing, 2007" Browne outlines the value investing philosophy that has made his investing career, and that of so many other value-oriented money managers, so successful. This series of articles are paritally extracted from his great little book.

"ON SALE" are two of the most compelling words in advertising. Imagine that you are in the supermarket, strolling down the aisles gathering your groceries for the week ahead. In the meat aisle, you discover that one of your favorites, prime Delmonico steak, is on sale-- down to just $2.50 per pound from the usual $8.99 per pound. What do you do? You load up the cart with this delicacy while it's cheaply priced. When you return next week and see those Delmonico steaks priced at $12.99 a pound, you pause. Perhaps this week, chicken or pork might be a smarter buy.

This is how most people shop. They check the sales flyers stuffed in the Sunday newspaper and make their purchases when they spot a bargain on something they want or need. They wait until a refrigerator goes on sale no matter how much they need a new one. Every holiday they flock to the mall to take advantage of the huge bargains that are only offered a few times during the year. When interest rates drop, they run to the bank or mortgage broker to refinance or take out new and bigger mortgages. Most people tend to look at pretty much everything they buy with an eye on the value they get for the price paid... except in the stock market.

In the stock market, there is the irresistible excitement and lure of the hot stocks everyone is talking about at cocktail parties-- the ones that are the darlings of the talking heads on cable stock market shows, and the financial newsletters tell us that we must own. It is the wave of the future! It is a new paradigm! People believe that they'll miss a terrific opportunity if they don't own these super exciting stocks. When stocks climb, broker research reports scream Buy. When stocks fall, the experts tell us to Hold when they really mean Sell.

There are reasons for this pattern of behavior: First, investors are afraid of being left behind and like the idea of owning the hot and popular stocks everyone is talking about. They also find a certain comfort in knowing that lots of other people have made the same choices (like fans cheering for the same sports team). But it's not just everyday, individual investors who fall prey to the herd mentality; it also happens to professional portfolio managers. If they own the same stocks everyone else owns, they are unlikely to be fired if the stocks go down. After all, they won't look quite so bad compared to their peers, who will also be down. This unique situation fosters a mind-set that allows investors to be comfortable losing money as long as everyone else is losing money, too.

The other reason investors fall prey to the fads and follow the crowd is that investors, both individual and professional, tend to become disillusioned when the stocks they own or stock markets in general decline significantly. They end up with a bad taste in their mouths that prevents them from buying stocks while the value of their retirement funds is falling. When stocks go down, people lose money. The news-- on television, in the papers-- seems all doom and gloom. Investors get scared.

However, buying stocks should not be so different from buying steak on sale or waiting for the car companies to offer special incentives. In fact, the Internet has made bargain buyers of everyone: You can buy used books from stores in the United Kingdom, computers don't really care where the seller is-- you just want the bargain (often found on eBay)-- and in our increasingly borderless world, the "stores" you shop at are not limited to those that are a short drive away.

The same holds for stocks. The time to buy stocks is when they are on sale, and not when they are high priced because everyone wants to own them. I have been investing for myself and for clients for more than 30 years, and I always try to buy stocks on sale, no matter where the sale is. Buying stocks when they are cheap has for me been the best way to grow my money. Stocks of good companies on sale reaped the highest returns. They have beaten both the market and the more glamorous and exciting issues being chatted about at cocktain parties or around the watercooler at work.

Hot stocks (or growth stocks, in financial world parlance) have always been considered the more exciting and interesting form of investing. But are they the most profitable? When people invest in growth stocks, they are hoping to invest in companies that have a product or service that is in high demand and will grow faster than the rest of the marketplace. Growth investors tend to own the darlings of the day-- hot new products or companies with lots of sex appeal. They tend to be the best among their industry group and innovators in their field.

There is nothing wrong with owning great businesses that can grow at fast rates. The fault in this approach lies in the price that investors pay. Nothing grows at superhigh rates forever. Eventually, hypergrowth slows. In the interim, investors have often bit the prices of these hot, glamour stocks up to unsustainable heights. When growth rates decline, the result can be injurous to the investor's financial well-being.

This trend can easily be seen in the world of funds. Over the past five years, value funds have outperformed growth funds by 4.87% annually compounded. This is remarkable when you consider that the press frequently hails professional investors who beat the markets by a penny or two.

The value investing concept is supported by rigorous academic studies. These studies make a compelling case that buying the cheapest stocks based on simple principles produces better results. From 1968 to 2004, value portfolio characteristics produced superior returns. In many cases, the degree of outperformance in these studies was several percentage points greater. You don't have to read all these studies, but understanding the research and results will help you better appreciate the tremendous advantage that value investing provides.

A few percentage points of better performance can have a huge impact on your net worth. Suppose you invested $10,000 in your retirement account, and it compounded at 8% for 30 years. By the time you were ready to retire, you would have just over $100,000. A tidy sum! However, if you could compound that same $10,000 over the same 30 years at 11%, your nest egg would grow to nearly $229,000. That would make a big difference in the way you spend your retirement years. Just as it makes sense to buy steaks, cars, and jeans on sale, it makes sense to buy stocks on sale, too. Stocks on sale will give you more value in return for your dollars.

To be continued...


Credits: Much of this article is extracted, with some modification, from The Little Book of Value Investing by Christopher H. Browne, 2007.


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