Volatility is inherent to the stock markets; the question that often bothers investor is, “how to navigate turbulent stock markets?” Fortunately those value investors who make long term investment through systematic investment plan (SIP) can easily weather the financial crisis created by market turbulence. They need not fear the volatility index or the VIX index and call FRM or financial risk management experts.
When market turbulence is playing havoc and ruining the prospects of thousands, how can value investors remain unaffected?
Reasons Behind Value Investor's Calm
The relative peace and calm enjoyed by value investors, even amidst severe market volatility emanates from the sound knowledge they posses about:
- Estimating the Intrinsic Value of Shares: Every thing in this world, including a stock has an inherent or intrinsic value. Knowing or estimating is the key.
- Fix the Fair Price of the Stock: Once you know the intrinsic value it is easy to fix the fair value of a share -it has to be below or at par or at a tiny premium to the intrinsic value.
- Margin of Safety: stock should not be bough at high valuations - even those of excellent companies
- Mastery over Control of Emotions: Investors are driven by two powerful emotions, greed and fear. Value Investors develop the sound mental framework to keep these two demons under check.
Warren Buffett's Bank of America Investment
Let us take a practical example. Post Lehman Brothers' market crash markets were in disarray - investor were fleeing the markets in panic. Warren Buffett made a huge investment of US$ 5.00 billion in Bank of America (BoA) in the year 2011 - in 700 million share warrants that could be converted into equity shares at a price of US$ 7.14 a piece. On 30th June 2017 the value of that investment stood at US$ 17.00 billion, a clear profit of US$ 12 billion. How could he do it? Could he crystal gaze the future? Absolutely no. Even though the stock market was in paranoia he simply knew the real worth of Bank of America shares!
Two Extreme Market Conditions
Stock markets are constantly in motion like a pendulum, between extreme pessimism and unjustified optimism. Individual stock prices tend to reflect the general market trend or mood. Still an astute investor will be able to spot attractive opportunities. For the intelligent investor, extreme stock market volatility is not a foe but a true friend. With practical examples let us examine how sane and profitable investment decisions can me made amidst extreme stock market volatility.
What to Do When Markets Are Extremely Bullish?
Stock markets globally are at their peak, like today (18th July, 2017):
- Dow Jone Industrial Average: Over 21,500
- S&P BSE Sensex: Around 32,000
- NIFTY 50: 9,900 level
Such a market condition generally drives up prices of stock across the board. There are two broad ways to act under such conditions:
- Move to Bonds
- Identify stocks neglected by the market
Let us examine these two options closely.
Investment in Bonds
Bonds behave right opposite to stocks. When stocks become expensive, bonds become cheap. A sharp investor can find bond issues of rock solid companies trading at prices below their par value or face value. Prudent investments in such bonds can provide good interest income as well as capital appreciation.
However, profitable bond market investments are possible only in financially mature and developed markets like the US and Europe. Indian bond market is still in early stages of development, lacking necessary depth and access.
Stocks Neglected by the Market
Contrary to the popular belief, stock markets are neither perfect nor rational. Market players tend to become prejudicial towards certain stock and neglect them. Such neglect or error in judgement helps the value investor who is able to identify wonderful opportunities.
Today, when the stock markets around the world are at their historical highs, shares of following wonderful companies are still trading at attractive valuations:
Serial Number
|
Stock
|
PE x P2BV Ratio
|
Dividend Yield
|
||
Recom-mended <1.5
|
Recom-mended <15
|
Recom-mended <22.50
|
> 2.50%
|
||
1
|
NHPC
|
1.06
|
11.21
|
11.88
|
5.67%
|
2
|
PFC
|
0.46
|
15.60
|
7.18
|
3.70%
|
3
|
REC
|
0.65
|
5.96
|
3.87
|
3.70%
|
4
|
NMDC
|
1.50
|
13.75
|
20.63
|
4.56%
|
5
|
SJVN
|
1.20
|
8.69
|
10.43
|
7.03%
|
6
|
Neyveli Lignite
|
1.16
|
5.02
|
5.82
|
6.92%
|
7
|
NGC
|
0.82
|
12.60
|
10.33
|
4.29%
|
8
|
OIL
|
0.81
|
15.62
|
12.65
|
3.15%
|
9
|
GE SHIP
|
0.74
|
10.12
|
7.49
|
2.50%
|
10
|
VEDANTA
|
1.52
|
5.27
|
8.01
|
8.49%
|
Handling the Bear market
While many innocent and uninformed investors fear the bear markets, there cannot be a better opportunity to create significant long-term wealth than a bear market. Have we not already become wiser from Warren Buffett's BoA case study?
When you know the real worth of a share and during a great market crash the share is available at a throwaway price will you celebrate or flee the market?
A-la Warren Buffett, I too made investments during the massive market plunge post Lehman Brothers incident. The invest I used to make used to get eroded by 25-50% on the market next day. But I was not scared - I went on making further investments in the same stock - sometimes doubling the investments. Believe me, I was nervous but not scared.
As with Buffett's investments, mine too recovered and gained 250-300% in a span of about six to twelve months.
Suggested Further Study:
- Value Investor Buys From A Pessimist And Sells To An Optimist
- You Only Find Out Who is Swimming Naked When The Tide Goes Out
- Buy Stocks When Others are Fleeing
Conclusion
Stock market swings are natural and beneficial. There is a sure and safe answer to the question, “how to navigate turbulent stock markets?” Value investors who make long term investment through systematic investment plan (SIP) can overcome the financial crisis created by market turbulence. There is absolutely no fear of the volatility index or the VIX index or call FRM or financial risk management experts. Investors can safely and gainfully navigate stock market turbulence.
