Value Investor Buys From A Pessimist And Sells To An Optimist

Widespread but totally irrational is the behavior of many a lay investor on the stock market.  They buy high and sell low, totally opposite to what commonsense demands.

Greed and Fear, the twin internal ghosts that had remained unexercised, is at the root of this sad malady.  Anyway it is a long and different story; let us focus on the subject at hand.

Lay investors usually enter the stock market very late, nearly by the end of an enthusiastic price surge – a Bull Run. They know very little about investing, leave alone investing in shares.  They enter out of greed, lured by chances of making a fast buck. Mostly they borrow money – at high interest – and invest.  The prices they pay for the shares they buy are invariably high and unsustainable.

While the lay investor can be excused for their judgmental error, the mutual fund managers, who are supposed to be experts, and on whom millions of ordinary investors repose their trust also end up in the same situation, not out of ignorance, but due to circumstances.  During enthusiastic market conditions, a large and different kind of lay investors, again drawn by the desire to make fast returns and aware of their ignorance of financial markets, pump money into mutual funds, a relatively safe and prudent bet under the circumstances, in their view.  The fund managers are now faced with a sudden and a very serious problem of plenty.  In the financial world, money cannot be kept idle even for a second; it has to invested immediately, in order to generate a return.  The market being high and prices being unreasonable, and yet burdened with excess funds that need urgent deployment, fund managers end up committing the same mistake as lay investors - investing at very high, unjustifiable and unsustainable prices. 

In the mean while, the print and television media pour fuel to the fire, by generating relentless noise in support of perpetual advance in the market – meaning prices of shares - like how the market is unstoppable on its march, predicting still higher market levels, and so on, roping in brokers and experts, who mouth similar platitudes.

Such a market condition provides a great and unique opportunity for the value investor to harvest his crop.  He sells his shares he had accumulated over a long period, at very low and attractive prices, during market lows, to the optimistic recent entrants.

As can be expected, following the general law of gravitation, which postulates that whatever goes up has to come down, the market rapidly melts down and eventually crashes.  There is a worldwide, general carnage.  The lambs are being slaughtered mercilessly, and there is nowhere to hide.

Greed is replaced with fear.  Both the lay investors and the fund managers panic and push the sell button hard.  The same media and experts, who till yesterday were praising the market, change tack and start spreading gloom, by highlighting the crash in horrific and graphic details, making references to the Great Depression of the 1930s, and so on. 

In the process of the market’s rollercoaster ride, thousands have destroyed valuable capital, decimated lifetime savings and their ancestral properties, and ruined their lives and those of their dear ones. 

Market at this juncture is unjustifiably low and shares of blue-chip companies are available at throwaway or very attractive prices.  The situation presents yet another unique opportunity to the value investor.  He pounces at it, and buys the same shares at very low prices from players who are extremely pessimistic about market.  The value investor might even have purchased from the very same pessimistic investor, to whom he had sold at very high prices, when that investor was very optimistic, not very long ago!