Warren Buffett once said that as an investor, it is wise to "be fearful when others are greedy and be greedy when others are fearful". This statement is somewhat of a contrarian view of the stock market and directly correlates to the asset's price: when others are greedy, prices typically skyrocket, and people should be cautious lest they buy into an asset that subsequently leads to low returns. Pay too much. It may present a good buying opportunity when others are fearful.
Remember, price is what you pay, value is what you get, and pay too much and the rewards will be drastically reduced. To elaborate on this, the value of a stock is relative to the amount of earnings it will generate over the lifetime of its business. Specifically, this value is determined by discounting all future cash flows back to their present or intrinsic value. Pay too much, and over time the returns generated when a stock is attracted back to its intrinsic value will be eroded. In the right circumstances, to act greedily when others are fearful, and to reap higher rewards: predictability must exist, and short-term events leading to subsequent price downgrades must not be eroded by the "moat".
Warren Buffett isn't just a contrarian investor. He might be what you might call a "business-oriented value investor." Meaning, he doesn't buy anything and everything just because it's on sale. It's Ben Graham's style (and Buffett's at first). It's called the "cigar-ass" investing style, in which people pick up discarded commercial cigar barrels that line the roadside and sell them at a deep discount to book value and keep the money. Next good smoke. Ben Graham looks for "net net worth," or businesses that are below net current assets, or current assets minus total liabilities.
Even though Warren Buffett started his investing career this way, he thrived in the face of meager net opportunities. With the help of Charlie Munger, he discovered a land of excellent businesses, the birthplace of Xisha Candy and Coca-Cola (KO), businesses with durable, competitive economies -- moats -- and rational, honest management . He then looks for a good price and takes advantage of the opportunity when others fear it. As he's said in the past, it's much better to buy a good business at a better price than a great business at an excellent price.
Scary events that lead to good investment opportunities can include short-term shockwaves from macroeconomic events such as recessions, wars, sectoral apathy, or short-term, non-moat shockwaves that damage business performance.
In the 1960s, the value of American Express (AXP) was halved when it was discovered that the collateral it used to secure millions of dollars in warehouse receipts simply didn't exist. The collateral in question was salad oil, and it turns out that commodity trader Anthony De Angelis falsified inventory levels by filling the tank with water while leaving a tank of oil. Small tubes of salad oil for auditors to find. The incident is estimated to have caused damages of more than $50 million.
After reviewing the company's business model, Buffett decided that the company's moat would not be materially affected by the incident, and he invested 40% of the partnership's capital in the company's stock. Over the past five years, AXP has grown fivefold.
In 1976, GEICO teetered on the brink of bankruptcy, in part because of a business model shift that saw the company extend its auto insurance policies to at-risk drivers. Then-CEO John J. Byrne assured that the company would return to its original business model. Buffett initially invested $4.1 million in the company, which has grown to more than $30 million in five years. Geico is now a wholly owned subsidiary of Berkshire Hathaway.
Shockwaves like the salad oil scandal and business models have created value and given Warren Buffett handsome returns over the years. Being greedy when others are fearful is a valuable mindset that can pay off handsomely for investors.
Once the shoe shine boys start posting stock tips, then it's time to leave the party. Charlie Munger once compared the stock market bubble to a long New Year's Eve party. The bubbles are flowing, everyone is enjoying themselves, and there are no arms on the clock. No one knew it was time to go, and they didn't want to. How about another drink?
Being a business value investor has to know when to get out and be ready for this perfect opportunity, be greedy when others are fearful, but be greedy for the long term, enduring economics and rational, honest management.
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