At about 2:30 in the afternoon, today, July 1st, I took a look at my Seeking Alpha screen of the stocks that I follow and noticed that every single company I follow is up 1% or 2%:
Personally, I get ticked off seeing prices rise like this. If you are a net buyer of stocks (and that is the key term), then you should not be happy seeing these price increases because these companies are becoming less and less attractive. For every dollar of profit and dividends that ConocoPhillips generates, you have to pay 1.37% more today than you did on Friday. Today, you have to pay 1.82% more for each dollar of profits and dividends that Emerson Electric generates than you did on Friday. Sure, if you are planning to sell those companies, this is good news. But if you are planning to buy stocks, you should hate this crap because it means stocks are getting more expensive, and represent lower risk-adjusted returns going forward than they did on Friday.
Nevertheless, I understand the typical human wiring that regards higher prices “as good” and lower prices as “bad.” We receive stock price quotes every day, and there can be a psychological thrill knowing that you hypothetically could sell your stocks for a higher price than you paid for them. I get that.
But one unfortunate side effect that typically occurs during a bull market is that investors begin considering stocks that they would never pay attention to during a recession. I have said this before, and I’ll sell it again, Charlie Munger is right when he says that you should never own a stock which you could not stand to see fall in price by at least 50%. Since Buffett and Munger took over Berkshire Hathaway, they have grown book value by over 19% each year. That is one of the best investing records of the 20th and 21st century. Yet, the price of Berkshire Hathaway stock fell 50% during four different intervals in the past forty years of their stewardship.
Think back to 2009. What stocks did you feel comfortable holding on to then? Those are the kinds of stocks that you should still be focusing on today, because a strategy is meaningless if you cannot stick to it during the next recession.
The words of the Roman lyrical poet Horace come to mind: “Remember that there is nothing stable in the course of human affairs; therefore, avoid undue elation in times of prosperity and undue depression in times of adversity.” Right now, things are going “well” in the economy and the stock market, especially relative to where we were five years ago. But Horace is right when he says that we need to avoid undue elation. The big temptation is that investors might feel comfortable lowering the quality of their portfolio (by shifting away from the big names like Coca-Cola, Johnson & Johnson, and Procter & Gamble) because everything seems to be going up. Don’t fill victim to that. A great way to screen for stocks, while sticking within the spirit of the Horace quote above, is to only own companies that you would feel comfortable owning for the next ten years. If you are not comfortable with that kind of holding period, it may be because you are starting to glance at companies with lower earnings quality because they tend to go up in price more during a bull market. Resist that temptation.
Originally posted 2013-07-01 14:33:35.