Academia has long argued that risk is quantified by beta, which looks at the volatility of a stock’s share price in relation to some index (with more volatility, or a higher beta, being seen as riskier). As many value investors have argued in the past, true investment risk is captured by the potential for permanent loss of capital, not volatility. However, after reading a quote from the "Intelligent Investor" by Ben Graham, I’ve changed my mind.
When Warren Buffett bought shares in the Washington Post (WPO) in 1973, he knew he was getting a steal: With a going market price of less than $100 million and assets that could have been sold “to any one of ten buyers for not less than $400 million,” Warren backed up the truck. As Warren noted in a speech years later, the ironic thing was that academia would tell you that the Post was getting riskier as the stock fell lower and lower:
“Now, if the stock had declined even further to a price that made the valuation $40 million instead of $80 million, its beta would have been greater. And to people that think beta measures risk, the cheaper price would have made it look riskier. This is truly Alice in Wonderland. I have never been able to figure out why it's riskier to buy $400 million worth of properties for $40 million than $80 million.”
There’s a simple answer – it’s not. Businesses have an intrinsic value which is independent of an ever-changing stock price, which brings me back to Mr. Graham’s quote:
“Price fluctuations have only one significant meaning for the true investor. They provide him with an opportunity to buy wisely when prices fall sharply and to sell wisely when they advance a great deal.”
Reading this quote helped me realize something — beta isn’t just meaningless. On the other hand, it’s a blessing to the investor — the higher, the better. For the investor who is going to be a net buyer of stocks for the next decade, lower equity valuations is a plus; the more they diverge from intrinsic value over the short term, the better. As someone who has been looking to load up on PepsiCo (PEP) stock during this current rough patch, I can honestly say that I would love some volatility, especially to the downside; as a net buyer and owner for the next 10, 20 or 50 years, that’s only logical.
For the intelligent investor, don’t let a bit of volatility shake your conviction; while it may look like risk to the trader, it’s a blessing in disguise to a buyer and an owner.
About the author:
I think Charlie Munger has the right idea: "Patience followed by pretty aggressive conduct."
I run a fairly concentrated portfolio, with 2-5 positions accounting for the majority of my equity portfolio. From the perspective of a businessman, I believe this is sufficient diversification.