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More Beta? Yes Please...

March 02, 2012 | About:
The Science of Hitting

The Science of Hitting

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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:

The Science of Hitting
I'm a value investor, with a focus on patience; I look to buy great companies that are suffering from short term issues, and hope to load up when these opportunities present themselves. As this would suggest, I run a fairly concentrated portfolio by most standards, usually with 8-10 names; from the perspective of a businessman rather than a market participant / stock trader, I believe this is more than sufficient diversification.

I hope to own a collection of great businesses; to ever sell one, I would demand a substantial premium to the average market valuation due to what I believe are the understated benefits to the long term investor of superior fundamentals and time on intrinsic value. I don't have a target when I purchase a stock; my goal is to replicate the underlying returns of the business in question - which if I've done my job properly, should be very attractive over many years.

Rating: 4.3/5 (15 votes)

Comments

Patience Investing, Inc.
Patience Investing, Inc. - 2 years ago
Hi,

Thanks for a nice article. In fact, realizing this, we are working to redefine risk. Warren Buffett has also talked about this in his 2011 letter to shareholders:

"The riskiness of an investment is not measured by beta (a Wall Street term encompassing volatility and often used in measuring risk) but rather by the probability – the reasoned probability – of that investment causing its owner a loss of purchasing-power over his contemplated holding period. Assets can fluctuate greatly in price and not be risky as long as they are reasonably certain to deliver increased purchasing power over their holding period. And as we will see, a non-fluctuating asset can be laden with risk."

The Science of Hitting
The Science of Hitting premium member - 2 years ago
Patience,

"We are working to redefine risk"...

Who's we? And where can I see the outcome? Thanks!
Patience Investing, Inc.
Patience Investing, Inc. - 2 years ago
Hi,

I am a PhD in Finance candidate at the University of New Brunswick, Canada, concentration in Behavioural Finance. Me and my supervisor (Prof. Eben Otuteye) have the same line of thinking regarding risk. So we have undertaken a project, called "Redefining risk".

We are expecting to complete the project by the end of this year.

Thanks.

Best,

Mohammad Siddiquee
The Science of Hitting
The Science of Hitting premium member - 2 years ago
Mohammed,

That is very interesting; anyway to possibly get a copy when it's done???
Patience Investing, Inc.
Patience Investing, Inc. - 2 years ago
sure, would you please e-mail me your contact details at patienceinvesting@gmail.com
BEL-AIR
BEL-AIR - 2 years ago
Science of hitting you are most right, and have come to the right conclusions.

Listen to Warren's comment about volatility at 55.45 of this video..

http://www.youtube.com/watch?v=4xinbuOPt7c

He says "It would be impossible to make any real money if it were not for volatility"

The oracle says

"I love volatility"

"Volatility will enable you to make alot of money"

"The more volatility the more money we will make"

So beta and volatility should be our friend, and we should welcome it.

But for the untrained or undisciplined investor that is not a value investor, then it can become a nightmare, but any true value investor actually needs it and looks forward to it to make good returns, other wise we would never get the good deals.

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