Ever since I posted the analysis on Adobe yesterday, I've had this looming feeling that a little clarification was in order. Some of you are looking for reinforcement on your long-term, buy-and-ignore portfolio; some are really trying to find those heart-pounding, mouth-watering, back-up-the-truck deals in the markets.
At today's prices, I believe that Adobe is appropriate for the former — it is a great company that appears to be selling at a moderate discount. Allow me to explain:
A Tale of Two (Intelligent) Investors
When it comes to buying stocks, there are two types of intelligent investors — the safety-seekers and the non-conventionalists. While the approach is the same — buy wonderful companies when they are selling at a discount — the execution is quite different.
Safety-seekers are looking to buy the Johnson & Johnsons, Coca-Colas, Wal-Marts, and, in this case, the Adobes of the world without over-paying for their stock. They are looking for a bottom or near-bottom so they can minimize their exposure to the short-term drops which, to them, are often gut-wrenching and cause them to second-guess and reconsider their holdings, no matter how sound the companies are.
Safety-seekers are constitutionally averse to short-term price swings. They have a long-term outlook on their positions, but they tend to watch (and at times, overanalyze) the short-term swings. They are patient, but they have likely been burned in the past (or know many people who have) and tend to prefer bigger companies over bigger opportunities.
Non-conventionalists, on the other hand, try to put their money where they see the most value, regardless of the size of the company (or opportunity). To them, the size and stability of a company is merely a qualitative factor that helps them determine the margin of safety that is needed. When they see gigantic Company A at a 25% discount and small Company B at a 75% discount, they'll load up on Company B and pass on Company A (assuming, of course, that both opportunities are sound).
Non-conventionalists truly see price drops as opportunities, not just in theory, but in practice. Every dollar drop in the price of their holdings (from general market movement or noise) makes their hearts beat faster — not out of fear, desperation, or doubt, but from the excitement of being faced with greater opportunity, safety, and potential rewards. When their hearts pop out of their chests, they back up the truck and load up more, even if they have to sell some of their Company As (above) to do so.
The Psychological Perception
Being one or the other is a matter of your psychological perception of stock prices and risk. Your margin of safety is meant to put all companies on a level playing field. In theory, Johnson & Johnson at a 40% discount should be less attractive than American Eagle at, say, a 70% discount. In practice, if you look at the two and gravitate towards JNJ, you are a safety-seeker. If you subconsciously believe that the larger companies at a moderate discount are better investments than smaller (though also stable) companies at substantial discounts, you are a safety-seeker.
The Risks and Rewards of Each Strategy
There is absolutely nothing wrong with being one or the other. The safety-seekers will tend to make more consistent profits and suffer the occasional small loss; the non-conventionalists will generally make greater profits and experience the occasional larger loss. In the end and assuming both stick to their core strategies, the non-conventionalist will generally make more money but the safety-seeker should still beat the markets by a satisfactory margin.
Are You a Safety-Seeker or a Non-Conventionalist?
The only way to know if you are one or the other is to have purchased underpriced companies last year to find that they have (or had, for a time) dropped significantly in price. F Wall Street visitors can use American Eagle Outfitters as a prime example — the price was slashed by some 40% when the markets started tanking. (By the way, Buffett dismisses the idea of paper trading for this exact reason. There is no way to know for certain if you are comfortable owning businesses unless you get to experience the actual feelings associated with realized and unrealized gains and losses.)
If you bought AEO in the mid-20s, what went through your mind when it broke $17 a share and you were down a substantial amount? If you second-guessed your analysis, became desperate, or lamented your buy, you are likely a safety-seeker (or should consider buying bonds). If, on the other hand, you saw your position slashed and grew more excited each day, if you backed up the truck and loaded up (or wished you could have), you are likely a non-conventionalist.
It's Psychological — Tough To Change
I've said it before: investing is 99% art, 1% science. Watching your stock prices is 100% psychological. Though it is possible to become a non-conventionalist, it is not easy. (Heck, the markets have shown us that most people can barely stand to be safety-seekers!)
Personally, I'm a non-conventionalist. (I used to be a safety-seeker, and an uninformed speculator before that.) And lest you equate non-conventional with aggressive, let me assure you that "conservative" and "conventional" are not the same thing.
Bringing It Full Circle To Adobe
This entire discussion is a long way of saying the following: My mouth isn't watering at the opportunity to buy Adobe. I think it is a great company and a good buy for safety-seekers, but I'm not backing up the truck just yet. I think it can be bought at these prices and buyers can expect a satisfactory return; still, I don't know that it is a true steal in the non-conventional way.
I'm not crazy about tech in the first place. Though I was able to confidently say that Apple was overpriced in October, I don't know that I can confidently say it is underpriced today. Even though I believe that Adobe was fairly priced last year and is at a slight discount today, I'm not backing up the truck just yet. I'll have to wait until my heart starts pounding and I don't think I got that point across yesterday.
And yes — when you are a non-conventional investor, you do get excited when things get really ugly and your target (or owned) companies drop in price. At least that's the feeling I get.
Hope that helps.