A number of stocks have made stunning gains since the start of the year. For example, Tesla TSLA stock price has more than tripled this year, Amazon AMZN is up 65% in 2020 and Apple AAPL shares are currently trading 30% higher year-to-date.
Some investors may fear that they will miss out on further gains for those stocks, and other companies that have recently risen in price. This may cause them to buy stocks that have recently delivered exceptional gains without first conducting thorough analysis into their long-term investment potential.
However, following the advice of Berkshire Hathaway BRK.A BRK.B chairman Warren Buffett could represent a better approach. Buffett's long-term view and caution regarding overly optimistic forecasts could be key reasons for Berkshire's 20% annualized return since 1965.
A long-term view
Some investors may view fast-rising stock prices as an opportunity to generate high returns in a short period of time. This may lead them to take a short-term view of a stock's prospects.
However, this strategy may end in disappointment. The stock market's performance is impossible to accurately predict. Therefore, short-term investors, or speculators, may experience large losses in a short space of time in what continues to be a volatile market.
A better idea is to take a long-term view of any company you purchase. The past performance of the stock market shows that any share can experience high volatility at any time, should its trading outlook change significantly versus expectations. Through having a long-term outlook, you can more easily overcome short-term disappointment that may be followed by a stock price recovery.
As Buffett once said, "If you aren't thinking about owning a stock for 10 years, don't even think about owning it for 10 minutes."
Focusing on company fundamentals
Rapidly rising stock prices are often predicated on very optimistic financial forecasts. In some cases, they can prove to be correct. However, in many cases, unexpected events occur that cause a company's sales and profit outlook to be very different from previous estimates.
Therefore, investors should not pay too much attention to generous growth rates being estimated for any company. Instead, analyzing a company's fundamentals may be a more productive use of your time. It may enable you to find stocks that are mispriced, and to allocate capital more productively.
This point is arguably more important now than ever. Due to the uncertain economic situation, businesses with sound finances, rather than optimistic forecasts, may therefore offer better stock price prospects over the long term.
As Buffett once said, "Forecasts may tell you a great deal about the forecaster; they tell you nothing about the future."
A patient approach
It is tempting for any investor to overlook the high valuations of fast-rising stocks. You may feel that a high valuation can be justified based on the growth potential of a specific business.
However, the stock market's track record suggests that stocks with overly-generous valuations can be among the biggest fallers during downturns and bear markets. Therefore, it may be prudent to demand a margin of safety for any stock you purchase due to the ongoing uncertainty facing the economy.
This may mean that you miss out on further stock price growth in the short run. However, adopting a patient approach and awaiting attractive prices for any stocks you purchase could build a portfolio with stronger foundations that can overcome a difficult economic outlook.
Buffett has always had a patient approach to investing, and has never been in a rush to buy any stock. As he once said, "You do things when the opportunities come along. I've had periods in my life when I've had a bundle of ideas come along, and I've had long dry spells. If I get an idea next week, I'll do something. If not, I won't do a damn thing."
Disclosure: The author has no position in any stocks mentioned.
Read more here:
- Peter Lynch on Managing Loss-Making Positions
- Benjamin Graham on the Importance of Being a Rational Investor
- Warren Buffett on Adapting to a Chainging Investing Landscape
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