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Robert Stephens, CFA
Robert Stephens, CFA
Articles (431) 

Warren Buffett: Don't Cheer When the Stock Market Soars

Net buyers of shares may find life more difficult after 2020's gains

December 22, 2020 | About:

Many investors will be feeling happy about the performance of their portfolios in 2020. Even though the stock market declined as much as 34% in the first quarter, it has since surged to new record highs. As a result, many investors will find their holdings are in profit this calendar year.

In my view, it could be illogical for some investors to cheer rising stock markets. A large number of them are likely to be net buyers of stocks, rather than net sellers, in the near future. This means they will buy a larger value of shares in monetary terms than they sell in 2021.

A rising stock market generally means it is more difficult to find stocks that offer wide margins of safety. Therefore, rather than feel encouraged about the S&P 500's recent rise, investors should be concerned about how they will apportion capital in a richly-valued stock market.

Buying opportunities in today's stock market

This year's stock market surge has largely been built on the increasing popularity of tech majors and growth stocks. Sectors such as technology have experienced rapidly-expanding valuations due in part to increasingly optimistic growth forecasts.

At the same time, many stocks that trade at a discount to their intrinsic values have failed to deliver similarly high returns. This may lead value investors to become frustrated with the performance of their portfolios. They may find it difficult to watch growth investors generate high returns while their portfolios underperform the wider market.

However, holdings that grow in value at a steady pace may be more attractive than those businesses experiencing rapid returns. They provide investors with a greater opportunity over a longer time period to buy at discounted prices. Over the long run, this can lead to higher returns that have a more positive impact on portfolio valuations.

Buffett's 1978 letter to shareholders

This viewpoint was neatly summarized by Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) chairman Warren Buffett (Trades, Portfolio) in his 1978 letter to shareholders:

"We are not concerned with whether the market quickly revalues upward securities that we believe are selling at bargain prices. In fact, we prefer just the opposite since, in most years, we expect to have funds available to be a net buyer of securities. And consistent attractive purchasing is likely to prove to be of more eventual benefit to us than any selling opportunities provided by a short-term run up in stock prices to levels at which we are unwilling to continue buying."

Undoubtedly, an investor who is likely to be a net seller of stocks in the future will naturally cheer a rising stock market. They will be able to dispose of their positions at higher prices that may include significant profits.

However, an investor who is likely to be a net buyer of stocks in the near future may be better off ignoring the ups-and-downs of the stock market. This may provide the added benefit of making it easier to put emotions to one side so they can efficiently allocate capital to quality companies trading at fair prices.

Those companies may have failed to deliver on their potential in 2020. However, this provides value investors with further opportunities to capitalize on their long-term growth potential in future while they trade at large discounts to their intrinsic values.

Disclosure: The author has no position in any stocks mentioned.

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