Why a Wish List is Important
Ser Jing is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
At its most basic, investing is all about buying an asset at a price that is lower than its intrinsic value. Given the current economic climate, with uncertainties over the European Union, China’s slow-down in growth and the looming US Fiscal cliff amongst others, would you be a happy buyer of stocks if prices start collapsing due to general economic malaise? I guess your answer would be a resounding ‘Yes!’ as you probably know the often repeated mantra of ‘buy low, sell high’. Seeing great companies with stable or growing businesses having its share price fall to unreasonable levels would trigger the inner-Buffett in you; or so you hope.
Studies done in the realm of cognitive psychology have found some interesting results between what people think they will do and what they actually do when they are in a different mental state. This phenomenon is termed as an empathy gap. A simple example can be illustrated if I asked you to think of a buffet dinner for Thursday after you have had a 2-pound steak fillet on Tuesday – chances are you would have been turned off by the idea but come Thursday evening, that buffet dinner would very likely seem really enticing to you.
An often cited academic study which explores the empathy gap is highlighted here. In essence, a group of male university students were told to imagine that they were sexually aroused and then answer questions regarding their attitudes toward different kinds of odd sexual activity in a scale. After at least a day, they were instructed to go home and repeat the questionnaire while watching a video with highly sexual content. The amazing thing was, the participants became 72% more willing to engage in odd sexual activity! Those young men could not imagine how they might feel when they were in an aroused mental state.
In investing, an aroused mental state could correspond to extreme risk-aversion, or fear, when we see the markets falling every day. The stocks that we would have been happy to purchase at $X are now avoided like the plague at $X/2. The reason is that even though we tell ourselves ‘I am going to be a huge buyer of stocks during market panics’ during the good times, we cannot imagine how fearful we might become in times of general market or individual company distress, hence the empathy gap. And here’s the real kicker – knowing about the empathy gap does not make you immune to it. You have to act on it.
Legendary global investor Sir John Templeton was said to have kept a wish-list of stocks that he had analyzed during calm markets and noted the prices which he thought would present a bargain. He would use the list when the markets were in turmoil. Having that list is a very powerful way to override your emotions and overcome the empathy gap. Sir John’s grand-niece, Lauren Templeton, an accomplished investor in her own right gave a great speech on her grand-uncle’s ‘wish list’ – catch it here.
During the 08/09 financial crisis, stocks like Starbucks (NASDAQ: SBUX) and Intuitive Surgical (NASDAQ: ISRG) fell dramatically, losing up to 80% of their market value. Starbucks fell from its pre-crisis peak of $37 in November 2006 to $7 in November 2008 while Intuitive Surgical fell from $360 in December 2007 to $85 in March 2009. Before their stock price collapse, in which the global financial crisis played a huge role with good companies and bad companies being sold indiscriminately, both Starbucks and Intuitive Surgical were being sold at lofty TTM earnings multiples of 53 and 108 respectively. This showed that prior to the onset of the financial crisis, both companies were very highly regarded by Wall Street. Valuation concerns might have played a role in the collapse of their stock price, but at the very least, they had solid balance sheets and clear growth hooks.
Howard Schultz had just returned as CEO of Starbucks in January 2008 and had clear plans to revitalize the Starbucks experience. Intuitive Surgical’s Da Vinci robots have a very high switching cost for trained medical professionals and were being adopted by more hospitals each year. Doctors were also finding out new medical procedures that could be accomplished using the Da Vinci robot and patients preferred the minimally invasive procedures that the robot could provide. The explosive earnings growth of both companies from 2009 to 2012 highlighted their strength and why investors who steeled their nerves and bought on the way down had achieved enviable gains.
Both companies are now multi-baggers at their current price of $47, for Starbucks, and $496, for Intuitive Surgical, if someone had purchased shares in them at the trough. Would you have had the mental fortitude to buy shares in them at their nadir? Even banks like JPMorgan (NYSE: JPM) had its stock price increase almost 250% from its trough in 2008 even though it lacked strong growth potential and had a much more complicated balance sheet. It goes to show that companies that can survive or even prosper during tough times can be offered at basement-bargain prices from time to time and as an investor, if you know what price represents great value, having an aid for making stock purchases can prevent you from being scared out of buying the best companies at the best possible prices.
Like Sir John Templeton said, “The time of maximum pessimism is the best time to buy and the time of maximum optimism is the best time to sell’, having that wish-list would ensure you will have the mental fortitude to stomach all that red in the market and buy the best companies – all gift-wrapped by Mr. Market for you.
serjing has no positions in the stocks mentioned above. The Motley Fool owns shares of Intuitive Surgical, JPMorgan Chase & Co., and Starbucks and has the following options: short JAN 2013 $47.00 puts on Starbucks. Motley Fool newsletter services recommend Intuitive Surgical and Starbucks. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.