Is a bull market here? It depends on who you ask. But leaving aside the semantics of whether the current market rally has made the cutoff, it’s definitely demonstrating strong momentum. The S&P 500 is now up nearly 15% in 2023, on its way to undoing its 2022 losses.
Famed investor Warren Buffett is often quoted as advising investors to “be greedy when others are fearful, and fearful when others are greedy,” which he explained in his 1986 shareholder letter. As the market quickly rises, it’s good to have some perspective.
At least some part of what’s going on is that a few stocks are pulling more than their weight and lifting the entire market. That’s spiraling into general confidence as investors see numbers fly higher, and this is the precise scenario that Buffett is telling investors to be wary of.
If we’re entering a new bull market, which is bound to happen at some point even if it’s not exactly now, investors need to pump the brakes a bit and move with caution. I would heed some of Buffett’s other sage pieces of advice.
1. Invest in great businesses
Buffett stresses that he looks for great businesses to invest in and doesn’t focus on stock movements. “We own publicly traded stocks based on our expectations about their long-term business performance, not because we view them as vehicles for adroit purchases and sales,” he said in this year’s shareholder letter. As old-school as Buffett might seem, that’s contrarian for a stock picker. Then again, he concludes that he and partner Charlie Munger “are not stock-pickers; we are business-pickers.”
It might seem counterintuitive, but focusing away from stocks could be the key to market-beating returns. In fact, Buffett often counsels investors to invest most of the their money in an index fund, such as one that mirrors the S&P 500. He thinks that for the average investors, getting out of stock picking entirely is the best approach.
Keeping this in mind is crucial when there’s a lot of hype surrounding specific stocks and the market in general. Investors, especially amateur ones, could get slammed when buying stocks because they look exciting. As the market rises, it’s even more incumbent on investors to make sure they’re buying stocks because the fundamentals are there. Many investors who thought they had it made were crushed when the market popped last year. In the 1986 letter, he continued: “What could be more exhilarating than to participate in a bull market in which the rewards to owners of businesses become gloriously uncoupled from the plodding performances of the businesses themselves?”
Investing in great businesses with strong financials and robust long-term potential provides protection against large price swings.
2. Buying stocks trading below their intrinsic value leads to wealth creation
Buffett has said that when great companies, according to his definition, sell below their intrinsic value, that can lead to incredible stock gains. He quotes his mentor Benjamin Graham as saying, “In the short run, the market is a voting machine but in the long run it is a weighing machine.” Over time, the market will come to recognize whether a stock holds any weight and price it accordingly.
He has often said that Berkshire Hathaway has not bought any stocks over a certain time period because he didn’t see anything undervalued enough to warrant a position.
In a bull market, it can be harder to value stocks with clarity, since values tend to become bloated. Keeping intrinsic value in mind can help investors think more clearly. Buffett defines intrinsic value as “The discounted value of the cash that can be taken out of a business during its remaining life.” He admits that it’s not so simple to determine and not an objective number. It goes beyond the tangibles, which include things like capital and infrastructure, but it starts with that. Investors should think about factors like how strong the brand is, meaning whether it has resale value, and how powerful its profit generation is.
And it gets back to what Buffett often stresses are the four key elements of how he defines a great business: a strong cash position, a durable competitive advantage, great management, and varied earnings streams.
Although investors should carefully weigh these factors, the point to hammer home is that buying stocks is about expecting prices to rise over time, which begins with great businesses trading at undervalued prices, and not about the next exciting stock or bull market.
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