The Business of Value Investing.pdf

Establish a Sound Investment Philosophy 51

Assuming you have analyzed the business and determined its oper-

ations sound and its management able, the 40 percent decline in

the price of the shares is meaningless in the long run relative to the

value of the business. The movement in the stock price has not per-

manently eroded your capital. If you succumb to emotion because

you can ’ t stomach watching the stock price decline and sell the

stock, you have made a temporary decline in the stock ’ s price lead

to a permanent loss of capital.

I can ’ t overemphasize the tremendous importance of separating

the activity of the stock price from the activity of the business. Stock

prices tend to overreact in both directions. If a company reports

quarterly results that are a few pennies less than the estimates ana-

lysts had in place, the price of the stock can go down by double dig-

its in no time at all.

Consider this statement made by William Ruane and Richard

Cuniff of the Sequoia Fund in 1987. I preface by adding a little

color to the market environment of the time: Until August 1987,

the stock market had surged. This surge was followed by a stock

market crash in October 1987, when the Dow Jones declined

by nearly 23 percent in a single day. Cuniff and Ruane astutely

commented:

Disregarding for the moment whether the prevailing level

of stock prices on January 1, 1987 was logical, we are certain

that the value of American industry in the aggregate had not

increased by 44% as of August 25. Similarly, it is highly unlikely

that the value of American industry declined by 23% on a sin-

gle day, October 19.^3

Investors should ponder this thought when stock prices fl uctu-

ate widely. At the time of this writing, the U.S. Treasury has spent

over $ 150 billion to aid American International Group (AIG)

and over $ 1 trillion on rescuing the fi nancial sector. As a guest

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