Street Capitalist: Event Driven Value Investments

This week’s column by Jason Zweig (Take a Deep Breath, Turn Off the TV, Calm Yourself) comes at a good time. The markets are experiencing a level of volatility that they haven’t been through in a long time. Such wild swings in stock prices have the ability to induce fear in investors, causing them to make gaffes like selling companies too early or racking up high commission fees by engaging in frequent trades.

According to Zweig, fear is contagious:

You can catch other people’s emotions as easily as you can catch a cold. In an experiment by neuroscientist Elizabeth Phelps at New York University, people either watched someone else get a mildly painful electric shock or suffered the shock themselves. Their brain responses and their dread before the shock were highly similar in both cases, suggesting that seeing another person’s fear is all it takes to make us afraid. Even encountering the circumstances under which the other person was shocked is enough to trigger your own fear.

When you cave to fear, you cease being a rational investor. You stop looking at the fundamentals and instead submit to your emotions. Often, it’s this sort of investing that ruins your portfolio.

To master fear, Zweig outlines four rules:

Break the circle. Instead of socializing with other investors nursing their losses, hang out with folks who do not obsess over the market. You are less likely to be spooked by dilated pupils, grim faces and quavering voices.

The idea of breaking your circle is one which I believe is practiced by a number of prominent value investors. They may talk about the market with their teams and associates, but they tend to reside away from Wall Street where they would be incessantly affected by the buzz of brokers and investors on Wall Street. Being away from the commotion of the markets can allow an investor to have the peace of mind needed to buck the trend or chaos that might ensue when the markets panic.

Value investors operate out of many places besides Wall Street: Warren Buffett in Omaha, Seth Klarman (of the Baupost Group) in Massachusetts, Mason Hawkins (of Longleaf Funds) in Memphis, Mohnish Pabrai in Irvine, and Bruce Berkowitz (of the Fairholme Fund) in Florida. All of these investors have had good long term track records while residing away from Wall Street.

Turn off the tube. The sight and sound of screaming traders with fear in their eyes are enough to fill you with fright, whether you are conscious of it or not. If hitting the mute button won’t suffice to calm you down, turn off the TV.

Here, I’d also recommend to be cautious of the internet as well. Many investors also like to visit message boards like on Yahoo for the specific companies they own. Many of these message boards can be cesspools of rumors and lies. During a time when the market is being excessively volatile, you risk letting your guard down and listening to these deceiving liars.

It’s important that you keep up to date with news on your companies, but you should do so by utilizing more official means of information. Instead of looking at the prices of diving charts that they show on CNBC, you should take the time to see if what’s going on in the market can actually affect the businesses you own. With Warren Buffett now buying stocks personally, it’s easy to see that he believes some businesses have been oversold. That does not mean that all are oversold, some sectors will probably be in for tough times. Anything with excessive leverage could be at the mercy of their spooked creditors.

Think positive. When Warren Buffett feels his blood pressure rising or his nerves on edge, he calms himself down by gazing at snapshots of his family or playing a game of bridge with his friends.

In The Snowball, Alice Schroeder described how Warren Buffett was excellent at compartmentalizing his emotions. This is probably a pretty hard thing for investors to do on their own, but maybe there are some other methods for staying positive. I think that having a system in place for investing or trading helps. By taking a systemic approach, you work to divorce emotions from your investing and really make it a dry activity. Benjamin Graham is said to have had simple forms for security analysts to fill out when investing a particular company – they filled the forms and then checked them against their particular system. If the company appeared cheap enough it was bought.

One idea I’ve heard that sounds interesting is to spend time studying famous leaders through history. We know that Buffett reads a tremendous amount and when he was younger he spent a lot of time reading biographies about famous business leaders (think Carnegie, Rockefeller). Investors could also read about leaders who faced periods of crisis (Churchill for example), the lessons they glean from such experiences could be used to create a powerful latticework of mental models for protecting them against Mr. Market’s swings.

The other factor is to just know yourself and how you react to stressful situations. For Warren Buffett he may like bridge, but perhaps what works for you is a jog or listening to some music. If you understand yourself and your emotions, you should be able to keep positive as the market dives.

Finally Zweig says:

Stick to it. Set yourself the simple, stark goal of investing more money in something you don’t want to own. You may need help fighting your fears, so visit www.stickk.com and make a public commitment to your future action. Buying a stock fund next week is mentally easier than buying it today — especially if you recruit some friends to cheer you on.

Chances are, we’ll be in for more market volatility than what we saw last week. If that’s the case, it’s going to be important for you to learn how to keep your emotions in check and keep your investing method in tact. If you do this, I believe that you’ll be able to take advantage of the market and find some good buys. They probably wont talk about this on CNBC or in the rest of the mainstream media, but when you’re looking at risk. Instead of gauging it by the market’s prices, try the following:

In our opinion, the real risk that an investor must assess is whether his aggregate after-tax receipts from an investment (including those he receives on sale) will, over his prospective holding period, give him at least as much purchasing power as he had to begin with, plus a modest rate of interest on that initial stake. Though this risk cannot be calculated with engineering precision, it can in some cases be judged with a degree of accuracy that is useful.The primary factors bearing upon this evaluation
are:

1) The certainty with which the long-term economic characteristics of the business can be evaluated;

2) The certainty with which management can be evaluated, both as to its ability to realize the full potential of the business and to wisely employ its cash flows;

3) The certainty with which management can be counted on to channel the rewards from the business to the shareholders rather than to itself;

4) The purchase price of the business;

5) The levels of taxation and inflation that will be experienced and that will determine the degree by which an investor’s purchasing-power return is reduced from his gross return.

These factors will probably strike many analysts as unbearably fuzzy, since they cannot be extracted from a data base of any kind. But the difficulty of precisely quantifying these matters does not negate their importance nor is it insuperable. Just as Justice Stewart found it impossible to formulate a test for obscenity but nevertheless asserted, “I know it when I see it,” so also can investors – in an inexact but useful way – “see” the risks inherent in certain investments without reference to complex equations or price histories.

Warren Buffett – Letter to Shareholders (1993)