If you’re a seasoned investor, there’s a good chance you’ve heard Warren Buffett’s famous maxim, “Be fearful when others are greedy, be greedy when others are fearful.” It’s a timeless quote that illustrates the best attitude to take toward investing.
To buy low and sell high, you need to be ready to buy when others are selling, which means buying stocks when they’ve gone down. It goes against our instincts, but it’s the best way to ensure that you don’t over-pay for equities.
That said, the quote doesn’t offer much in terms of specifics. What does it really mean to be greedy when others are fearful? Try to find a stock market bottom? Buy periodically on the way down? Wait for P/E ratios to get low enough? The quote doesn’t offer much clarity on what yardstick for “fear” Buffett is talking about.
Fortunately, it’s possible to piece together what Buffett means by looking at his investing actions over the years. By looking at trades Buffett has reported in his SEC filings, we can determine what he thinks a “fearful market” looks like, and when to buy into one. As it turns out, it can all be condensed into one simple rule.
Buffett’s #1 rule: Don’t try to time the bottom
Warren Buffett has long counselled against market timing. Going on the record as saying nobody knows what the market will do in a given day, week, or month, he suggests that investors use valuation as a yardstick instead. Buffett’s words match his actions on this.
The Oracle famously loaded up on Delta Airlines stock early on in the current market crash. Was late February the absolute bottom for that stock? Definitely not. But it was still cheap compared to early February prices.
What to do instead
Rather than trying to find market bottoms, you should aim to buy stocks when they’re cheap relative to intrinsic value. There are many ways of measuring intrinsic value, the most common are future earnings, future cash flows, and book value.
We can look at one of Warren Buffett’s favourite Canadian stocks, Suncor Energy (TSX: SU)(NYSE: SU) as an example.
With a stock price of $23.94 as of this writing, the company traded at just 12.89 times future earnings, which means it would bring in its entire market cap in 12.89 years of earnings assuming no growth.
Suncor is similarly cheap relative to book value. Trading at 0.87 times book value (assets minus liabilities), it’s actually cheaper than the underlying business would be if sold off bit by bit.
Of course, stocks don’t usually get this cheap for no reason. Suncor Energy is currently taking a massive hit from weak oil prices, and will almost certainly post poor earnings for the current quarter.
Nevertheless, it stands to recover if oil prices come back. With Saudi Arabia and Russia already talking about ending their oil price war, that may happen sooner than most people think.
Foolish takeaway
The bottom line is that nobody can time market bottoms with absolute precision. However, it is possible to tell when stocks have gotten cheap relative to their value.
By buying quality stocks on the dip, you can build a foundation for lasting wealth. Just ask Warren Buffett.
