Markets are people, and people overreact — bull markets get too excited and people pay irrational prices for popular stocks sometimes, and bear markets get too fearful and people sell regardless of company fundamentals and drive prices down to silly levels at other times. We can come up with some assessment of what we think a rational valuation should be for a given business on a given day, though it will always be colored by the valuation carried by the broader market (just go back in time and pitch an exciting growth stock that’s trading at 40X revenues in 2015… and see if you can get people to stop laughing), but we also need to keep in the back of our minds that the market’s short term movements will not abide by our rational ideas. A stock will shoot higher than we think possible during times of excitement, and can fall far below our assessment of value during times of pessimism.
The idea is to sell some when the market is being irrational on the up side, and to buy some when the market is being irrational on the downside… or, if you’re a patient long-term investor, just hold through the ups and downs, with some confidence that the long term trend toward rising share prices will win out in the end (it won’t with every stock for sure, but it always has with the market overall). It’s all easier said than done — we have evolved to want to run with the herd and to find safety in numbers, not to choose our own path, so buying when a stock is falling is hard even if it looks like a bargain, and selling when a stock is rising is hard even if it looks wildly overpriced. Even if we know that over the long term, that’s probably how we improve our probability of success.
That’s part of my rationale for setting aside some volatile growth stocks in a “Lock Box” portfolio, and I added the third position to that portfolio yesterday… so we’ll start by talking some about that.
I first bought Goosehead Insurance (GSHD) when it dipped last Fall (though I had dabbled in options and written about it a couple times before that), and this week, with the shares again dipping and just flirting with my “buy below” price (about $108), I ...