Why I Follow Overvalued Companies (#5)

Charlie Munger's approach is for the patient investor

The May 2021 issue (paid) of Watchlist Investing included Quick Looks at two clearly overvalued companies. Why spend the time to study these companies when the universe of stocks is so large?

The short answer is because good companies are rare. The longer answer includes the fact that such a search strategy fits my personality. Let me explain using an analogy of a house fire.

Imagine you awaken to the sound of sirens and look out the window to find your neighbor’s house on fire. You immediately go outside to comfort your neighbor, who is watching helplessly from a safe distance. S/he then turns to you and makes an offer for you to buy their house. Do you accept or not?

Why I like this example is it incorporates some of the things I think about in my investing process:

• First, stocks catch fire all the time in the market. The neighbor is analogous to Mr. Market (Ben Graham’s allegorical character) who sometimes panics and offers bargains.

• Next, the situation isn’t at all clear but relies on probabilities. You have to judge the underlying situation correctly and consider how price factors into the equation (you can accept more uncertainty given a lower price).

• Lastly, and here’s the crux of this essay, your ability to act quickly is often dependent upon your prior knowledge of the stock (house). Like the stock market, you can always say no. But if you’ve spent the time to understand your neighbor’s house you’ll have more confidence stepping in and can do so quicker (true bargains don’t last very long). Maybe your neighbor’s house has sprinklers, or maybe the walls are made of stone. Or, maybe you know your neighbor has a collection of propane tanks in the basement ready to explode and it’s a hard pass.

This type of approach fits my personality. It isn’t for everyone. I’m okay spending the time to follow companies that are seemingly overvalued for years on end, patiently waiting for a chance to jump in and buy. I’d rather arrive at the scene of a house fire prepared and have my prior due diligence serve as a reference point for any new information that’s come to light.

I’ll conclude with one of my favorite quotes from Charlie Munger, which speaks to this patient approach.

“One person said to me, 'I have a list of 300 potentially attractive stocks, and I constantly watch them, waiting for just one of them to become cheap enough to buy.' Well, that's a reasonable thing to do. But how many people have that kind of discipline? Not one in 100.” – Charlie Munger

Thanks for reading!