Intrinsic value investors should ideally buy when a stock trades at a price below its value and should not if it trades above value. Consequently, when they look at their portfolio, the same rule should be applied to every investment in it. At today’s price and today's estimated value, should I:
- Buy more of the stock (if it has become even more undervalued)?
- Hold on to it (remains undervalued or has become fairly valued)?
- Sell it (become over valued)?
However, that requires you to be dispassionate about past mistakes and rational in your judgments.
I know that what I choose to do will often be guided by the worst of my emotions, rather than good sense. I will double up (or down) on my losing investments, not because they have become more undervalued, but because of hubris, will hold on to my losers, because denial is so much easier than admitting to a mistake, and sell because of panic and fear.
Here is what I try to do to counter my all-too-human emotions.
I believe that the biggest mistakes in investing are made not in what or when you buy, but in what or why you choose not to buy and what and when you sell (what you have already bought).
I know that I need to look at my past investments, not to lament mistakes I have made or to wallow in regret, but because each investment in my portfolio has to meet the same test to remain in my portfolio, as it did when I first bought it.
Left to my own devices, I know that I will selectively revalue only those investments that I like, and only at the times of my choosing, and ignore revaluations that will deliver bad news. It is for this reason that I force myself to revalue each investment in my portfolio at pre-specified intervals (at least once a year and around significant news stories).
I am far more likely to both panic and be defensive about investments that are a large portion of my portfolio than for investments that are small. One reason I stay diversified across many stocks (each of which passes my investment test) rather than a few.
- Be explicit in my valuation judgments
It is far easier to be delusional when you buy and sell based upon secretive, complex and closed processes. It is one reason that I not only try to keep my valuation assumptions explicit but also share my valuations. I know that someone will call me out on my delusions, if I try to tweak them to deliver the results that I want.
Along the same lines, I have tried to be public about admitting mistakes when I make them, because I have found that it frees me to clear the slate.
- Have faith but don't make it doctrine
I have faith (misplaced though it might be) that I can estimate intrinsic value and that the price will eventually converge on the value and that faith is strong enough to withstand both contrary market movements and investor views. At the same time, I know that I have to be willing to modify that faith if the facts consistently contradict it.
Aswath Damodaran is a professor of finance at the Stern School of Business, New York University. The above is an extract from his blog post - The Search for Investment Serenity: The Look Back Test!
