Nothing has been happening in the market for a while, you’ve been thinking about buying some stocks but you haven’t done so. Suddenly in the space of a couple weeks the market is up 20%, the stocks you were eyeing went up a lot and now you feel regret. The market rally is over.

Is it too late to buy?

The short answer - it’s never too late to buy a great stock, but you may have missed the first 20% of the rally. Nothing you can do about that.

Here’s an example. The luxury brand Hermes has an average P/E ratio of 41 over the past 20 years. At no point did it ever look cheap.

But over the same 20 years, it has delivered a market beating return of 21.5% per annum. In total, the stock is up 4906% over 20 years.

The moral of the story is that it is never too late to buy a great company. Forget about first 20% that you missed, so that you don’t miss out on the next 4880%. 

(If you’re not familiar with Hermes, we previously compared it to three other great luxury brands here).

Can you pay any price for great companies?

No. You cannot pay any price, even for a great company.

The reason is quite simple, your return is determined by how much larger the ending price is than the starting price. The ending price does not change, so the more you pay at the start, the lower your return will be.

If you pay too much, your ending price can be lower than your starting price. That is a negative return.

Should you wait for it to get cheaper?

No. Waiting for things to get cheaper seems logical, but it is actually a form of market timing. Nobody can time the market. Doing so successfully is merely luck and studies have shown that it doesn’t work, even when professionals attempt it.

As we have seen with Hermes, the other problem is that the stock may never get cheaper, in fact, it could go much higher than it currently is.

Is all known information already priced into the stock?

The efficient market hypothesis would have you believe that all known information is priced in.

But in reality, that is hard to say. You will never actually know until many years in future. If you had bought a stock and it outperformed the market, looking backward you could say expectations were not fully priced in. If the stock underperforms, you could look back and say the expectations priced in were too high.

My opinion is that humans are bad at estimating the future, especially the distant future. So if you are a long-term investor, you can find mispriced stocks, even amongst popular companies.

However, it is easier to identify mispriced stocks amongst those that are not well followed by the media, public and analysts.

Six rules to buy expensive companies

Down to the nitty-gritty, how do you buy an expensive company?

The answer is valuation. You have to place a value on the company, by converting your expectations of the future into financial numbers. That is correct, you need to do some crystal ball gazing. Right about now, you’re realising why investing is such a challenging game. You’re expected to do the impossible.

Here’s how to make the impossible, probable:

1. Margin of safety. This is a well-known concept. It was popularised by Ben Graham (Warren Buffett’s mentor). With margin of safety, you are trying to buy a stock for less than you think it is worth. The reason for doing that is that if your valuation is wrong, there is a buffer to protect you.

2. Dollar cost averaging (DCA). DCA applies to any currency, just replace dollar with the currency of your choice. What DCA means is to buy your stocks over time. Perhaps you spend the same amount buying a stock or index monthly, over the course of a year. During that period there will be times when it is up and times when it is down. You will benefit by paying an average price over time. This strategy works especially well if you have it set to happen automatically after pay day.

3. Competitive advantage. Invest in companies that have products which are in demand and that can remain in demand over time. For instance, you know that in 50 years from now, people will still be eating chocolate bars. But we cannot be so sure that people will still be using iPhones at that time. The point of this example is that some items are enduring. Nestle Milk Chocolate was first introduced in 1875 and you can still buy it 150 years later – that is enduring.

4. Don’t get FOMO (fear of missing out). If you’re not sure about a stock, just don’t buy it. If you lose your money on a bad investment, it is gone forever. Put your money in the bank, earn some interest and live to fight another day.

5. Don’t aim for the highest returns. Your goal with a portfolio is to earn reasonable returns over a long period of time. That is how you get rich. Aiming for the highest possible return makes investing into a form of gambling, where you take unnecessary risks.

6. Default to the index. If your favourite stock is driving you nuts or putting you on an emotional rollercoaster, just buy the index automatically and forget about it. You will still make multiples of your money in the decades to come.

I would like to hear what you’re up to.

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