To our clients:
This year we have done an unusual amount of trading in the stock market. We thought you might be interested in the following explanation of the reasons for this modification to our favored buy-and-hold approach to value investing in common stocks.
In the past two years there has been a growing volatility in the market, due to institutions and individuals piling into whatever has been going up. At the same time they have been discarding whatever has been going down. Consequently market prices have become grossly over-valued for the market’s favorites, and under-valued for some other stocks.
Every day we look in the market to see if anybody is offering to sell a stock at a bargain price, or to pay an unreasonably high price for one of our holdings. Occasionally, we see an opportunity to buy shares of a high quality company cheaply or to sell one of our holdings at an unusually attractive price. With the increasing volatility in the market such buying and selling opportunities have become more frequent.
Most of the cheap stocks are not attractive for the long term because it seems to us unlikely that they can produce above average growth in value for an extended period of time. However, shares of such a company can become so depressed that the probabilities favor a rebound in market price. In that case we are willing to take advantage of the opportunity to buy the shares with a view to holding them for resale in the near to intermediate future. During the rebound process such an investment can provide a high rate of return by moving up 30% to 50% or more over a relatively short time. After such a rise takes the stock back up to a more typical price we believe that it should be sold because its returns thereafter are likely to be relatively unrewarding.
Sometimes the market pushes up the shares of one of our higher-quality companies to a price so high that it appears unwise to hold out for an even higher price. Even so, we know that the stock can go up, sometimes a long way up, after we sell. It is not possible to know in advance either the peak price when selling or the rock bottom when buying.
When we sell the over-priced shares of a great company it does not mean that we are out of them forever. We are willing to buy again if the shares come down to a bargain price-a scenario we fully expect as the market continues the long-term fundamental revaluation that we believe started some time ago.
Sincerely,
CHEVIOT VALUE MANAGEMENT