Warren Buffett Warns Value Investors Buffett’s Stock Market Crash Investment Strategy Value Trap

by birtanpublished on October 4, 2020

During the initial ccpv drop that we had back in march everybody was looking at buffett wondering what he was gonna do because he's the guy always looking for value right they were waiting for him to swoop in and start buying stuff but he waited and he waited and waited and talked about how bearish he was on the economy in the stock market but then finally you started seeing him buy up some stuff and then he was buying more and more and he was talking about japan and then snowflake was the last thing he did so the question is if you're

Investing like buffett and you're trying to make the most out of a crash how do you know whether you're investing in something that has value or if you're investing in something that's just a dud that's a trap that becomes really important especially in these types of markets that may keep falling meaning more deals maybe or more traps so that's what we're going to talk about in this video how you can be more like buffett and get value instead of falling into a value trap and as always if you guys want to learn more about my

Personal strategy and the one a lot of our fallible members use check out this free training there's a link in this video and down below in the description and comments way easier than what buffett does and still makes great profits so we're going to use an article from macro ops called how to avoid value traps with one simple scoring system so first of all what is a value trap well what's value in general value is when you think the stock market is mispricing a particular stock which is why it's so cheap so by buying that stock you're

Saying pretty much that the market is wrong and that eventually investors are going to realize that hey this is actually a great value and start buying it the price goes up and then that's how you make money that's value investing in the most simplest terms but the truth is is that markets are generally efficient the majority of the time meaning they're correct they're pricing things at a certain price because that's how much they're actually worth so if you consider yourself a value

Investor and you're trying to buy all these cheap stocks well they might be cheap for a reason and you buy into them thinking you see something that no one else does when in fact you're falling into a value trap because that stock's not going to go anywhere really it might fall even more and you know how it is with screens we could all run a p screen and get a bunch of stocks that have a low pe so hey they must be undervalued right but no so on the macro ops podcast we actually had an interview

Recently with brad hathaway and he's the managing partner of far view capital which is a hedge fund focused on special situations and long-term value investing now one of the things we discussed was asking the right question which is really important when investing because like we said mr market is generally right most of the time so to avoid a value trap what you want to ask yourself is why is this stock being sold at this price in the first place so brad talked about a little more he said as an early investor it's easy to get caught up in

The here's why i'm right and here's how much money i can make but looking ahead of time to say if i'm wrong here's why that really forces you to look for those factors ahead of time so if you could define it in a period where you're not emotionally invested it's much easier to make that decision to sell at a loss when that decision comes to pass so what brad is saying is that you need to look for a reason that you might be wrong it's the same thing that we always talk about in these videos as an investor you

Always got to be focused on your downside and that applies regardless of your strategy so even in value investing it might not be a price thing it might be more of a fundamental thing okay if the company does this then i might be wrong about where the company's price is heading so here's an example say you find a stock trading at three times the p e ratio with a decent balance sheet and a small but positive cash flow so the first thing you got to do is ask yourself why is this stock being sold at this price if it seems okay so some answers might include management has

Diluted shareholders it's a low margin business the industry has a little runway over the next five to ten years and acquisition costs are growing while the market's shrinking now each of those answers becomes a barometer to judge your bull thesis if you want to buy it so if you're seeing shrinking margins then your both thesis might include a reversal of that trend so you need to see better margins if the industry has little growth then your thesis might depend on the company expanding into other areas other

Verticals and then you could basically evaluate how likely is it that the company is going to be able to pull this off because all these things become hurdles if the hurdle is too high then the idea is less attractive right and you shouldn't invest so the way you can do this a system you could use is the occam's razor rating system and occam's razor basically says that when you have two competing theories the simpler one always prevails so the key word here is simpler so when you ask yourself why is the stock being

Sold at this price you want simple and easy to understand things that are easy to fix because the harder the solution that's required to turn around the company well the harder the turnout is going to be less likely it's going to happen so you can use this idea to kind of rate your stocks so each hurdle that you think of when you ask yourself that question can get a rating between -3 and positive 3. so a negative 3 rating means you have zero confidence in the company's ability to overcome that hurdle a positive three

Rating means you think it will easily clear that obstacle then you can add up the scores and get your occam's razor rating the higher the number the higher your confidence in your bull case so if we go back to these four hurdles that we mentioned before we can run it through this system to see what score we get so here are the hurdles on the left side and then here are the scores about how easy it will be to get over that hurdle for the company so management dilute shareholders gave that a score of two in this example plan is in place to buy

Back stock so that gives shareholders more value everyone loves that it's a low margin business how hard is this hurdle to overcome negative two because there's not much room for margin expansion within their core business industry has little runway over the next five to ten years negative one because management is expanding into other verticals but it's too early to give it a higher rating sales costs are growing over time while the gross margin shrinks and i think in the beginning i said the

Overall market shrinks when i first read this but it's gross margin that he's talking about here and this is a number three because that hurdle should be really easy to clear because these are all one-off expenses that won't occur again and again so you add it all up and you get a score of two now of course there's a lot of subjectivity to this scoring system but that's okay because the whole point is that you're tracking your own process you can track what you thought at the time and then compared to what actually happens

And the more companies you score using this method the more data you're gonna have about what hurdles companies struggle with the most so if you score 10 companies and give them all plus threes on reducing costs of sales spend then that should increase your confidence the next time you see that hurdle so over time you could keep tuning your system to get better and better now one thing i want to talk about a little more is occam's razor because it's a very important concept in markets and a lot of people learn it the hard

Way because that's how the market teaches it the market will take a complex highly involved phd thesis and spit it right back in your face in the form of a giant loss or even a blowout the market doesn't care about fancy complexity which is why long-term capital management with all their phds they blew out in the late 90s and at the same time a swimming pool contractor a guy who built swimming pools he turned ten thousand dollars into 18 million in just over a year and that was dan zanger by the way if you've heard of

Him i think he still has the record and he was not doing anything near as fancy as ltcm and the point i'm making with all of this is that simplicity is what wins out in the stock market and occam's razor explains that really well nasim teleb talks about it too he said for alas those who risk their own funds put a premium on simplicity and practicality others academics driven by rank and status management consultants economic experts and financial analysts they have an incentive to indulge in complexity

And muddle so the people actually winning with their own money in the market simplicity is what's important everyone else who's just talking talking talking well they like to talk with complexity and it goes well with another quote from ed sakota the famous market wizard he says win or lose everybody gets what they want out of the market so a lot of times your standard academic analyst consultant or guy on reddit is looking for intellectual acceptance among his community or peer group he's trying to look smart where the guy who's actually focused on the market he's only

Looking for one thing a profitable investing process he's only interested in profits he could care less about getting praised on cnbc so how do you become more like him instead of the academic well that's where the concepts of ruthless reductionism and occam's razor come into play so rudeless reductionism is ruthlessly reducing any complexity that shows up in investing process complexity always creeps into investing nowadays because we just have so much information you could go on a charting platform and

Put so many different indicators on your chart and i'm sure you've seen people do that and really instead of helping that just hurts the process most of the time same thing if you're looking at way too many fundamental inputs information flow itself is not much of an edge anymore everybody has all the information and it's very easy to access online so the real edge is in organizing that information flow we want to reduce all of it into actionable ideas instead of creating those elaborate

Theories on why an asset should move up or down leave those for the cocktail parties or your reddit thread a profitable process is something that's actionable understandable and easily measurable if you don't know exactly how a particular area of your process contributes to the bottom line then you need to throw it out so if you're looking at five indicators and you don't actually know what two of them are doing how they're actually helping if you can't specifically identify that then get rid

Of those two indicators because they might sound fancy or make you look smart but that's not the goal in the market if you're serious in the market then your goal should be very clear to make profits and reducing your process does more than just clear out the noise from it it's also helpful in evaluating your trading results because if you've got a process that has way too many variables then it's going to be really hard to measure results you're not going to know what's working because when you have trades that didn't work out if you have a convoluted

Process then how are you going to find what went wrong in it did you do the charting wrong was it bad trade management did you have psychological issues correlation issues the wrong macro thesis who knows maybe it was just a probability thing maybe it was a good process but it just didn't work out that time it's really tough to know if your process is all convoluted makes it real hard to identify that bad apple so to make the best process you can and the

Best strategy you always gotta evaluate what's working and what's not and then throughout the stuff that's not working and this leads us to occam's razor which we already talked about a little bit and like we mentioned given two opposing hypotheses this simpler one always prevails and why is that well because the simpler one is easier to test a complex theory is usually one that started off simple but then failed so instead of tossing it out the person just added more and more onto it to give them a sense of false confidence

So here's an example of the wrong way to do things when you're building a process develop your explanation and model with a set of assumptions then add even more theory and assumptions making it more complex and do that until you got a nice sense of false confidence then run that model full bore put a bunch of money into it in the market and you're gonna lose or blow out and finally you'll spend years trying to figure out where you went wrong it's a stupid way to do it here's what you want the process to actually look like you want to develop that model

With assumptions and then ruthlessly reduce it to its bare essentials then you want to test it and evaluate it and if there's a negative result go back to the drawing board positive result then continue to do what works and if you keep iterating like that eventually you'll have a successful strategy and this brings up another concept simplicity on the other side of complexity now when you start out building a process what's going to happen you're going to start with say one indicator and then to try and make

The strategy better you're going to add a few more indicators right and before you know it you are more complex than you probably should be but that's actually part of the process but once you get to that complex state what you need to do is simplify again because you have all this data coming at you so you need to figure out which data is actually important which parts of your process actually add to your bottom line so you pick out all the other stuff and then all of a sudden you're

Back to simplicity so you go from simple to complex back to simple again but going from that complex back to simple that's the hardest part apple is a great example of what they've done with phones when they came out with the iphone i mean that's a computer in your hand right it's not simple it's extremely complex but they went through that entire process to the point where they found simplicity on the other side of complexity and you got that product that's really easy to use and works great where competitors

Were way more complex and that's why they didn't take off so that's the same idea you need to have when building your strategies and a strategy we built and use which we talk about in this free training which if you haven't taken there's a link in this video and down below in the description and comments that's exactly what we did it's a momentum strategy which we built up but then reduce back down and become simple because with any systematic strategy you got to think about a lot of complex things how are you going to evaluate momentum

Is it over 6 months 9 months 12 months how often are you going to rebalance how many positions are you going to hold what are your position sizes going to be it sounds simple when you start it right momentum means you're going to get into the stocks that go highest the fastest but then the complexity is like how do you actually do that because there's so many different factors so the trick is to get past that point and back to the simplicity saying okay let's reduce it down to here just five positions rebalancing once a month steady position sizing in each

Making it all very simple so that it's easy to execute as well and once you have that and you're executing year after year well that's how you build your wealth and again if you want to learn more how to use that strategy just check out this training and if you want more videos like this on market strategies and how to make money in the market then definitely subscribe to this channel take the training subscribe and i will see you in the next video stay followed out there bye

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