Timing vis-à-vis Time in the Market

“Investing is simple, but not easy. We all know that we should own great quality companies, which offer great products and services that consumer like. We also know to diversify, not trade too much, and keep investment expenses low. However, we also know that we should not overpay for quality companies as well. In addition, we know that we should not time the markets.

The fascinating part for lot of investors is that they agree with the last two statements. They know that we should not time the markets. They also know that we should not overpay for quality companies. While many investors seem to understand the theory, real world application is quite often the tough part.

The first hurdle is that waiting for a company to fall to a certain price and not investing right away is a form of market timing. This is where it is important to understand that a lot of platitudes about the stock market are just that. They are not an objective strategy to guide you through the ups and downs and the changes in the stock markets. Once you start following a strategy, the next logical step would be to keep improving on it. Continuous improvement is a management concept from Japan, which has helped a lot of companies do their best. This concept can be applied successfully to the world of investing as well.

So, the first huddle is to identify great companies which checked on all of the boxes. Then, if someone would not invest in it either because the yield was lower than some arbitrary measure or the P/E ratio was higher than an arbitrary measure. In a way, person was timing the market. The worse situation here for an investor is that he is not investing in some good quality companies, but buying stocks of companies that appeared cheap. This is most common mistake and termed as value traps.

The quality companies will eventually do very well in comparison with the companies whose valuations were cheap but the companies were not standard. One of the famous quotes from Buffett, will reiterate the point that:

“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price.”

“Time is the friend of the wonderful business, the enemy of the mediocre.”

Quite often a good company trading at little above the price bucket of an investor’s valuation range will skip buying the scrip. Though, he liked the company, the business, its prospects, but waiting for a dip that never arrived.

One should set up criteria and adopt discipline and prudence while taking step towards investment. Also, to leave stubbornness at bay so can take quality decisions to invest in quality companies when presented with the opportunity.

One should realize that if they had identified a great company with promising future they should just invest in it. It is quite understandable that one should not overpay dearly for a great company too. However, valuing companies is more art than science. A company with a low P/E ratio that doesn’t grow earnings is more expensive than a company with a higher P/E ratio that grows earnings. You have to take into consideration the quality of the earnings stream, the possibility for future earnings growth, the possibility for disruption down the road, how long that earnings stream can last for, and how cyclical that stream is.

In general, a lot of companies are priced fairly a company may be overvalued by a little or undervalued by a little. It doesn’t matter in long run because we are not in the business of forecasting short-term fluctuations in share prices but in business of investing for the long-term. So as such get the benefit from a long-term trend in the business that would lift earnings, dividends and intrinsic values. Even if you overpay slightly for a quality business, over the long-run, overpayment would turn out to be a small rounding error. The far bigger problem would be NOT investing in the first place, notably because of something.

In the long run, growth in earnings contributes more than expansion of price/earnings multiples.

All of this works however, if you are going to be a patient long-term investor who will hold through thick or thin. You will not lose hope even if scrip takes 3-5 years to start working out. One has to understand that not all positions would work, but on the aggregate, the portfolio will work wonders for the patient and persistent investor. This also eliminates significant amount of risk attached with equity investments.

An investor who buys every month gets an opportunity to experience market twelve times in a year. The ability to invest every month (SIP) is more important than the ability to buy at the bottom and sell at the top. In other words, time spent in the market beats timing the market.

The stock market as a whole tends to exhibit an upward bias over time. It is not all the time of course, and there are always obstacles along the way. There are always “reasons” to sell or not to invest. Yet, it has built a lot of wealth over the past decades for patient, long-term investors.

Investing is difficult. We do not know exactly how the future would turn out. Nobody really knows for sure if a stock is cheap today or expensive. This is why our valuation techniques should be questioned constantly, because they are prone to error.  A company with a low P/E may turn out to be more expensive than a company with a high P/E, if the latter grows earnings and the former doesn’t.  It’s a balancing act, where we do not want to chase yield or chase growth and overpay for it. Valuation is part art, part science, which is why formulaic investing can fail you, if you do not have enough fail safe mechanisms in place. Selecting quality companies is a good start, as is diversifying across companies, industries, and time. Continuously reviewing investments, and your process, can help identify improvement opportunities. The goal of this exercise is to overcome fears and invest decisively without paralysis by analysis.

So next time someone identifies a quality company with good prospects that’s not excessively expensive one should click on the “Invest / buy” button.”