Warren Buffett’s negative stance on gold is pretty well known within the investing community. But as fears of inflation continue to rise, the precious metal is once again becoming a popular refuge for those looking to protect their wealth. So should I be ignoring the Oracle of Omaha’s views? Well, for my portfolio, I don’t think so.
The recent volatility in the market is certainly unpleasant, making the relative stability of gold far more enticing. However, thanks to the price drops of many fantastic stocks, buying opportunities have likely emerged. So, how do I find them? Let’s explore.
The not-so-secret recipe of building wealth
In my experience, buying and holding shares in high-quality businesses that have a profound impact on improving the world is a recipe for sustainable wealth generation over the long term. This isn’t exactly a secret, and it’s something Warren Buffett has been saying for decades.
But simply identifying these companies is not enough. The price of the stock also needs to be taken into account, and the importance of valuation is something most investors tend to forget. All too often, a ground-breaking discovery or disruptive start-up makes headlines sending its share price surging. The prospect of a revolutionary product or service generates a lot of excitement. And that can push share prices to lofty levels. What’s more, investor growth expectations tend to grow even bigger as the share price climbs, especially if the company has a history of beating analysts’ forecasts.
But eventually, the price can become divorced from the underlying fundamentals. And when that happens, buying shares of even the most well-run enterprise can be a disastrous mistake. Why? Because all it takes is one sign of trouble or slowing growth to trigger massive downward momentum.
Investors of DocuSign know this all too well. The electronic signature solutions business saw its share price nearly halve in a single day last month after management issued guidance that was lower than analysts’ forecasts. I like to describe these situations as Fantastic Business, Terrible Stock.
Uncovering buying opportunities, Warren Buffett-style
Fortunately, such volatility can create buying opportunities. When any business releases an underwhelming earnings report or is at the centre of a negative news story, the share price has a habit of falling. And this happens regardless of whether the underlying value of the company is affected.
It’s not uncommon for a company to miss earnings expectations due to a temporary problem. In fact, the last two years have seen plenty of this as Covid-19 continues to disrupt entire industries. But the question to ask is, what caused the drop in performance?
Suppose it’s only a temporary problem, and the business itself is a well-run organisation with a strong balance sheet and fat cash flows? In that case, a buying opportunity for me may have just emerged thanks to investors falling prey to their emotions. Or, as Warren Buffett put it: “Be fearful when others are greedy, and greedy when others are fearful”.