Warren Buffett: Be Fearful When Others Are

Greedy
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By ADAM P. BROWNLEE
 Updated Apr 5, 2019
Warren Buffett once said that as an investor, it is wise to be “Fearful when
others are greedy and greedy when others are fearful.” This statement is
somewhat of a contrarian view on stock markets and relates directly to the
price of an asset: when others are greedy, prices typically boil over, and one
should be cautious lest they overpay for an asset that subsequently leads to
anemic returns. When others are fearful, it may present a good value buying
opportunity. 

Keep in mind, the price is what you pay, and value is what you get—pay too
high a price and returns are decimated. To elaborate on this, the value of a
stock is relative to the amount of earnings it will generate over the life of its
business. In particular, this value is determined by discounting all future cash
flows back to a present value, an intrinsic value. Pay too high a price and the
return that arises as a stock gravitates back to its intrinsic value over time will
erode. Act greedy when others are fearful and reap enhanced returns, under
the right set of circumstances: predictability must be present, and short-term
events that create the subsequent downgrade in prices must not be moat-
eroding.

Of Cigar Butts and Coca-Cola

Warren Buffett is not just a contrarian investor. He may be what you might call
a “business-oriented value investor.” Meaning, he does not purchase any and
everything just because it is on sale. That was Ben Graham’s style (and
initially Buffett’s). It is called the “cigar-butt” style of investing in which one
picks up discarded business cigar butts laying on the side of the road, selling
them at deep discounts to book value with one good puff left in them. Ben
Graham looked for “net-nets” or businesses priced below their net current
assets or current assets minus total liabilities.

Although Warren Buffett began his investing career this way, in the face of
anemic net-net opportunities, he evolved. With the help of Charlie Munger, he
discovered the land of outstanding businesses, the home of See’s Candy and
Coca-Cola (KO), businesses with durable, competitive economics—the moat
—and rational, honest management. He then looks for a good price and takes
advantage of opportunities when others are fearful. As he has said in the past,
it is much better to buy a wonderful business at a good price than a good
business at a wonderful price. 

Salad Oil: Don’t Leave Home Without It

The fear-inducing events that lead to superior investment opportunities can
include short-term shock waves created by macroeconomic events such as
recessions, wars, sector apathy, or short-term, non-moat damaging business
results.   

In the 1960s, the value of American Express (AXP) was cut in half when it was
discovered that the collateral it had used to secure millions of dollars of
warehouse receipts did not exist. The collateral in question was salad oil and it
turns out that commodities trader Anthony De Angelis had faked the inventory
levels by filling his tankers with water while leaving small tubes of salad oil
within the tanks for the auditors to find. It is estimated that the event cost AXP
in excess of $50 million in losses.

After reviewing the company’s business model, Buffett decided that the
company’s moat would not be materially impacted by the event, and he
subsequently invested 40% of his partnership’s money in the stock. Over the
course of five years, AXP increased by five-fold.

The Gecko
In 1976, GEICO was teetering on the edge of bankruptcy due in part to a
business model shift in which it extended car insurance policies to risky
drivers. With assurances from the then company CEO John J. Byrne that the
company would revert to its original business model, Buffett invested an initial
sum of $4.1 million in the company, which grew to over $30 million in five
years. GEICO is now a wholly-owned subsidiary of Berkshire Hathaway
(BRKB). 

Shock-waves such as salad-oil scandal and business model drifts create

value and have allowed Warren Buffett to reap substantial returns over the
years. To be greedy when others are fearful is a valuable mindset that can
reap substantial rewards for the investor.

The Bottom Line 

Once the shoeshine boy starts giving out stock tips, then it is time to leave the
party. Charlie Munger once likened a frothy stock market to a New Year’s Eve
party that has gone on long enough. The bubbly is flowing, everyone is
enjoying themselves, the clocks have no arms on them. No one has a clue
that it is time to leave, nor do they want to. How about just one more drink? As
a business-value investor, it is imperative to know when it is time to leave and
to be prepared for that perfect opportunity, to be greedy when others are
fearful, yet to be greedy for an investment with long-term durable economics
and rational, honest management.