Bubbles, Schurbbles and Dubbles

I've been hearing a lot of talk about a financial bubble in the ASX. Bubbles to me, mean there should be a correction and that prices will contract. In its simplest form, I believe a bubble implies prices above worth.

I think investors need to be aware markets contract all the time. You'd be a fool to think that the market can continually grind up indefinitely. When the bubbles burst, most people lose substantial amounts of money. 1987, 2000 and 2008 are some recent examples of bubbles. What we need to do is stick to facts. Yes, bubbles come, but in between all of these bubbles the Dow Jones Industrial Average has risen from about 1,300 in 1985 to just over 17,000 in 2014, but yet, people have lost a lot of money. This is because people try to dance in and out of stocks. People, get too obsessed with trying to find the stock that's going to be green tomorrow and avoid the red one. But, that's not how one should approach the stock market. The stock market should be approached with a business mind frame. When buying a stock you are buying part ownership of a business. A simple example will illustrate this point. Let’s assume you own a shoe store and its generating $1,000 a year in profit and today someone came to you and offered you $5,000 for it and you decline. Let’s say you decline because you think that business is doing really well and its worth more. The next day, someone else comes in and offers you $2,000 you decide to sell because you think something is wrong.

Funnily enough, this is the approach people take to the market. They buy stocks based on opinion, fads, friends, or if they had a good lunch that day and decided to buy based on that, who knows. It’s crucial to pivot away from this philosophy and stick to facts. In the above example, I mentioned nothing about a change in the operating components of the company, the only variable that changed (apart from the day) was that someone is offering a different price and that you somehow translate that to imply a drastic action needs to be taken. If I told you to jump off a cliff would you do it? Then why, would you let me tell you when to buy/sell something based on opinion in isolation of fundamental fact. This diametrically opposed view of the stock market, that is, that we are buying fractional ownership in a real business lies at the heart of what we need to be doing, not speculation and substantial guesswork. One thing that always baffles me is that many investors spend more time trying to find a better discount on a loaf of bread or a refrigerator than where to allocate their invest-able funds. 

To get back to the bubble topic, we need to focus on what the business is doing. If a company’s stock price has pulled back from $10 to $6 because of a “bubble” but the business is doing well (all things being equal), then I’d buy more. Take advantage of volatility, it’s one of our good friends. But hey, never listen to anyone. Warren Buffett will tell you that. The best and only good investment ideas should come from independent thinking and not crowd psychology.