Warren Buffett: Be Fearful When Others Are Greedy

Warren Buffett once said that it's wise for investors “to be fearful when others are greedy and to be greedy only when others are fearful.” This statement is somewhat of a contrarian view of stock markets that 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. It might present a good value investment opportunity when others are fearful.

Price is what you pay and value is what you get. Paying too high a price can decimate returns. The value of a stock is relative to the number of earnings it will generate over the life of its business. This value is determined by discounting all future cash flows back to a present value. This is also known as an “intrinsic value.”

The return that arises as a stock gravitates back to its intrinsic value over time will erode if you pay too high a price. 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 erode intrinsic value. Here’s how Buffett did it.

Of Cigar Butts and Coca-Cola

Warren Buffett isn't just a contrarian investor. He's what you might call a “business-oriented value investor.”

He doesn't purchase stocks just because they're on sale. That approach was his mentor Ben Graham’s style. Known as the “cigar butt” style of investing, this approach picks up discarded business cigar butts from the side of the road, selling them at deep discounts to book value with one good puff left in them.

Warren Buffett began his investing career this way but he evolved in the face of anemic net-net opportunities. With the help of Charlie Munger, he discovered the land of outstanding businesses, the home of See’s Candy and Coca-Cola (KO). These were businesses with durable, competitive economics (the protective moat) and rational, honest management.

Buffett 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.   

The value of American Express (AXP) was cut in half in the 1960s when it was discovered that the collateral it had used to secure millions of dollars of warehouse receipts didn't exist. The collateral in question was salad oil and it turned 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.

Buffett decided after reviewing American Express’s business model 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. American Express increased fivefold over five years.

The GEICO Gecko

GEICO was teetering on the edge of bankruptcy in 1976 due in part to a business model shift in which it extended car insurance policies to risky drivers. Buffett invested an initial sum of $4.1 million with assurances from company CEO John J. Byrne that GEICO would revert to its original business model. That $4.1 million grew to over $30 million in five years. GEICO eventually became a wholly-owned subsidiary of Berkshire Hathaway (BRKB) in 1996.

Other Investing Advice From Warren Buffett

The salad oil scandal and GEICO’s business model drift are prime examples of the kind of shockwaves that can create value and that 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.

But Buffett's comment about fear is far from the only or most quoted bit of investment advice that he's shared over the years. He's dropped some interesting comments on everything from investing pointers to lifestyle guidance and simply managing your money.

Businesses That a Fool Can Run

Buffett once said, "You should invest in a business that even a fool can run, because someday a fool will.” His premise is that investment decisions shouldn't be based on the individual or individuals who are at the helm at the time you're considering buying in. Read the company's annual reports, as many as you can get your hands on. Then base your decision on your research.

Your Retirement Savings

As for your personal budget, Buffett has a few pointers here as well. He's famous for commenting that credit cards are the kiss of financial death. He's also shared a pointer for retirees: "The perfect amount (of money to give your children) is enough money so they would feel they could do anything, but not so much that they could do nothing."

He advises against draining your financial well by helping family members to the point where you have nothing left to continue to invest in the security of your retirement. Your offspring might not appreciate the sentiment but at least they shouldn't have to support you in your old age.

The Bottom Line 

It's time to leave the party when the shoeshine boy starts giving out investing tips. Charlie Munger once likened a frothy stock market to a New Year’s Eve party that's gone on long enough. The bubbly is flowing, everyone is enjoying themselves, and the clocks have no arms on them. No one has a clue that it's time to leave, nor do they want to. How about just one more drink?

It's imperative as a business-value investor to know when it's time to leave and to be prepared for that perfect opportunity. Be greedy when others are fearful but be greedy for investment with long-term durable economics and rational, honest management.