“We always try to be greedy when others are fearful and fearful when others are greedy.”
-Warren Buffett
It’s not a big stretch to see that a lot of the world is afraid right now. For example, take a look at some recent news headline snapshots:
“Searching for ways to tackle the unfolding economic crisis…
If you had taken a nap like Rip Van Winkle a year ago and woke up today, here is what you would find:
- Lehman Brothers and Bear Stearns out of business
- AIG, Fannie Mae and Freddie Mac owned by Uncle Sam
- The Dow Jones Industrial average down 40%
Perhaps you would just like to go back to sleep for another year and wake up to hopefully find things in less of a state of absolute pandemonium.
Alas, if you did that, you would probably miss out on one of the largest wealth building opportunities in your lifetime.
Dovetailing the opening quote by Mr. Buffett (a reasonably successful investor!), the time to ‘get in’ is when pessimism and uncertainty are running high - just as they are right now. When hoards of investors and consumers are scared and cynical, they aren’t looking at the true intrinsic value of investment opportunities are not making logical decisions. Emotion (read: fear) is driving their actions and pushes the real value of investments below their true worth.
Take the asset class that I like the most right now: real estate. I don’t think that you’ll find a more out of favor sector of the entire U.S. economy. The credit crisis and foreclosure tidal wave have all but extinguished even the most resilient of investors hopes for a comeback in the near future. However, select investments do make sense in both the short and long term. For example, take look at the following deal breakdown for a single family home deal in Roseville, Michigan (one of the cities in Metro Detroit where my real estate firm purchases bank owned homes):
Purchase price: $20,000
Repair Cost: $10,000
Total Cost Basis: $30,000
Annual Net Cash Flow (allowing for repairs, vacancy, capital improvements and all operating expenses): $3,600
Now, even if you strip out the idea that the house is worth more than $30,000 from a comparative market value standpoint and you strip out the idea that the house will ever appreciate in value (both of these are extremes, but bear with me), you are looking at purchasing an asset at a price of about 8.3 times annual cash flow. In stock parlance - this would be like buying a company at 8.3 times earnings, or a P/E ratio of 8.3.
Considering the fact that the S&P 500 (a broad market indicator) is trading at roughly 18 times earnings (P/E ratio of 18), you can see that real estate is not necessarily the bastard asset class across the board that much of the media would like you to believe. In fact, if you throw any semblance of long term price appreciation in the mix, combined with any benefit of income from real estate being more tax efficient (not always a given)- you have a strong performing asset.
–> you will not that I left the idea of leverage out of the equation in this analysis for a more ‘apples-to-apples’ comparison
Right now, I think there are some great buys on the stock market side of things as well. Cyclical stocks are going to be out of favor right now (think: steel makers and home builders). Among others, I think this is a great time to grab stocks like Nucor Steel (NUE) and KB Homes (KBH). I have owned Nucor for over 4 years now and could launch into a few reasons to buy, outside of the fact that their shares have been pummeled by the fear mongering of late. KBH is trading for less than its net tangible asset value - meaning you could (theoretically) purchase the entire company and liquidate it and at least make your investment back. This is a relatively rare occurance in the modern stock market.
Since this is not a stock picking blog or real estate blog, I will not opine further. I only use these examples to illustrate that one can profit from all of the madness going on right now by just looking at the horizon and not at everyone else’s head under the ground.
As is plainly evidenced, fear and greed will always play a dominant role in investment decisions. The question is: which side will you be on?
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For those in the Metro Detroit area interested in learning more about real estate investing, the industry or what is going on in general in the marketplace right now, the upcoming Real Estate Investors Association of Macomb (REIA of Macomb) is going to be great. Than Merrill of the A&E show Flip This House is going to be on hand to razzle and dazzle with his tremendous knowledge and investing techniques. Meet people from around the area who are of like mind and occupation. Go to the website to learn more.
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I also encourage anyone who wants to learn more about successful investing (of any kind) to read the compilation of letters that Warren Buffett writes to Berkshire Hathaway shareholders each year. Go here to download some good reading.
