The S&P 500 was up more than 1% on May 14, 2011 and down more than 1.3% on May 15, 2011. Most of the S&P 500 stocks are increased 2 to 6% on May 14 and lost same kind of percentages on next day.

If you thought market was going to turn up after 7% decline, you might have bought stocks on May 14,2011 thinking that, you don’t want to lose the upside. But next day, that newly bought stock positions are in a loss. You might have thought I don’t want to loose more money and to protect your money sell at a loss.

So how do you behave in this uncertain environment? To generate market-beating return, you should behave as mentioned below.

Stock prices are determined by the supply and demand for that particular stock at that day. Some days, market is so pessimistic. Supply will be more, demand will be less and the stock price will drop. Some days, market is so optimistic. Demand will be more, supply will be less, and price of the stock will go up.   Market mood changes depends upon that day’s economic reports or any other news, which is related to the current pressing issues.

Here is the investing wisdom,

1. You should know more about the company you are trying to invest or what ever the stocks, which you are holding. You should have sense of intrinsic value of the company that is the worth of the company.  If the market prices are trades 30 to 50% discount to your estimated intrinsic value of the company, add more stocks to your holdings. If the company stocks are trading at above or at your intrinsic value of the company, just sell it.

1. Market should not command your buying and selling decision. You should act depends upon your calculated intrinsic value of the company. 

Look at this example, you thought particular company intrinsic value is $10/share. You bought at $7.5/share that is 25% discount to intrinsic value. That is good buying decision.  After couple of months, stock trade at $9/share. You felt good. You made a 20% profit in couple of months, thinking of selling at $10/share. But the market down turn happened, your stock fallen to $5/share in couple of days of heavy selling in the market. Now you are 33.3% down from your purchase price. You are scolding yourself, why I didn’t sell at $9/share? Now I lost my profit of 20% and lost 33.3% of my invested money.  You were in tension scolding yourself and fear of losing more money. The stock may go down to $4/share you may lose more. You are tensed now. Hard earned money is going down in front of your eyes. You have urge to act. You try to protect your money and sell at $5/share and took the loss. You will be thinking I will invest the remaining amount in another stock and try to recover my loss. After you sold, after couple of weeks, stock slowly reaches to $8.5/share. Now you are kicking yourself again, why did I sell my position at $5/share? Now the stock is increased to $8.5/share. Most of the investors behave the above-mentioned way.

To generate market-beating return, you should behave below mentioned way.

You did your thorough research and calculated intrinsic value of the company, which is around $10/share. You bought at $7.5/share that was a good buy. When the stock reached $9/share, you didn’t sell, you were waiting to reach $10/share to sell the stock. That’s fine too. Now the market crashed, your stock fallen to $5/share. Nothing changed in the company, you still believe the intrinsic value of the company is $10/share. Only the market price came down because of macro environment.  When the stock trades at $5/share, the shares are trading at 50% discount to intrinsic value of the company. If you have cash you can buy more, now your average price will be $6.25/share or you have other holdings, some stocks are trading near intrinsic value or above intrinsic value. You can sell those stocks and raise cash and buy this bargain stock at $5/share. You can hold the stock until it reaches to $10/share. Now you made around 60% of your invested money.  That’s way you need to behave in this uncertain times. You should not get panic and sell at the bottom.

By Jeeva Ramaswamy

Jeeva Ramaswamy is ardent disciple of Warren buffet and managing partner of GJ Investment funds (www.gjfunds.com) which is value based investment fund focusing on US and emerging markets modeled after 1956 Buffett partnership. Since inception GJ Funds have consistently beaten Dow, NASDAQ and S&P 500 indices and 95% of the mutual and hedge fund managers by wide margin, generated 72% compounded annual return. He can be reached at jeeva@gjfunds.com