Better Investing Step 2: Be Patient

About Latest Posts Scott PhillipsScott Phillips is The Motley Fool's Chief Investment Officer in Australia. He is Advisor of The …

a woman

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More

Welcome to The Motley Fool's '5 Steps to Better Investing' series. With some time for reflection between Christmas and New Year, this is a good chance to review the year just gone, and prepare for the 12 months ahead.

In Step 1 we covered, 'You don't have to make it back the way you lose it'.

Once you've disposed of unwanted ballast and taken on fresh supplies, you're ready to set sail.

Step 2: Patience is a virtue
Despite many theories to the contrary, the share market is a moody and irrational beast.

Sometimes the mood impacts the market as a whole, or entire asset classes – we've been through tech and bio-tech booms and busts and we're living through the current mining boom here in Australia.

Other times, investors' views of individual companies can drive a share price to unreasonable highs or lows – occasionally the same company at different times in its history. Microsoft (Nasdaq MSFT) peaked at almost US$60 per share in late 1999, and its diluted earnings per share clocked in at US$0.84, giving it a price/earnings ratio of 71 times.

Fast forward to the end of 2011, and the share price is around US$26, reasonably unchanged since early 2002, yet profits have grown to around $2.69 per share, for a P/E ratio in the single digits!

The Microsoft example neatly illustrates the extreme moods of the market – its unbridled optimism and deep pessimism. Hindsight is always 20/20, but I don't know how anyone could justify paying almost US$60 in 1999, and I think it's pretty likely that today's price undervalues the business by a wide margin.

Investors can benefit from patience in two key areas.

Patience in buying
A company can be a wonderful business, but not necessarily a good investment. The difference is price. There's no precise formula for success – despite what some will tell you – simply because the future is unpredictable. However, if you're paying a high multiple of earnings, there's little margin for error.

A missed opportunity can be a big disappointment, especially if that company goes on to a much higher share price. However, an impatient purchase of an overpriced company can do long term damage to your portfolio.

In investing, waiting for the risk/return scenario to be more firmly in your favour is one success factor we can have almost total control of.

No amount of patience will reward the investor who purchased Microsoft at US$60 in 1999. By getting caught up in the hype of the market, purchasers at that price are still down over 50% twelve years later. Being a patient buyer – and avoiding that fate – is key.

Patience in holding
Okay, so you've found a quality business, with favourable economics and prospects and at a great price. So far, so good.

However, soon after buying the company, the market tanks, taking the company's share price with it. Or, alternatively, the company releases results that disappoint the market, and the shares pay the price. Lastly, maybe you've held the shares for a year, and while they haven't dropped, they haven't increased either.

In any of the above scenarios, an investor can't be blamed for being a little concerned.

It takes a very strong character to look these facts square in the face and ignore them – and that's exactly the character we need to develop. To be clear, if something has happened to make us less comfortable with the company whose shares we hold, we should definitely reassess and be prepared to sell.

However, if all of our reasoning still stands, and we're still equally comfortable with the underlying business, we shouldn't let the market scare us into selling. After all, this is the market that told us Microsoft was worth US$60 in 1999 and Rio Tinto (ASX: RIO) was worth $124 in May 2008, $23 in December 2008 and $70 a year later.

Many fortunes have been made by investors willing to ignore short-term price gyrations in favour of long term share price appreciation.

Foolish take-away
Investing isn't always easy. However, we have it within our power to make investing simpler or far more difficult. The difference is the amount of effort we put in, and how patient we are prepared to be.

Brokers and the Australian Tax Office are the prime beneficiaries of hyperactive traders – there are many studies demonstrating the deleterious effects of over-trading and tax on our portfolios.

In this age of online brokerage and instant access to real-time share prices, the impetus to do something is stronger than ever. One of the hallmarks of Warren Buffett's investing is his extreme patience. I'll leave the last words to the Oracle of Omaha:

'I've had periods in my life when I've had a bundle of ideas come along, and I've had long dry spells. If I get an idea next week, I'll do something. If not, I won't do a damn thing.'

Are you looking for quality stock ideas? Readers can click here to request a new free report titled The Motley Fool's Top Stock For 2012.

Scott Phillips is The Motley Fool's feature columnist. Scott owns shares in Microsoft. The Motley Fool's purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson

More on ⏸️ How to Invest

A group of young people lined up on a wall are happy looking at their laptops and devices as they invest in the latest trendy stock.

Building a share portfolio as a young investor? Here's where I'd start

I think investing in ASX shares is a great idea. But where to begin?

Read more »

nerdy looking guy with glasses peeking out from under bed sheets
⏸️ How to Invest

How to avoid this costly ASX investor trap – it's harder than you think

Emotional investing is one of the most common mistakes people make. Here's how to avoid it.

Read more »

Young female investor holding cash ASX retail capital return
⏸️ How to Invest

How to turn $20,000 into $300,000 in 10 years with ASX shares

$20,000 investments in Domino's Pizza Enterprises Ltd (ASX:DMP) and these ASX shares 10 years ago would have made you rich...

Read more »

AGL capital raise demerger asx growth shares represented by question mark made out of cash notes
⏸️ How to Invest

What is an ex-dividend date, and can you profit from it?

What exactly is the ex-dividend date of an ASX dividend share? Is it something you can profit from for a…

Read more »

Five stacked building blocks with green arrows, indicating rising inflation or share prices
⏸️ How to Invest

What is reflation, and why is everyone talking about it?

Investors are starting to talk about the dangers of 'reflation' for the ASX share market. Here's what that means for…

Read more »

asx share price on watch represented by investor looking through magnifying glass
⏸️ How to Invest

Here's why Warren Buffett prefers buybacks to dividends

Berkshire Hathaway Inc (NYSE:BRK.A)(NYSE:BRK.B) has been buying back its own shares. Why is that better than paying a dividend for…

Read more »

⏸️ How to Invest

Why I think Warren Buffett is right to think a market crash is always coming

Following Warren Buffett’s lead in planning for the next market crash could be a profitable long-term move, in my opinion.

Read more »

asx investor daydreaming about US shares
⏸️ How to Invest

How to buy US shares from Australia right now

If you have been wondering how to buy US shares from Australia to gain exposure from the highly topical market,…

Read more »