When the economy’s wobbly, it’s tempting to run into the arms of a safe haven such as gold. Yet billionaire investor Warren Buffett believes this is a critical mistake.
There’s no denying the shiny yellow metal has a track record of being a solid hedge against inflation. However, is it possible that stocks are, in fact, better?
In the short term, no – 2022 has been a perfect demonstrator of this, with stock prices spiralling into the gutter. But in the long run, the situation can be very different.
Using shares as an inflation hedge
It’s easy to forget, but underneath each ticker lies an actual company. Every business is different. But providing they are managing to navigate the economic storm effectively, the cost of inflation will likely be passed onto customers while the impact is eventually overcome. That’s why, during a recovery, quality shares tend to outperform other asset classes. And that includes gold.
However, the key word here is ‘quality’. Simply throwing money into the stock market blindly in the hopes of capitalising on the tailwinds of recovery is seldom likely to go well. Even if using an index fund to track the FTSE 100 or FTSE 250, by not scoping in on individual businesses, investors could be leaving a lot of money on the table.
The challenge is knowing which stocks to buy. And that’s something Buffett has been mastering over the course of his entire investing life.
How Buffett picks stocks
Stock picking is a complex and nuanced process that combines both art and science. There’s the quantitative side of analysis, looking at the financial statements and building valuation models. And there’s also the qualitative side of the equation focusing on intangible characteristics such as competitive advantages and management talent.
Personally, I believe the latter is the most important. Obviously, financial statement analysis is a critical and essential part of the stock-picking process. But, all too often, investors get lost in the numbers instead of spending little time investigating what’s ultimately driving them.
That’s why screening for stocks using various financial ratios rarely returns any winning investments.
Buffett also appears to agree with this view since he’s constantly talking about the importance of things like having sustainable competitive advantages rather than what to look for on a balance sheet.
Price versus value
The recent stock market correction was quite severe. While the FTSE 100 managed to emerge relatively unscathed, the same can’t be said for the FTSE 250, which tumbled more than double-digits.
As such, if an investor finds a top-notch company worth buying today, there’s a good chance it’s undervalued. However, relying on this assumption could be a critical mistake.
Even the best businesses can make terrible investments if the wrong price is paid. That’s why Buffett always checks whether a stock is trading below its intrinsic value. If so, then the next question to ask is why?
Perhaps the market is simply being overly pessimistic? Or maybe there’s a fundamental problem that’s been overlooked.
