StreetWise: News of the day should not spark panic selling

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There is an often quoted saying that a butterfly flapping its wings in one part of the world could cause a disruption in the weather a thousand miles away. While many take this aphorism at face value despite its incredulous facet, there lies within a basic nugget of truth.

"The Butterfly Effect," the concept originated with MIT meteorologist Edward Lorenz, was intended to illustrate the concept that small events can have large, widespread consequences. As such the butterfly effect has become a metaphor for the existence of seemingly insignificant moments in time that alter history and shape destinies.

Fast forward to the recent decline of the S&P 500 index after the start of the Ukraine's crisis was triggered last November by the then-Ukraine president Viktor Yanukovich's refusal, under Russian pressure, to sign deals on closer political and trade ties with the European Union.

The Crimean peninsula now has the potential to become a history altering altercation. Adding to global distress, China is increasingly mired in an economic morass of its own making.

The world has no shortage of crises. However, you do not want to become distracted by those who sermonize on Armageddon.

Consider a brief paraphrase from Warren Buffett's latest letter to his shareholders. On the subject of panic selling, Mr. Buffett wrote, "Why would I sell off stocks that are small participations in wonderful businesses? True, any one of them might eventually disappoint, but as a group they are certain to do well. Could anyone really believe the earth is going to swallow up the incredible productive assets and unlimited human ingenuity existing in America?"

Every stock has an intrinsic value (generally a discounted cash flow evaluation) to which its price is anchored, although share prices will fluctuate due to the daily ebbs and flows of supply and demand. What is decidedly more important is that the price of a stock will converge toward its intrinsic value.

If you can sensibly estimate earnings out five years, and if the stock sells at a reasonable price in relation to the bottom boundary of its intrinsic value, then a purchase is a reasonable decision -- otherwise move on to other candidates.

Investment timing is important only to the extent that the timid or inexperienced investor will enter the market at a time of extreme exuberance only to become disillusioned when the market declines and paper losses occur. This is an age old dilemma. The antidote, as Mr. Buffett points out, is to accumulate shares and never sell when the news is bad and stocks are well off their highs.

Lauren Rudd is a financial writer and columnist. You can write to him at LVERudd@aol.com.


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