In the last few weeks, we have featured interviews with John Templeton discussing the concept of maximum pessimism. This is the second and final part of Lauren Templeton and Scott Phillips discussion of maximum pessimism and its relationship to Templeton:
Another way to consider this activity is in the terms of comparing near-term versus long-term prospects, in many cases sellers lose sight of the longer-term earning power of a firm and sell based solely on the basis of poor near-term prospects. One simple illustration of this behavior is to consider that Sir John held stocks an average of seven-and-half years while managing the Templeton Growth Fund, but today investors in the market only hold stocks for an average of eleven months. This tells us a great deal about the temperament of the average investor and an overwhelming focus on near-term variables.
While the act of taking advantage of near-term pessimism to capitalize on a better long-term result may be simple in concept, executing this behavior in the financial markets is much more difficult in practice. This is owed, perhaps not surprisingly, to human behavior. The fact that humans are mostly wired for instant gratification (obtaining their desired outcome) can be established at the earliest age, as one study conducted by researchers on preschoolers (Mischel, Shoda, Rodriguez, 1989) found that children who opted for short-term rewards of lesser value often grew into adults who did the same.
Obviously, the name of the game in value investing is the sacrifice of near-term gratification for the anticipation of much larger long-term benefits. Buying at the point of maximum pessimism is taking this behavior to its most extreme. All too often though, investors do not buy into falling prices, even when they logically understand the benefits of holding stocks for longer periods. This behavior often comes at the expense of the greatest benefit that the stock market has to offer, which is the magic of long-term compound interest. However, this act of discipline and the ability to see an optimistic outcome in the face of strong adversity was Sir John’s calling card as an investor and what ultimately separated him from the behavior and results of other investors.
Lauren Templeton is president of Lauren Templeton Capital Management, LLC, and Scott Phillips is author of the newly released Buying at the Point of Maximum Pessimism: Six Value Investing Trends from China to Oil to Agriculture (FT Press, 2010). Templeton and Phillips are also coauthors of Investing the Templeton Way: The Market-Beating Strategies of Value Investing’s Legendary Bargain Hunter (McGraw Hill, 2008).