I would like to add that with focused investing you tend to research your positions a lot more thoroughly and therefore more confident in the long term direction of the stock. This helps in ignoring the short term market ‘noise’. Ben Graham pointed out, the day-to-day market fluctuation is not a fundamental analysis; it is a barometer of investor sentiment at that point in time. You cannot take it seriously.
Sometimes sentiments rather than fundamental may be dominant force driving a particular stock lower. The P/E multiple is clearly subject to many factors including market sentiment/risk aversion. Multiples can contract across the board in periods of risk aversion. Even companies with strong fundamentals are punished – at least temporarily. During these periods, there will be high drawdowns, particularly in focused portfolio. Please remember, in the long run – Earnings Determine Market Price [EDMP] while in the short run – Emotion Determine Market Price [EDMP].
Virtually all studies show that, at any given moment, about 60% of the return and volatility of a given company’s stock is dictated by the overall stock market – 30% by the market as a whole and the rest 30% by the industry subgroup. A falling tide may initially sink all ships, the cream of the top will inevitably float back to the top.
Corrections are part and parcel of the investment process – they come and go. All past market crashes are viewed as opportunities, but all future market crashes are viewed as risks. If you can recognize the silliness in this, you are on your way to becoming a better long-term investor. Over the past century, the average bull market has lasted 49 months for an average return of 153% while the average bear market has lasted 17 months for an average return of – 38&. For overall stock market [S&P 500] – it is well known that ‘It always is two steps forward and one step back when it comes to investing’.
It is always advisable to keep a good part of your capital in cash reserve. Never invest all your funds. Cash is an underappreciated asset because it is one of the few things that rise in value as the market corrects. Any correction should actually be viewed as an opportunity to rebuild positions on the same long-term fundamentals you liked before but at a more attractive price. It is not timing the market as much as improving your cost basis.