Let us imagine that we have an exchange-listed stock with strong fundamentals: average revenue growth of the business units in the two digits, some of those units very well protected by government regulation, a product that people will buy regardless of the economic situation, margins in the tens and with room to broaden, and steady and predictable future cash flows by recent past data. It calls for our attention, doesn’t it? At this point, you know that value is different from price, so you compute the value of the business and unfortunately, it is below the current price. Bad luck. But we keep it on our radar. And after some time, the price starts dropping. And dropping. And dropping. Your analysis suggested that the fundamentals won’t change much under adverse conditions, and now the market prices the business well below its value… and well below rationality. How on earth could that happen? It seems our dear Mr. Market is in a terrible mood, and it’s offering cents on the dollar. Would you take the deal, or does it look too dangerous to buy shares under such a pessimistic scenario?

The truth is that this event is not an imaginary example. It happened in real life. It took place in 1973 when Warren Buffet acquired a big stake in The Washington Post, and it has been one of the best investment decisions he has ever taken. You can wonder why that happened, but Warren just didn’t. He already knew about Mr. Market and his swinging moods. He already knew that in investing you have to be opportunistic, so he did his homework on the company and just waited patiently. This quick drop in price may look dangerous, as it took place in a relatively short time, and for academia and many investors, this is an equivalent of a high-risk operationIt is represented by the Greek letter ‘beta’, and it is computed based on past price volatility; or in other words, how has the stock behaved compared to the market. That is, a stock that historically has moved less than the market index is considered to have low volatility–low beta–whereas another one with hectic movement is considered volatile–high beta.

Many institutional investors use this information to accommodate portfolios with a certain risk to specific profiles of investors. They match that risk with investors who can tolerate it and feel comfortable with it. When price movements occur, they rebalance the portfolio, dumping and buying shares, to match again the overall risk with that of the investor profile. However, we now have seen the absurdity of the reasoning. A stock with an immediate plummeted price is not riskier than before–as long as it keeps the strong fundamentals–, but it’s simply more attractive! Not to mention all the frictions derived from rebalancing a portfolio: spreads, fees, commissions, and taxes. Buffett likes to joke that calling someone who actively trades in the market an investor “is like calling someone who repeatedly engages in one-night stands a romantic”.

In 1973, Mr. Market was pricing The Washington Post for $80 million. An analysis of the business using reasonable and common assumptions based on recent data provided a $400 valuation. That’s an absolute huge discount. When buying a publicly listed company, it is necessary to protect your investment with a decent margin of safety. This margin of safety is the difference between the market price and the actual estimated value. This difference will protect you against possible unforeseen events that may negatively influence the value of your investment. The funny thing is that the market price actually kept dipping after Buffett’s purchase, due to the 1974 recession, and thanks to its large margin of safety his position was never threatened. Eventually, the market recovered, and alongside the value of his investment. His opinion on beta was later on condensed in his famous speech The Superinvestors of Graham-and-Doddsville: “I have never been able to figure out why it’s riskier to buy $400 million worth of properties for $40 million than $80 million.”

Intelligent investors acknowledge what volatility represents and take advantage of the situation when is due. The legendary Peter Lynch was actively managing the Magellan Fund at that time and reaped the benefits of it, as he confessed in an interview years later.

Some indicators are currently warning us about future volatility. It is hard to see how the accessibility to undervalued stocks can be considered hazardous to investors who are simply entitled to either ignore the market or exploit its folly. Either because Mr. Market is having a hard time, or because institutional investors are dumping excellent stocks for rebalancing purposes, keep in mind that beta measures past volatility, not the quality of the business. Despite the market price being available for all to see, not many individuals decided to jump on the bandwagon. Opportunities as such are scarce in a lifetime.