Buffett doesn't buy just because 'the stock price has fallen.' How beginners in US stocks can learn to distinguish between cheap and undervalued
There is not a day that goes by without seeing Warren Buffett’s name in introductory books or news about US stocks. As someone called the ‘world’s greatest investor,’ many beginners likely assume that when stock prices fall significantly, he must immediately move to buy. They probably think he is always ready to jump in.
To put it briefly, it is said that Buffett does not buy just because a stock price has fallen. His criteria for buying is not whether it has become cheaper, but whether the price is undervalued relative to the company’s actual worth. In this article, we will organize the difference between ‘cheap’ and ‘undervalued’ for beginners, using Buffett’s philosophy and recent earnings figures as clues.
‘Fallen’ and ‘undervalued’ are different things
First, let’s clarify the difference in terms. A stock price having ‘fallen’ is a fact that the price is lower than it was before. On the other hand, ‘undervalued’ is a judgment that the current price is low compared to the company’s intrinsic value.
Buffett is said to have expressed this difference with the sentiment that ‘price is what you pay, value is what you get.’ Even if the price drops, if the company’s value has dropped by the same amount, it is not undervalued. It is dangerous to look only at the stock price and decide that ‘it’s cheap because it’s half the price.’
An example where it has fallen but is not undervalued
Let’s verify this with hypothetical numbers. Suppose a company’s stock price is $200 and its earnings per share (EPS) is $10. The P/E ratio (price-to-earnings ratio), calculated by dividing the stock price by earnings, is 20 times.
Afterward, business performance deteriorates, EPS drops to $6, and the stock price falls to $140. The stock price has fallen by 30%, but earnings have decreased by 40%. The P/E ratio is now 140 divided by 6, which is approximately 23.3 times. Even though the stock price has fallen, the level of the stock price relative to earnings has actually increased. If you buy thinking it has ‘become cheaper,’ you are actually buying something that is more expensive than before.
As in this example, it is common for a stock price decline to reflect a decline in a company’s value. Buying without investigating the reason for the fall means you are not looking at the value.
Is the reason for the fall temporary or structural?
So, what should you look at? One thing is the reason for the fall.
If the reason is temporary, the company’s value has not been damaged. These are cases such as the overall market becoming unstable or a one-time expense occurring. In such cases, a stock price decline can be a buying opportunity.
On the other hand, if the reason is structural, the value itself is declining. This includes losing competitiveness, a shrinking market, or main products becoming outdated. In this case, it is natural for the stock price to fall, and no matter how much it drops, it is not necessarily undervalued. The saying ‘there is a reason why it is cheap’ is often cited.
Buy only companies you understand
Another pillar of Buffett’s philosophy is the stance of only buying companies that he understands. He calls his range of understanding his ‘circle of competence’ and is said not to touch companies outside of it.
If you do not understand the business model, you cannot judge whether a stock price drop is temporary or structural. If you cannot judge, you will end up relying solely on the reason that ‘it has become cheaper.’ Understanding the company is a prerequisite for judging whether it is undervalued.
Allow for a margin of error in estimating value
A company’s value cannot be known precisely. Future earnings are merely estimates, and there is always an error in estimation. Therefore, the concept of a ‘margin of safety’ is emphasized. By buying at a price sufficiently lower than the estimated value, you try to minimize losses even if your estimate is off.
Suppose you estimate a company’s value at $150 per share. Even if the stock price drops to $145, if your estimate is slightly off, it becomes overvalued. Only when it drops to $120 or $100 does it become a buying opportunity with a margin of safety. Instead of buying just because it ‘fell,’ wait for a price that allows for a margin in your estimate. This attitude leads to prudence.
Even if the price falls, wait
Berkshire Hathaway, led by Buffett, is known for holding a massive amount of cash. In the earnings report for the April-June quarter announced in August 2026, the company’s holdings of cash and cash equivalents were reported to be approximately $365 billion. Although this is a slight decrease from the record high at the end of March, it remains a staggering amount.
What is worth noting is the share buyback. Berkshire resumed share buybacks in March 2026, after having stopped them for nearly two years. It is reported that share buybacks in the April-June quarter totaled approximately $4.5 billion, and exceeded another $3.3 billion in July. The policy is to conduct buybacks when the stock price is below the intrinsic value estimated by management.
In other words, even for its own stock, the company did not buy for about two years until the price fell below its value. It is not “buying because it went down,” but “buying because it was judged to be cheaper than its value.” This order is important. Note that Mr. Buffett handed over the position of Chief Executive Officer (CEO) to Mr. Greg Abel in January 2026 and currently serves as Chairman.
Holding cash is also an option
Many individual investors feel anxious about holding cash. They think, “If I don’t invest quickly, won’t I miss the opportunity?”
However, when there are few undervalued opportunities, waiting itself is a decision. There is no need to force funds into stocks that do not meet your criteria. Cash is also the capacity to act when an opportunity arises.
What beginners can adopt
There is no need to invest exactly like Buffett. However, his way of thinking can be a reference.
When a stock price falls, investigate the reason. Think about whether it is a company you can understand. Look at numbers that measure value, such as earnings and P/E ratios, to distinguish between “fallen” and “undervalued.” And for short-term swings, in addition to judging value, decide on trends and stop-loss positions. Do not jump in just because it is falling. That habit is the first step to reducing losses.
Note This article is for informational purposes only and does not recommend the buying or selling of any specific stock. Please make final investment decisions at your own risk.