Although I consider myself an investor rather than a trader, I am also very committed to the notion that one of the most important factors in investing is the entry point price. As I have written in the past, as a general matter there are no intrinsically "good" or "bad" investments, it all depends on price. At a high enough price, the stock of a very fine company can be a horrible investment; at a low enough price, the stock of a weak company can be an attractive investment.
As various pundits have pointed out, "Mr. Market" sometimes serves up real bargains for no apparent reason. Especially in the last few years in which the market seems to move with high correlation and with very little differentiation among sectors or individual equities, the stocks of very strong companies can decline precipitously and provide attractive opportunities for investors.
In the past couple of years, I have tried to identify strong companies and select price points below which I will back up the truck and buy. Two that I followed in 2010 and 2011 were Wal-Mart (WMT) and Microsoft (MSFT). In each case, the company was in a strong position in its market, was trading at very attractive multiples, and had an extremely strong balance sheet. Both of these companies had large share repurchase programs under way and research revealed that, even after accounting for stock options, the share count of each of these companies was declining at a brisk pace. I resolved to buy WMT whenever the price got below 50 and to buy MSFT whenever the price got below 25. Calculating price earnings ratios after backing out net balance sheet cash convinced me that at these prices, the stocks were very, very cheap. Of course, if I saw the price of one of these stocks decline precipitously, I would try to make a judgment about the reason for the decline. In the past couple of years, most declines have been due to market-wide panics and not to problems identified with the companies themselves. So far, this strategy seems to be working out reasonably well.
An alternative strategy would be to sell a put option at the price determined to be attractive. One disadvantage in this strategy is that the investor may never actually acquire the stock. In addition, if the put is of long enough duration, the investor could get blindsided by some nasty development.
Investors must be careful not to fall into the trap of thinking that a stock is "cheap' solely because it is selling at a price substantially below its high. I sidestepped most of the 2000-2003 Crash but as tech stocks got beaten down, I thought I would step in at attractive entry points. Intel (INTC) had sold in the 70s, so I thought that I was getting a bargain when I bought at 48. And I thought I was really getting a steal when I bought Cisco (CSCO) at 29 (it had traded over 75); my broker even commended me on making a "smart" contrarian move. Needless to say, these investment have not worked out well although I dollar cost averaged down to much lower prices.
There is no substitute for fundamental research into the value of the company in whose stock you are investing. Balance sheet strength, the price earnings ratio, the dividend yield, sum of the parts value, management's commitment to shareholder value, and cash flow available to owners must all be analyzed carefully. There is no basis for assuming that the investors who bought the stock 6 months ago for twice the current price were playing with a full deck of cards.
I just bought some Google (GOOG) last week below $590; it will be interesting to see how it works out.
Disclosure: I am long MSFT, WMT, INTC, CSCO, GOOG.
Source: http://seekingalpha.com/article/321425-value-investing-buying-on-dips
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