I often get a comment or email, which goes along the following lines – I have been analyzing this company and the company seems undervalued to me. Should I wait for a lower price before I start my buying?
My usual response to this question is – Do you want to delay an informed decision based on an uninformed guess?
Lets think through this dilemma further. Lets assume you have been analyzing a company for some time and feel that the company is easily worth 100, but selling at 50. Now the company is a great buy, but due to the sentiments of pundits, your friends and your milkman, you ‘feel’ that the stock could go lower. As a result you are thinking of holding on a bit longer so that you can buy the stock at 40.
Now this is a very tempting thought. Who doesn’t want to buy a stock at the cheapest possible price? I can bet a lot of us have engaged in this mental gymnastic (I definitely have!).
The only problem with this approach is that it is a waste of time and energy and muddles up the decision making process.
Is it possible to predict stock prices?
The key underlying assumption behind the above thought process is that somehow we know the direction of the stock price. Let assume for a moment that is true. If that is the case, then why bother buying the stock? Go ahead and buy calls or puts on the stock and you will be rich.
It is quite possible that in extreme markets such as seen in the last quarter, the market is on a sustained downward trend and you strongly believe it will continue to do so. However this kind of sustained movement happens only a few times and market can turn around abruptly (There were no sirens in the first week of march when the market started turning and has jumped 50% from the lows).
If however you still have a very strong reason to believe that the stock price will keep dropping, is it not smarter to buy in small lots and average your cost down, rather than wait for the absolute bottom.
Combine technical analysis?
A lot of chartist and technical analyst claim to know the short-term direction and I have heard of people wanting to combine the two approaches. I personally don’t subscribe to it.
It is not due to the fact that technical analysis or charting does not work (I don’t have the skill or knowledge to evaluate that), but due to the fact that for a long term investor like me a 10 or 20% difference in the purchase price will not make as much difference to my end result as being accurate on the analysis of the stock.
If my thesis is right, I will make good returns and a 10-20% price difference will not make a huge difference. However if I am wrong on my analysis, a 10% discount will not save me. As a result, I would rather focus on analyzing the company in depth rather than try to time the stock precisely.
Am I perfect?
Now all this talk could give this false impression that I never get swayed by price and never try to time the stock. Far from it!! I have been guilty of trying to average down my cost several times and have missed the boat in that process.
As I have noted in the past, I typically build a 50-60% position in the beginning and then keep buying till I hit 100% of my position size. This works well in a falling market, but leaves me with a smaller position if the stock turns around quickly. I faced this with maruti suzuki recently. I started buying at around 500 levels and was able to build a 70% position. However the stock turned around suddenly and I remained ‘anchored’ to the 500 level and did not build a complete position. Luckily I did not repeat this mistake in the case of CRISIL.
So what should we do?
Simplify the process. I personally avoid looking a charts, tea leaves, pundit speak and blogger recommendations before making a final decision. I would try to seek out the facts, analyze the company in detail, and if I am confident that I am getting a bargain, I will go ahead and buy the stock. How does it matter if the stock gets 20% cheaper if my analysis is correct and the company is doing fine?
How about trading?
The above thought process does not hold true for trading. If you are chasing 10-20% returns over the short term then you may want to get the absolute bottom on a stock. Of course if your basic analysis is wrong then an unsuccessful trade can always become a long-term investment :)
Final question: How many of us are still waiting for our favourite stock to hit the feb-march lows before we go ahead and start buying?