May 10, 2009

Are you still waiting ?

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?

17 comments:

Abhi said...

Nice post Rohit,as always. :-)

I have been the culprit of the same thing in this fall. Trying to time the entry is not an easy thing to do. I guess I have missed my chance of getting at a good price in BEL, CRISIL.

Rohit Chauhan said...

Hi abhi
all of us guilty of that. who doesnt want the cheapest price. feels great when you buy at near bottom prices.
only problem is it is diffcult to do it consistently
regards
rohit

Abhi said...

Yes, but with BEL, I think it isn't still too late. It is still trading way below it's intrinsic value. By the way, have you recalculated your intrinsic value for Crisil/BEL recently?

Abhi.

Rohit Chauhan said...

Hi abhi
i have done a detailed calculation of the intrinsic values for these companies. just had a cursory look at these companies and liked what i saw. i think their intrinsic value has increased, though in case of crisil the stock price has gone much higher than the value. BEL ofcourse sells at a much higher discount than CRISIL

regards
rohit

sumi said...

Hi rohit,

your latest post is apt for me.I started following the stock market in March so I am considering those low prices for most stocks every time I am thinking of investing, even if the company satisfies all the other criteria that I have set. Emotional discipline is very important while taking such decisions your latest post really captures what most investors are going through right now.

sumi said...

Hi rohit,

your latest post is apt for the current scenario.Everybody is using the march lows to base their buying decisions. People are banking on the elections for the market to correct itself. I completely agree with you that once we are confident about a company and have managed to evaluate its intrinsic worth then buying at a discount is sufficient if we are looking at long term. 10%-20% really does not matter

Anonymous said...

Hi Rohit,
I also feel it's my situation you have written about. I am also waiting for Thermax, which i waited for 6 months to come below 160, my ideal buy price. But i bought only 25% of total position at 158.. now waiting to come around 160 and put remaining 100% funds.

regards
Ani

Rohit Chauhan said...

hi sumi
yes rationally it makes sense to buy the stock.however pulling the trigger is often quite diffcult.

ani - i recently started looking at thermax @225 and have yet to analyse it fully. however at 160 it was a steal.

why are you expecting the price will drop back to 160 again ?

regards
rohit

Sachin Purohit said...

I waited to buy Grindwell at less than 65 while it was about 75, only to eventually buy it at about 84. At 84 too, it is a good buy. However, my wait cost me an opportunity to buy it at the price it was available.

karthik said...

Hi Rohit,

You have commented that Crisils curent price is more than its IV. But as per my calc the IV for Crisil is 4000. So it is sill trading at atleast 30% discount.. Am I missing some thing here?

Anonymous said...

Hi Rohit

Back in December 2008, Neraj & I had left some comments about Thermax here http://valueinvestorindia.blogspot.com/2008/12/graham-style-deep-value-stock-portfolio.html

I have updated my records with latest results & raised my Buy price to 182 from 160 as i had said in my December comment. So i will be waiting for thermax to come around 180. I feel lucky as i managed to buy it at my conviction price of below 160.

Regards
Ani

Rohit Chauhan said...

Hi sachin
well, better late than never :)

Hi karthik
no, the rise in the price for crisil has been more than the intrinsic value. however the current price is still below the intrinsic value

Rohit Chauhan said...

hi ani
yes , thermax was a great value @ 160. so congrats for picking it up at that level.
your buy level is set at 180 now ..is that the 50% of the intrinsic value you have calculated ?

regards
rohit

Anonymous said...

Yes, The intrinsic values comes around 365. Thermax has posted not good numbers in 2008-2009, Hence 8.5% growth i assumed in the beginning will come close to the total numbers including March Qtr.

Hence i upgraded the buy price to 182

Ani

RK said...

Very valid statements. I think every inexperienced and new investor or trader (just like me) goes through this process and over a period of time he/she evolves a strategy that's suited to them.


rk
http://thedumbinvestor.blogspot.com

Anonymous said...

Forget 8.5% growth for Thermax, matching last years numbers is the great thing in first place. Results are out. just 2-3% better than last year.

Ani

Rohit Chauhan said...

Hi ani
thermax is in capital goods industry. in this industry the performance is quite cyclical. when analysing thermax look at an average expected growth for the next 5 years and make decisions acordinly

regards
rohit