Buying Stocks When The Price Goes Down: Big Mistake?

Elvis Picardo
Contact | Author Bio
ARTICLE HIGHLIGHTS
• Averaging down involves buying more of a stock when its price drops.
• This strategy works when a stock is truly undervalued.
• Some stocks deserve a price drop and may continue to decline, rather than rebound.

The strategy of "averaging down", as the term implies, involves investing additional amounts in a financial instrument or asset if it declines significantly in price after the original investment is made. It's true that this action brings down the average cost of the instrument or asset, but will it lead to great returns or just to a larger share of a losing investment? Read on to find out.

Tutorial: The World's Greatest Investors

Conflicting Opinions
There is radical difference of opinion among investors and traders about the viability of the averaging down strategy. Proponents of the strategy view averaging down as a cost-effective approach to wealth accumulation; opponents view it as a recipe for disaster.

The strategy is often favored by investors who have a long-term investment horizon and a contrarian approach to investing. A contrarian approach refers to a style of investing that is against, or contrary, to the prevailing investment trend. (Learn how these investors profit from market fear in Buy When There's Blood In The Streets.)

For example, suppose that a long-term investor holds Widget Co. stock in his or her portfolio and believes that the outlook for Widget Co. is positive. This investor may be inclined to view a sharp decline in the stock as a buying opportunity, and probably also has the contrarian view that others are being unduly pessimistic about Widget Co.'s long-term prospects. Such investors justify their bargain-hunting by viewing a stock that has declined in price as being available at a discount to its intrinsic or fundamental value. "If you liked the stock at $50, you should love it at $40" is a mantra often quoted by these investors. (To learn about the downside to this strategy, read Value Traps: Bargain Hunters Beware!)

On the other side of the coin are the investors and traders who generally have shorter-term investment horizons and view a stock decline as a portent of things to come. These investors are also likely to espouse trading in the direction of the prevailing trend, rather than against it. They may view buying into a stock decline as akin to trying to "catch a falling knife." Such investors and traders are more likely to rely on technical indicators, such as price momentum, to justify their investing actions. Using the example of Widget Co., a short-term trader who initially bought the stock at $50 may have a stop-loss on this trade at $45. If the stock trades below $45, the trader will sell the position in Widget Co. and crystallize the loss. Short-term traders generally do not believe in averaging their positions down, as they see this as throwing good money after bad.

Advantages of Averaging Down
The main advantage of averaging down is that an investor can bring down the average cost of a stock holding quite substantially. Assuming the stock turns around, this ensures a lower breakeven point for the stock position, and higher gains in dollar terms than would have been the case if the position was not averaged down.

In the previous example of Widget Co., by averaging down through the purchase of an additional 100 shares at $40, the investor brings down the breakeven point (or average price) of the position to $45. If Widget Co. stock trades at $49 in another six months, the investor now has a potential gain of $800 (despite the fact that the stock is still trading below the initial entry price of $50).

If Widget Co. continues to rise and advances to $55, the potential gains would be $2,000. By averaging down, the investor has effectively "doubled up" the Widget Co. position. Had the investor not averaged down when the stock declined to $40, the potential gain on the position (when the stock is at $55) would amount to only $500.

Disadvantages of Averaging Down
Averaging down or doubling up works well when the stock eventually rebounds because it has the effect of magnifying gains, but if the stock continues to decline, losses are also magnified. In such cases, the investor may rue the decision to average down rather than either exiting the position or failing to add to the initial holding.

Investors must therefore take the utmost care to correctly assess the risk profile of the stock being averaged down. While this is no easy feat at the best of times, it becomes an even more difficult task during frenzied bear markets such as that of 2008, when household names such as Fannie Mae, Freddie Mac, AIG and Lehman Brothers lost most of their market capitalization in a matter of months. (To learn more, read Fannie Mae, Freddie Mac And The Credit Crisis Of 2008.)

Another drawback of averaging down is that it may result in a higher-than-desired weighting of a stock or sector in an investment portfolio. As an example, consider the case of an investor who had a 25% weighting of U.S. bank stocks in a portfolio at the beginning of 2008. If the investor averaged down his or her bank holdings after the precipitous decline in most bank stocks that year so that these stocks made up 35% of the investor's total portfolio, this proportion may represent a higher degree of exposure to bank stocks than that desired. At any rate, it certainly puts the investor at much higher risk. (To learn more, read A Guide To Portfolio Construction.)

Practical Applications
Some of the world's most astute investors, including Warren Buffett, have successfully used the averaging down strategy over the years. While the pockets of the average investor are nowhere near as deep as deep as Buffett's, averaging down can still be a viable strategy, albeit with a few caveats:
• Averaging down should be done on a selective basis for specific stocks, rather than as a catch-all strategy for every stock in a portfolio. This strategy is best restricted to high-quality, blue-chip stocks where the risk of corporate bankruptcy is low. Blue chips that satisfy stringent criteria - which include a long-term track record, strong competitive position, very low or no debt, stable business, solid cash flows, and sound management - may be suitable candidates for averaging down.

• Before averaging down a position, the company's fundamentals should be thoroughly assessed. The investor should ascertain whether a significant decline in a stock is only a temporary phenomenon, or a symptom of a deeper malaise. At a minimum, factors that need to be assessed are the company's competitive position, long-term earnings outlook, business stability and capital structure. 

• The strategy may be particularly suited to times when there is an inordinate amount of fear and panic in the markets, because panic liquidation may result in high-quality stocks becoming available at compelling valuations. For example, some of the biggest technology stocks were trading at bargain-basement levels in the summer of 2002, while U.S. and international bank stocks were on sale in the second half of 2008. The key, of course, is exercising prudent judgment in picking the stocks that are best positioned to survive the shakeout.
The Bottom Line
Averaging down is a viable investment strategy for stocks, mutual funds and exchange-traded funds. However, due care must be exercised in deciding which positions to average down. The strategy is best restricted to blue chips that satisfy stringent selection criteria such as a long-term track record, minimal debt and solid cash flows. 


by Elvis Picardo

Durian Raja Kunyit

The flesh of the Raja Kunyit is creamy and yellowish like the turmeric (yellow ginger). It has a strong fragrance. The seeds are small, flat and uneven. The origin of the fruit is Gua Musang. Hence the name Musang King. The are many fake Raja Kunyit in the market. The opened ones posted above are the real ones. Have a good look. Don't get cheated.

Reflexology Path

A Reflexology Path is good to have in any condominium. It enhances the ambience of the place, promotes good health and friendship as well. It's a nice place to meet and to know.

Quarterly Report (QR) Vs Half-Yearly Report (HR)

QR is much more desirable than HR. When an investor wants to invest, he needs the latest information. Thus the QR is more useful to him than the HR.

If the HR is to replace the QR, activities in the stock market is bound to drop. This is because investors make changes in their portfolios using, among other things, the QR, to evaluate stocks and make decisions. If changes in portfolios are made once every 6 months instead of once every 3 months, volume transacted at Bursa will drop immensely. This is bad for Bursa, broker firms, the government and the banks as well. The only people who will benefit are obviously, the insiders.

Why is it necessary to change the QR to HR? In fact a monthly report would be much better.

The plantation stocks make known their productions once every month.

Investors need the QR. It would be foolish to replace it with something less useful or informative.

AT 3.19 Jerneh is a good bet

Jerneh looks a good bet at RM3.19 per share. It is paying a dividend of not less that 1.87 per share soon. Later on it is likely pay a capital distribution of RM2 per share. At the present price of RM3.19 per share, you have a good chance to make about RM680 before expenses and tax if you buy 1000 shares now and keep them for the next few months.

As at Dec 31, 2010, its NTA per share was RM3.91 per share. No matter from whatever angle you look at it, there is money at Jerneh at RM 3.19 per share.

Nonetheless, nothing is certain in the stock market. If you like calculated risk, this is a good one for you.

As usual, you buy at your own risk absolutely.

KFima & FimaCorp to merge?

MONDAY, JULY 4, 2011

TheEdgeWeekly just had an article on KFima and FimaCorp of which both of them could be merged under a single entity and could be somewhat similar to the merger between Sunway and Suncity OR it could be via privatization of FimaCorp. KFima is also cash rich with net cash of RM151.2 mil. If KFima is to take FimaCorp private, it has to fork out RM200 mil to take FimaCorp private and might need to borrow additional RM50 mil. TheEdge mentioned that it doesn't make sense for the exercise to be fully paid by cash. It's quite true in the sense that if fully paid by cash, KFima shareholders would benefit more than FimaCorp shareholders as KFima shareholders would stand to benefit from the additional earnings contributed by the extra 39% equity stake in FimaCorp while earnings from FimaCorp would not be diluted by extra share issuance. However, FimaCorp shareholders could not participate in the potential upside of KFima's share price. Perhaps a share swap would be more ideal as FimaCorp shareholders would stand to benefit from potential upside of merged entity's share price. A bumper dividend from FimaCorp could be ("Could be only :p") on the cards to sweeten the deal and could pump in cash from FimaCorp to KFima. Another thing, just to make things clearer as the article could be somewhat vague about the plantation hectarage, they would have a total of about 23,000 hectares of agricultural land (Oil palm and pineapple) if both entities are merged. Usual benefits of merger are economies of scale and elimination of inefficiencies etc etc. The merger would be good for the shares as well as FimaCorp shares are hardly traded, remains illiquid and trading at such low valuations, thus better to be taken off KLSE. On the other hand, KFima's or the merged entity's shares could have a larger share base to enhance liquidity when merged.

Major shareholders of KFima are buying KFima shares over the past few weeks. There should be some good deal in the offing for KFima. Valuation remains very attractive as KFima is still trading at low PE of only 6.4x based on historical earnings while PBV is at about 1x. KFima share price has remained at this level for a very long time, thus it's about time to make a move. At this price, it's still good to go in. Dividend yield remains commendable at 4%. It has strong balance sheet with net cash of RM151.2 mil coupled with cash cow businesses in printing government security and confidential documents in addition to oil palm/pineapple plantations.

Having said all these, the deal remains uncertain as there is no official announcement yet on KLSE. Nonetheless, based on its fundamentals alone, KFima is an attractive share to accumulate.
You might also like:
Fajarbaru (RM1.21): Watch out for LCCT award in November
Fajarbaru (RM1.26) 1QFY06/2010 Results: Ok ok, in line
Yee Lee (RM2.53): Big timers accumulating? Liquidity to ...
LinkWithin
Posted by David Koay at 10:42 PM
Labels: Fima Corporation, Kumpulan Fima

Pessimism, Skepticism, Optimism & Euphoria

Buy during times of pessimism: “Bull markets are born on pessimism, grow on skepticism, mature on optimism and die on euphoria. The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell.”

Among the maxims that I know, the one mentioned above is one that I like to commit to my memory.

Maximum pessimism here, means that most people if not all, are pessimistic about the stock market. At this time, the market is very quiet, volume transacted is very low, nobody wants to talk about equities, and more and more remisers are going for their holidays. How long this period will last? Nobody knows. During this period, political news and economic news will be bad not only in your own countries but in foreign countries as well. Most people will be in a state of despair. Some may even be cursing and vow not to touch equities again. But savvy investors will be building up their portfolios. They will buy slowly; they will take their time to pick and choose undervalued stocks. You can be sure that many such stocks will be on offer.

Someday the market will start to move up. But there will be many false dawns. Slowly and quietly, as the market continues to improve, skepticism surfaces. At this stage, many are doubtful, and many are still fearful and critical. From skepticism, the markets moves to optimism. Volume improves and prices move up daily. More and more people are throwing cautious to the wind. Those who have the courage to enter the market make money. They buy high and sell higher.

As the market continues to improve with more encouraging news daily, newbies commence to come in droves. Initially all will make money. They call this: "Beginners' Luck."

The last stage of a bull market is the stage of euphoria. It is at this time that many will say, "this time is different." The sad truth is that "this time is different" will eventually turn out to be the most expensive four-word sentence. I call this euphoria, "Extreme Optimism."

During this period of Extreme Optimism, all the small boys will be involved in the stock market. Hawkers, ice-creme sellers, vegetable sellers, shoeshine boys and even barbers will be talking about the market. Price improvement will be phenomenal and something that is to be expected every trading day. Every tip turns out to be a winner.

"The market is most dangerous when it is most attractive." This is another maxim you should not forget.

Whether you want to buy low and sell high or buy high to sell higher is entirely up to you.

You and only you alone know your own risk-tolerance.

In the stock market, if you do not have knowledge, wisdom, patience and discipline, you will find that making money here is most difficult whether you invest or trade. Upgrade yourself first before you think of profit.

River of Life

Jul 2, 2011
River of Life in full flow
KUALA LUMPUR: The much-anticipated River of Life project, which aims to revitalise and transform the city’s dirty rivers, has taken off.

Prime Minister Datuk Seri Najib Tun Razak yesterday launched the project which seeks to transform the Klang and Gombak rivers into iconic waterfronts on par with waterways in cities like Amsterdam, London, Melbourne and Paris by 2020.

The Greater KL-Klang Valley project is an Entry Point Project under the Government’s Economic Transformation Programme.

“I believe there will be a drastic change to Kuala Lumpur’s image. This is what Kuala Lumpur folk have been waiting for.

“The Klang river has all the elements to become an attractive waterfront bustling with daily activities,” Najib said at a ground-breaking ceremony near Jalan Pahang yesterday.

He said there would be a joint effort to clean the rivers and improve water quality.

“It is estimated that 170 tonnes of rubbish enter the Klang river every year but only 25 tonnes are cleared.


“There is also treated and non-treated sewage entering the river every day,” he said.

Najib said strict enforcement and a change of mindset were needed to ensure the rivers were kept clean.

The project, he said, had huge economic potential, would attract more tourists, create jobs as well as raise property value along the Klang and Gombak rivers.

Najib said the project was expected to contribute RM11.3bil to the country’s Gross Domestic Product until 2020.

The project is divided into three parts, namely river cleaning, which will involve a 110km stretch along the Klang river basin; river beautification along a 10.7km stretch by the Klang and Gombak river corridor which will include pedestrian walkways; and corridor development.

Najib also viewed the five masterplan proposals for the river beautification master planning competition.

Later, at the launch of the Kuala Lumpur Architecture Festival, he said a new affordable home scheme for low and middle-income earners would be launched on Monday.