Wednesday, November 26, 2008

Having Trouble Buying in this Market?

As a value investor, you have been on the lookout for great quality companies that you understand, in order to invest in them once they become sufficiently undervalued in the marketplace. In the current environment, I don't suppose that you are having tremendous difficulty in finding at least some undervalued companies. You're ready to pull the investing trigger, right?

Well maybe not. You might be hesitating to invest because you are unsure how much further the markets will decline. It would be ideal to have a precognitive or clairvoyant ability that would allow us to predict the lowest possible price for a stock, buy it, and then watch the price soar upwards soon after making the investment. The problem is, to my knowledge, no one has demonstrated such an ability. So, what should one do?

Well, if you are certain that you have recognized a good solid investment but are hestitating to do so, why not consider making a partial investment now? One strategy is to predetermine a maximum dollar amount you would like to invest in the opportunity and then split up the buy purchases by price levels. With this strategy, if the market suddenly rallies, at least you will own some shares as opposed to none.

For example, you might like a stock at $10/sh, and have decided it makes sense to buy at most $10,000 worth of the stock. You could decide that you will commit $5,000 now, at $10/sh, and then another $5,000 should the price decline to say $8/sh (the example is arbitrary, you decide what makes sense). With this method, you would at least own some of the undervalued stock now, in case the price starts to move upwards and out of your buy range. On the flip side, if the stock does decline further, you still have reserve funds to lower your average purchase price, which is a better alternative to having committed the full amount at a higher price. As well, you might want to use several buy tranches, depedending on the situation.

There are some drawbacks with this method. First, you will be paying more commission fees. Second, if the stock price does decline further, you might have wished you had waited.

I think the extra commission fees can make sense provided you are deploying enough capital into the purchase and the percentage of fees to investment capital is small enough. If you are low on capital, joining an investment club might be one solution to make the strategy practical.

If the stock price declines further, yes, we will wish we had waited. However, if you truly believe that no one can accurately predict market bottoms on a consistent basis, why torture yourself about making the decision to buy at least some shares of an undervalued company now? As value investors, we should recognize that our strategies are designed to work typically over a business cycle.

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