Buying Stocks Low

August 22, 2010

According to people who aggregate such statistics, in 2010 investors small and large have been, on the whole, moving money out of stocks and into bonds and gold.

They are selling low and buying high. That is what I expect of them. If enough people do that, it allows some of us to buy low and sell high. Which is why I bother with stocks: if you can't generate a good return on an investment, you might as well let a bank or credit union give you almost nothing for your savings, while lending you money out at exorbitant interest rates.

There are really big, flashing neon signs saying that many if not most stocks have bargain basement prices right now. Take the semiconductor sector. Eliminate the loser companies. Look at, for example Microchip (MCHP) and Marvell (MRVL) which I own, or Intel (INTC), Analog Devices (ADI), Maxim (MXIM), etc. which I don't own. Almost all, at Friday's closing prices, have forward price to earnings ratios in the vicinity of 10. That means buying a share of stock is getting you 10% earnings per year. Even if the economy stays relatively flat. Many of these companies are growing profits so quickly you could get effectively 12 to 15% by 2012 if you invested Friday.

Need I say how that compares to investing in CD's, or bonds, or the housing market? Or gold, which earns nothing, and is in a bubble that will burst soon enough?

It is true that at any given time stocks are subject to auction marketing prices. What that means is that the price you get if you buy or sell may not recommend fundamental value. You may get a lot more or a lot less than fundamental value. There is no guarantee what an auction market will do any given day, month, year, or decade.

Which is why smart, long-term stock buyers pick stocks individually and try to do most of their buying when the stock market as a whole is low. When the stock market is high bond markets are (usually) low, meaning bonds carry high interest returns. So the classic cyclical smart thing to to is to sell your bonds (a portion of them, anyway) during recessions (that is selling high). Use the bond returns to buy stocks (buying low). When you get into an obvious bull market, you sell some of your stocks (selling high) and buy bonds again (with high interest rates, which means low cost).

But as simple as this is, and as easy as it is to do with portfolio balancing, most people can't do it. Institutional investors can't, individuals can't, rich can't, not so rich can't. We are human. We get excited by a rising stock market. We buy when we should be selling. We get frightened by a fallen market, and get sell when we should be buying. Brokers don't care, they take their commissions whether you sell or buy.

Keep in mind, for all of this, that individual companies vary greatly against the background of the overall stock market. A company that does well (growing revenues and profits) during a recession may not show off as an investment until the next bull market. But the real value is in the profits, not in the stock price.

Do your own research, including checking what other investors are saying. It is easy and free these days to look at the financial histories of companies, read SEC filings, find out what other investors thing, and even tune into analyst calls.

I like a low stock price when I am buying, and a high price when I am selling, same as anyone. But by focusing on value and keeping fundamental, well-known rules in mind, I keep out of trouble and get way better returns on stocks than I do on my CDs (which I keep, despite the low interest rates, to smooth out my personal finances, since my income varies greatly month to month, and they help with occasional large expenses).

Keep diversified!

William P. Meyers

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