Remember to Buy Low and Sell High

Fundamentals of Market Investing by Adam J. McKee

To make money in the stock market, you have to do the opposite of what the rest of the market is doing.  When a stock is on a “parabolic” run, it is extremely risky to jump on that rocket ship.  What you want to do is find a stock that has been beaten down through no fault of its own.  On the morning June of 2017, the darlings of the market were the F.A.N.G. stocks (an acronym popularized by Jim Cramer denoting Facebook, Amazon, Netflix, and Google; Apple is often added as an extra A).  Many other tech companies, like chip maker NVidia, were aboard the same tech rocket ship.

In the months preceding this morning, the upward momentum of these stocks seemed unstoppable.  If you decided to take a long, leisurely lunch on that day, you came back to market devastation.  The FANG stocks and the whole tech cohort were down in a big way.  If you bought NVidia ($NVDA) in the morning’s euphoria, you were down 14%!  Note that this wasn’t like the great depression where everything fell all at once.  If you were not in tech, you had a good day.  The Dow Jones Industrial Average (DJI) was up nearly 100 points.  If you had been in NVidia for a year or more, you still were up in a big way.  Only those that bought high were hurt.  If you see a stock start to run, you have most likely missed the boat.  Find something else.

The other side is also true.  Just because something is cheap does not mean that it is a good deal.  You really must do your homework and know the companies you invest in really, really well.  Mr. Cramer suggests one hour of homework per week per stock.  My suggestion is to follow his advice and split your discretionary portfolio across a small number of great stocks in different sectors.  This is the only way you can hope to make money over time.

Mr. Buffett famously said that his favorite holding period for a stock was “forever.”  There is a logic to this idea, but it needs some further consideration.  When you are a value investor like Mr. Buffett, you try to identify great companies selling at a good price.  What essentially defines a great company is what it is worth now, and how well it can grow in the future.  The problem with great companies is that they don’t always stay great.  Even for the diehard value investor, there may come a time when a company has reached its zenith and can only decline in the future.  A rigid buy and hold strategy can be counterproductive.

Companies, even ones with great management, can become victims of their own success.  There are some practical limits to how huge a company can get.  The best and fastest way for a company to increase shareholder value is organic growth.  Organic growth is a phrase used by investors to refer to the increased value that comes from a company doing more of what it does to make money.

Let’s take McDonald’s as an example.  When McDonald’s first started selling hamburgers and French fries, people really loved the speed, quality, and price of the product.  The company didn’t have much in the way of competition; they were the first “fast food” restaurant to make it big.  Lack of competition and a product that the public loved set off a very long and very profitable run of growth for the company.  They opened restaurant after restaurant, and each one sends loads of cash back to the home office, which they used to open more and more restaurants.  When you have over 36,000 profitable restaurants, you make a lot of money.

The problem that McDonald’s has today is that they are a victim of their own success story.  They’ve built a restaurant just about everywhere it makes sense to build one, and they’ve moved out of the United States and into over 118 different countries.  As cities and towns grow and foreign markets become more viable, there will be room to build new restaurants, but it is not likely that the company will ever see growth like it did during the early years.  The promise of growth is the major reason that stock values go up; this means that the value of McDonald’s stock is much, much harder for management to move up.

They can become more efficient, cut costs, increase same-store sales, and many other things, but they are not likely to match the organic growth they once experienced.  Shareholder value is enhanced in these very large, slow-growing companies by paying a handsome dividend.  McDonald’s pays a little over 3%, for example.  The stability of some behemoth companies has led investors to consider them as “bond market equivalent” stocks.  Bond market equivalent stocks will not appreciate like fast-growing, smaller companies, but they are very safe and usually pay a good dividend.

If your investment goal is aggressive growth, you cannot keep your money tied up in companies like these.  They are safe bets, but they grow too slow to meet your objectives.  When you hold a stock long enough for the company to saturate its market and growth to slow down, it is time to sell it and reinvest your money into a more nimble company that has better future growth prospects.

[ Back | Contents | Next ]


Leave a Reply

Your email address will not be published. Required fields are marked *

This site uses Akismet to reduce spam. Learn how your comment data is processed.