Most people would agree that "value" is a difficult term to pin down, but most also associate it with certain quantitative measurements such as price to earning ratio, book value, or cash flow.
The problem with these fundamental ratios is that they are based on information that becomes publicly available only once every three months. As a result a lot of value investing is done made on backward looking numbers that may no longer hold true. For this reason, many traders call fundamentals - "funnymentals."
One of the most common value traps that value hounds fall for is that they try to extrapolate past performance (during an exceptional period of growth) into the future. This reversion to the mean approach works great during a normal cycle. During an end game cycle - AKA road to bankruptcy - it does not work so well.
On this road to bankruptcy as the stock goes lower, and lower, and lower many value hounds try to buy the "dips" as it gets cheaper and cheaper. This approach is called dollar cost averaging - or more specifically in this case - "averaging down." The problem with this approach is that it assumes the stock will eventually go back up. However, in the case of bankruptcy the stock goes to $0. At which point it is no longer possible to average down......
This brings to the question when buying something that is down - are you buying it at "a" bottom or "the" bottom. And more specifically - how can you tell the difference? This is really one of the fundamental questions we hope to answer on this blog over the next several months. It is not an easy question to answer.
So on to the photos....... let's try to see some "a" bottoms and one "the" bottom.
Downey Savings - Trailing 12 month Chart
Wells Fargo - Trailing 12 Month Chart
Apple Computer - Trailing 10 YEARS Chart
As you can see from the Apple Chart - if you can identify THE bottom or close to it and accumulate a healthy position at that level.....you can make huge money / returns over a long period of time. Apple 7 year return from 2001 low of $6 to 2008 high of $210 is something like 35X your investment. Those are the kinds of returns that get value hounds excited.
2 comments:
Da Professor-
The first 6 months of 2006 AAPL had a decrease in stock value from mid $80's to $50. Most would have seen this as a stock on the way back to the pre-2005 level's of under $20/ share. However, those that dumped their shares during this decline in 2006 would have missed the steady increase from July 2006 to December 2007 in which the stock climbed from $50 to $200. Why would a Value Hound not dump in 2006 and remain well positioned until December 2007 as it relates to AAPL. Was this a direct reaction to the buying and marketing frenzy of the I-POD and I-PHONE? Or does this stock value increase go far beyond Apple's introduction of those products?
1) When would a value hound have sold AAPL? Let's assume that he bought at THE bottom around $6 per share. He would probably have one of the following time horizons:
a) forever - wouldn't need to sell
b) X $per share - wouldn't sell until it got there
c) sell when I get scared - at which point he would likely have sold at the relative low of $50
2) Value hounds often get very caught up in the WHY of a move. 20/20 hindsight may allow us to extrapolate some reason or causation to the move, but it will not necessarily be an accurate or even useful explanation.
A better goal may be to buy it cheap and based on some type of analysis and expectation. As long as that original thesis is not shaken - why sell due to an earnings miss or negative news article.
A value hound might be buying more.
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