Investor Toolkit: The wrong way to shop for stocks

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Every Wednesday, we publish our “Investor Toolkit” series. Whether you’re a new or experienced investor, these weekly updates are designed to give you our advice on successful investing, including productive stock trading advice. Each Investor Toolkit update gives you a fundamental piece of investing advice and shows you how you can put it into practice right away.

Tip of the week: “Investors who go out of their way to buy stocks at lower prices often find themselves with stocks that are headed in the wrong direction.”

For some investors, buying a stock is a two-step process. First they decide which ones to buy, and then they decide what price they want to pay. Many investors aim to buy a stock at, say, 5% to 10% below current prices.

You can’t negotiate a favourable purchase price for stocks

Investors who “bargain shop” for stocks explain that they are simply looking to buy stocks like a smart consumer would buy a car. But they overlook one key difference. Car prices do vary, and some buyers do pay less than others, because they have better bargaining skills and more time to spend shopping around.

However, the stock market is more efficient than the car market, as an economist would put it. You can’t negotiate a favourable price for a stock. To get a lower price, you have to wait for the stock’s price to come down.


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Shopping for price leaves investors open to a double risk

Two-part investing exposes you to a double risk. Seemingly attractive stocks can drop for months, or even years, before a hidden flaw comes to the surface and explains their weakness.

For that matter, little-noticed stocks sometimes rise for months before the reason for their strength becomes apparent. In a lifetime of investing, you’ll choose both kinds of stocks.

If you always try to buy below the market, you’ll always get a “fill” on stocks with hidden flaws. They’ll always come down into your buying range … and they’ll keep on falling.

But you’ll never get to buy the other kind of stock—the kind that keeps going up. These stocks will always seem too expensive, and they’ll go on to get even more expensive. But you need a few of these ever-more expensive stocks to offset the losses from those that get cheaper and cheaper.

There’s no easy answer to the buy-now-or-wait dilemma. At times it may pay to hold off—for instance, a company’s stock will often rise when it announces a stock split, then fall after the split takes effect.

In the end, if a stock is truly worth investing in, you should be willing to buy it at current prices, even if that means you run the risk of having to sit through a 5% to 10% setback. Before it slips into its next 5% to 10% setback, after all, it may first go up 50% to 100%.

COMMENTS PLEASE—Share your investment experience and opinions with fellow TSINetwork.ca members

Does the current share price figure prominently in your stock-buying decisions? Have you bought stocks at prices higher than you liked, yet been rewarded when the price went up? Or have you bought stocks “on a dip” only to see them get significantly cheaper?

Note: This article was previously published on June 13, 2012.

Comments

  • Samuel

    Having the patience to wait for the right price, is a hallmark of a prudent investor.

    It is not a perfect system. However evaluating numerous companies of interest, and then waiting for when “Mister Market” panics into giving one the opportunity to buy a great company, at a fair or discounted price, is the the route to better returns.

    Attempting to buy any company, at a discount to its currently trading price, is of course just a form of gambling.

  • Samuel’s approach has the prudent investor possibly missing out on the 50 or 100% gains that Patrick speaks about. This prudent investor may have to wait for a very long time for the stock price to return to the original price which one would have to assume would likely take place only in a very deep recession, such as that of 2008-09. Meanwhile, Patrick’s investor might well have taken that value increase and put it in a safe place.

  • Agree with Samuel – no market or good stock moves in a perfect path up. There are always dips that add value to buying a good stock.

    One trap no one likes to talk about is “bloom coming off the rose” – so many times a good stock moves and by the time your stockbroker tells you about it or you discover it, several solid trading days have taken it to 52 week highs. Most days it is better to wait a week or two as the stock will retreat before it starts another leg up. The recent bank moves are in case in point – another example is imperial oil – bought that at mid 50’s and still waiting for it to go back there!

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