When to Buy Stocks

  • The Intelligent Investor looks forward to economic collapses because that is when we make the most money.

Situations to look into:

  • A company with a Durable Competitive Advantage (DCA) is suffering from a hiccup
    • Slow down in business
    • Going through a period of change
    • One time problem
  • Mr. Market is not interested in a sector causing a DCA Company's P/E Ratio to be low.
  • Corrections: during a bull market, there will be minor corrections.
  • Recessions
  • Capitulation

Recessions

A poor man would buy a home and hope its value rises immediately so that he could make a quick buck. Whereas a rich man would buy a home and hope the value of homes plunges and stays low for a very long time so he could buy 1,000 homes, own the entire city, and build a real-estate empire.

Economic collapses, recession, stock market crashes give us an opportunity to become very wealthy. It is when valuable investments go on sale at "fire sale" prices. The longer a recession lasts, the better it is for the Intelligent Investor. A long lasting recession allows us to accumulate more stock at meager prices. We are out to build an empire; not make a quick buck.

 

Example: American Express During the Financial Crisis of 2009

During the Financial Crisis of 2009, American Express plunges from $55 per share to less than $10 per share. In 2015, the stock price bounces to $95 per share.

American Express during the Financial Crisis of 2009
Source: Thinkorswim by TDAmeritrade

 

"Look at market fluctuations as your friend rather than your enemy; profit from folly rather than participate in it."

- Warren Buffett

 

Capitulation

Capitulation occurs when everyone has given up on a particular stock or all stocks. It is the belief that everyone who wants to get out of a stock or the overall market has already sold. Capitulation is a true sign of a bottom and is a very good time to invest in a stock or a set of stocks.

However, Capitulation is very hard to catch. Most people just do not have the time to watch a stock ticker everyday, everyday, everyday. But for investors that do have the time, capitulation is an opportunity to buy a very valuable investment at a rock bottom price.

Using Technical Analysis, indicators of Capitulation are:

 

Example: Identifying Capitulation Using Technical Analysis

Wells Fargo, a company with a Durable Competitive Advantage sold off during the Financial Crisis of 2009. The stock capitulated between February and April 2009. Using Technical Analysis we use a combination of the following indicators to detect capitulation:

  • Using the 200-Day Bollinger Band, the stock price has been below the lower band (red line) for quite some time.
  • The stock price has been going lower and lower while the MACD Oscillator is heading higher and higher.
  • The Volume has dramatically increased and it is significantly above the blue line as all of the above is happening.

 

Capitulation
Source: Thinkorswim by TDAmeritrade

 

Why We are Interested in the Above Situations

The stock price of companies with a Durable Competitive Advantage will always bounce back after their stock price falls. We make more money when their stock prices fall rather than when their stock prices go up. That is why we are interested in these situations. When these situations causes stock prices to fall, we swoop in to buy shares in very valuable companies. More profit is made during bad times. The cheaper the price gets, the better it is in the long run.

 

Scenario 1:  Rising Stock Price

Let's say we buy 100 shares of a very  valuable company at $10 per share costing us $1,000.

$10/Share x 100 Shares = $1,000 Net Cost

 

One year later, the price goes up to $15 per share and we accumulate 40 more shares costing us $600.

$15/Share x 40 Shares = $600 Net Cost

 

Another year later, the price goes up to $20 per share and we buy 30 more shares costing us $600.

$20/Share x 30 Shares = $600 Net Cost

 

Our accumulated Total Cost would be $2,200 and we would only have 170 shares.

$1,000 + $600 + $600 = $2,200 Total Cost

100 Shares + 40 Shares + 30 Shares = 170 Total Shares

 

Rising Stock Price: Accumulated Total Cost
Price Per Share Number of Shares Net Cost
Year 1 $10 100 $1,000
Year 2 $15 40 $600
Year 3 $20 30 $600
Total 170 $2,200

 

Another year passes and our shares goes up to $30 per share. The value of our accumulated investment would be $5,100.

$30/Share x 170 Shares = $5,100 Net Value

 

Deduct that with our Total Cost of $2,200 and our Net Profit would be $2,900.

$5,100 Net Value - $2,200 Total Cost = $2,900 Net Profit

 

Rising Stock Price: Net Profit
Price Per Share Number of Shares Net Value
Year 4 $30 170 $5,100
Minus Total Cost - $2,200
Net Profit $2,900

 

Scenario 2:  Falling Stock Price

Take a look at a different scenario where the stock prices falls. Say we initially buy 100 shares of the same valuable company at $10 per share costing us $1,000.

$10/Share x 100 Shares = $1,000 Net Cost

 

One year later, the price falls to $5 per share. Our $600 dollar investment would buy us 120 shares.

$5/Share x 120 = $600 Net Cost

 

Another year later, the price bounces back up to $10 per share and we invest another $600 to accumulate 60 shares.

$10/Share x 60 = $600 Net Cost

 

Our accumulated Total Cost would be $2,200, but in this scenario we would have accumulated 280 shares.

$1,000 + $600 + $600 = $2,200 Total Cost

100 Shares + 120 Shares + 60 Shares = 280 Total Shares

 

Falling Stock Price: Accumulated Total Cost
Price Per Share Number of Shares Net Cost
Year 1 $10 100 $1,000
Year 2 $5 120 $600
Year 3 $10 60 $600
Total 280 $2,200

 

Another year comes and the price goes up to $30 per share. The value of our investment would then be $8,400.

$30/Share x 280 Shares = $8,400 Net Value

 

Deduct that with our Total Cost of $2,200 and our Net Profit is $6,200.

$8,400 Net Value - $2,200 Total Cost = $6,200 Net Profit

 

Falling Stock Price: Net Profit
Price Per Share Number of Shares Net Value
Year 4 $30 280 $8,400
Minus Total Cost - $2,200
Net Profit $6,200

 

Our Net Profit in Scenario 2 is $6,200. Whereas our Net Profit in Scenario 1 is only $2,900. A falling stock price allows us to purchase more shares with the same Total Cost of $2,200. When the stock price rebounds and goes back up we have a Net Profit of $6,200 which is a whole lot greater than $2,900. Accumulating more shares for the same amount of money gives us larger profits. Thus, falling stock prices is an Intelligent Investor's best friend.

 

My Financial Analysis of Stocks

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