Averaging Down

[Musicwhiz]

But what if the investor is wrong?

What if the investor makes the simple mistake with their stock selection?

Is this not possible?

It's possible. Which is why we need to:-

1) Assess the business using quantitative and qualitative screens, relying on Income Statement, BS and CFS and ratios, in order to make an objective, rational assessment

2) Review the industry and business model of that Company to see if it is sustainable moving forward;

3) Assess Management quality and capability, including their previous promises of growth, to see if they have been delivering and whether they can cope with adversity;

4) Use conservative valuation to arrive at a suitable margin of safety so that the risk of loss is small (this cannot be completely eliminated though);

5) Let time pass to validate your judgement. If wrong, review the reasons for being wrong and strive not to repeat the mistake again.

[Moolah]

It's possible. Which is why we need to:-

1) Assess the business using quantitative and qualitative screens, relying on Income Statement, BS and CFS and ratios, in order to make an objective, rational assessment

2) Review the industry and business model of that Company to see if it is sustainable moving forward;

3) Assess Management quality and capability, including their previous promises of growth, to see if they have been delivering and whether they can cope with adversity;

4) Use conservative valuation to arrive at a suitable margin of safety so that the risk of loss is small (this cannot be completely eliminated though);

5) Let time pass to validate your judgement. If wrong, review the reasons for being wrong and strive not to repeat the mistake again.

Hi Musicwhiz,

I remember you from Wallstraits days. Heck I can't even remember my user id.

Ah yes, i agree with you that's what's probably needed but how many really do what you have written down?

Me?

I don't see it happening. All around I hear and I see the same old advice being sung over and over and over again: Drop More Buy More!

They fail to realise that the more often that not the only reason why they need to average down is that they had screwed up with their initial stock selection. They bought the stock based on a flimsy set of reasoning and when it drops, they just buy more.

[mrEngineer]

Agreed. Anyway, it is usually young investors like me who will question whether they should average down or not and not the successful investors as they already know what they want to do with the next investment.

In general rule of thumb, I think if one have not studied more than 50 annual reports and understood in depth half of them (meaning not only the basic financial statements but the business model, each individual business line performance, the board of directors, the shareholding structure, answer to the question on why it was listed, compare across a few years of performance & benchmark the ratios against other competitors), then one should not average down.

[corydorus]

Using in-depth on Annual Report is a quick and dirty guide. 50 is quite a large figure.
How in-depth is also subjective but is a good starting point.

I think this may implied avoid Averaging in General.


Cory

[yeokiwi]

It is always too hard for normal retail investors to have up-to-date information on the company. When a company share price drops and the price is compared with the historical PE or NAV, it typically will trigger a buy impulse.

But, the price drops can be due to those who have up-to-date information on the company's future earning and they dump the shares in anticipation of a drop in earning. In such case, a retail investor who has no idea of what is the latest earning figure of the company may just pick up the shares thinking that it is a good bargain.

Basically, no smoke without fire, it is not right to average down based on historical financial results unless one can explain the reason behind the drop.

[KopiKat]

But what if the investor is wrong?

What if the investor makes the simple mistake with their stock selection?

Is this not possible?

It's possible. Which is why we need to:-

1) Assess the business using quantitative and qualitative screens, relying on Income Statement, BS and CFS and ratios, in order to make an objective, rational assessment

2) Review the industry and business model of that Company to see if it is sustainable moving forward;

3) Assess Management quality and capability, including their previous promises of growth, to see if they have been delivering and whether they can cope with adversity;

4) Use conservative valuation to arrive at a suitable margin of safety so that the risk of loss is small (this cannot be completely eliminated though);

5) Let time pass to validate your judgement. If wrong, review the reasons for being wrong and strive not to repeat the mistake again.

I'll also do a Sun Tzu quote here (anyhow copy from other site),

知己知彼，百戰不貽﹔
不知彼而知己，一勝一負﹔
不知彼不知己，每戰必貽。

What it means when you apply it to stocks is, you really need to know not just yourself but also your stocks if you want to do well in your investment. Value investing had been proven to be workable by Warren Buffett and his write up on The Super Investors of Graham and Doddsville.

http://en.wikipedia.org/wiki/The_Superin...Doddsville

You just need to put in the hard work to learn it well. Many a time, you may have to learn it the hard way from mistakes made and money lost. Don't lose heart and take the easy route by crossing over to the dark side!

[karlmarx]

it takes time to appreciate good businesses and value them. and it usually takes more time for good businesses to become undervalued enough to pick up. i learnt that a good investor cannot have a 'trading' temperment, and has to be extremely extremely patient. especially in sg where the stock market is so small and mis-pricings are rare during period of stable economic growth.

[Moolah]

it takes time to appreciate good businesses and value them. and it usually takes more time for good businesses to become undervalued enough to pick up. i learnt that a good investor cannot have a 'trading' temperment, and has to be extremely extremely patient. especially in sg where the stock market is so small and mis-pricings are rare during period of stable economic growth.

Hi karlmarx,

A simple question. How much time?

Think about it. What if one adopt such a strategy, taking the the time to appreciate the good business and after say 2 years or 4 years or more, the business turns out to be less than average?

Yes, we might be a bit too optimistic and misjudged the business.

What's next then?

"i learnt that a good investor cannot have a 'trading' temperment".

Is the very basic of an investment temprement very different than a trader?

Take for example. Buffett had been quoted many times to say "the only the way to get out of a hole is to stop digging."

Now take this next statement.

"I was wrong; and the only thing to do when a man is wrong is to be right by ceasing to be wrong."

Are both these statements roughly the same?

And guess what - the other statement came from Jesse Livermore.

I know.. many investors gets all agitated when they hear the word cut loss.

I for one cannot understand why. To cut loss means to sell one investment mistake. Hey, everyone errs right? So what's wrong with correcting one's mistake?

By not correcting the mistake and instead to average down, doesn't it mean that one is not willing to accept the possibility that the very fact why their stock investment is losing money is because they had make a poor initial stock selection?

Anyway, I could be wrong but this is my simple flawed opinion on this issue.

[dydx]

I think there is really nothing wrong to average down by buying more shares in a counter, so long as the investor is convinced that the underlying business is good and safe enough for the longer term, its management is good enough, and the margin of safety - i.e. the gap bewteen the share price and its corresponding intrinsic value - is good enough. If the investor aims to acquire or accumulate a certain level of shareholding or enough shares in a counter, and at the same time to also achieve the lowest possible average price or cost for the block of shares, to average down is probably the most effective - and likely also the only - way to do so.

[karlmarx]

it takes time to appreciate good businesses and value them. and it usually takes more time for good businesses to become undervalued enough to pick up. i learnt that a good investor cannot have a 'trading' temperment, and has to be extremely extremely patient. especially in sg where the stock market is so small and mis-pricings are rare during period of stable economic growth.

Hi karlmarx,

A simple question. How much time?

Think about it. What if one adopt such a strategy, taking the the time to appreciate the good business and after say 2 years or 4 years or more, the business turns out to be less than average?

Yes, we might be a bit too optimistic and misjudged the business.

What's next then?

"i learnt that a good investor cannot have a 'trading' temperment".

Is the very basic of an investment temprement very different than a trader?

Take for example. Buffett had been quoted many times to say "the only the way to get out of a hole is to stop digging."

Now take this next statement.

"I was wrong; and the only thing to do when a man is wrong is to be right by ceasing to be wrong."

Are both these statements roughly the same?

And guess what - the other statement came from Jesse Livermore.

I know.. many investors gets all agitated when they hear the word cut loss.

I for one cannot understand why. To cut loss means to sell one investment mistake. Hey, everyone errs right? So what's wrong with correcting one's mistake?

By not correcting the mistake and instead to average down, doesn't it mean that one is not willing to accept the possibility that the very fact why their stock investment is losing money is because they had make a poor initial stock selection?

Anyway, I could be wrong but this is my simple flawed opinion on this issue.

helloo moolah,

1. it takes time to find a good business and accurately value it. if you're a businessman yourself, and possess intimate industry knowledge of the business you're investing in, then you stand a better chance of finding such good businesses and valuing it appropriately. it will take less time for those with such relevant skills, and more otherwise. could be 2 weeks, 2 months, or longer. depends on the individual. if a business changes constantly such that i would need to keep an eye on it for 2 to 4 years to track its development, i wouldn't be too interested in it.

2. my attitude towards investment, is to look at it as putting monies in a bank; i leave it there to grow and only check my balance from time to time. i will sell only when price has exceeded valuation. when you trade, you are often anxious; want the largest return in the shortest possible time. positions are opened and closed frequently, exposing you to more risk. this is different from cutting loss. cutting loss does not imply a person has a 'trading temperament'. many folks here cut losses after periods ranging from one to three years. and so have i.