Investment

Getting High

Getting High Edfu2.com 2

|Should you buy a stock whose price is at a 52-week or all-time high? Or does this even matter to someone looking to invest for the long term?|

Some very smart investors offer conflicting advice.

It has been argued that the overall trend of the market is the key driver of short-term gains or losses.

When the market is moving up, even mediocre stocks can enjoy an uptick in stock price (“the trend is our friend”). Conversely, when the market is moving forcefully down, even good investments can take a hit (“when the tide goes out…”).  This also implies that a questionable investment might look better than it is (the trend), while a downtrodden equity may be a good buy (the tide).

So, it can make sense to purchase stocks at high watermarks when the market is moving down because that should be a sign of additional strength. Likewise, delaying the purchase of a stock on the rebound when the overall market trend is up can provide a margin of safety. Recently we’ve seen a shift in the fortunes of stocks, but between industry segments instead of the overall market, offering some evidence of these assumptions. And while the bubble-debate doesn’t much interest me, the recent flurry of SPAC’s makes me nervous. These Special Purpose Acquisition Companies are simply funds that raise money to invest without having any idea what they might end up investing in. The entire point of using a SPAC is to bring companies to market without having to fully disclose a business’s finances. Which sounds more like gambling than investing.

Connected to this line of thought is the concept that over longer periods of time, “reversion to the mean” should be respected.

Put another way, stocks that go up too fast should tend to come back down, while stocks that drop precipitously can often bounce back. All of this is, of course, based on the premise that a pop or drop in an equity is not caused by an outlier event like accounting fraud or sudden product failure. But ultimately, the real problem is that using heuristics in these situations can also mean that we are confusing luck with skill.

My response to a boast about the skill involved in selecting Tesla at a propitious moment was, “Over the last twelve months fourteen other stocks outperformed Tesla so, maybe, you just got lucky?” Tesla is down about 30% since that conversation and my friend is still buying “the dips” but hasn’t added any other new positions to his portfolio. Duke Ellington once replied when asked what makes someone a professional in their field, “The pro can do it twice.”

I typically follow a stock for several weeks, or even months, before taking a position. This allows for time to learn about the company, read an annual report, fully understand what the business does and how it makes money, and see what triggers stock price movement. My preference has typically been to buy on weakness or adverse news. But reading some of the thoughtful commentaries that suggest purchasing on strength, has me reconsidering this bias. That a stock’s valuation is improving may a good sign, not an ominous warning.

No answers here, just something to think about.

Even when looking at stocks for the long haul, it makes sense to acquire a position in an equity investment when the odds favor maximizing the long-term returns. As volatility moves stocks over time – some because of macro events (a down market overall), others because of events specific to the stock (bad earnings report) – the investor should always be looking for an edge while avoiding the falling knife.

 

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