Here’s a question: when is the best time to buy shares? The answer, to no great surprise, is ‘when they’re cheap’.
Despite that, huge numbers of investors ignore this sensible advice.
When shares are cheap — because of either economic or company worries — investors sit on the sidelines, too fearful to buy. Yet when shares are expensive, because everything in the garden is rosy, they all pile in.
And, as multi-billionaire super-investor Warren Buffett once put it: “In the stock market, you pay a very high price for a cheery consensus.“
Namely, buying shares at one helluva mark-up to the price that they were going for when things weren’t quite so cheery.
I watched and waited and now I’m up 22%
I’m reminded of this whenever I look at my own portfolio, as I was doing just this last Sunday morning.
Take oil services specialist contractor AMEC, for instance. I’ve had it on my watch list for a couple of years, but it’s always been priced at something of a premium compared to the broader market.
Periodically, I’d re-run the figures, and chart AMEC relative to the FTSE 100. But in mid-January, relative to the rest of the market, it dipped below the FTSE 100 for pretty much the first time since late-2009.
In other words, people were selling — and so I pounced.
I’m since up 22% in capital terms, which is gratifying — especially as the broader market, over the same period, has largely gone sideways. But more importantly, I’ve locked in a useful income, and at an attractive price.
Royal Dutch Shell is a similar case in point.
Again, I’d watched and waited, and last September an opportunity presented itself. Since then, the broader market is up by about 7% — a performance I’ve more than doubled through buying Shell.
Finally, let me stress that the point of all this isn’t to brag. Instead, it’s to try and underscore two important lessons — lessons that investors often overlook.
Same outlay, more income
Regular readers will know that I’m mainly an equity income investor. What I’m looking for, in short, are shares that will pay me a decent and reliable dividend over time.
In which case, a fall in a share’s price presents an attractive opportunity: I can buy more of them.
So if, say, a company’s share price falls by a quarter, I can buy a third more shares. And if it falls by, say, 50%, then I can — logically enough — buy twice as many shares.
Now, falls of 25% or 50% aren’t everyday events, and investors need to examine the circumstances of such a fall quite carefully.
But a fall of, say, 10% is much less exceptional. And the same arithmetic works in your favour. I can buy 11% more shares — and thereby earn 11% more income.
Which is quite an incentive for sitting quietly, watching shares, and waiting for the market to present me with just that opportunity.
By panicking and selling, they turned $100 into $90 over 18 years
There’s another reason why waiting to buy cheaply makes sense. Simply put, a low entry point is your margin of safety. And that margin of safety serves as a valuable psychological buffer against panic when things turn down.
In contrast, many investors — having bought at a higher price when things were cheery — promptly sell when the bloom comes off. Put another way, instead of seeing a potential buying opportunity, they look for the exit.
One of my favourite statistics for illustrating all this comes from investment author Tim Hale’s excellent Smarter Investing.
The period 1984-2002, writes Hale, was a bull market when stock markets turned $100 of spending power into $500. But in this bull market, he observes, private investors succeeded in turning that same $100 into just $90.
Sobering stuff.
4 steps to plan for profit
So, how to turn this into an actionable investment strategy?
First, you’ll need to find a way to curb your emotions — and learn to see market falls as potential buying opportunities, not exit points. I can’t help you much with that.
Second, you’ll need some target companies to keep an eye on, and a ‘watch list’ to do the actual monitoring for you.
For what it’s worth, I use a popular free online portfolio service, holding a notional single share of every company I’m interested in, ‘bought’ at the share price prevailing on the day I became interested in it.
Thirdly, you’ll need patience. Mr Market could throw a buying opportunity your way — but then again, he might not.
And finally, you’ll need cash, in order to be able to pounce when the moment is right.