Why do people get excited when their favorite retailer holds a sale, but not when Wall Street does?
Let’s start with the obligatory disclaimer – this is not an encouragement nor a discouragement to buy or sell particular securities, stocks carry risk, consult a financial advisor but you don’t have to, etc. That was for that infinitesimally small segment of the population that is a) literate enough to read this post, yet b) dumb enough to do whatever a disembodied online voice suggests. There, now you can read the post absolved of any obligation to think.
Most investors know, in theory, that it’s foolish to buy at the top of the market and sell at the bottom. (Of course, human nature means that the opposite is true in practice – otherwise the top and bottom wouldn’t be where they are.) But it’s equally foolish to assume that the market will carry you along indefinitely if you just buy a flat representation of it and don’t research at all. We have 12+ years of real-world evidence of that. Factoring in inflation, the Dow has risen by an average of .4% annually since February of 1997. Your index fund would have been better off if it had collected tin cans since the Packers last won a Super Bowl.
There is such a thing as overdiversification. You might find stability in a comprehensive index fund, but it’s impossible to find any significant value. Buying a basket of Dow stocks, or something similar like a Wilshire 5000 index fund, will likely give fantastic returns over an 80-year period. If you plan on not waiting until you’re 115 years old to enjoy your money, there are more targeted ways to go about attempting to build wealth in the stock market.
Instead, look at companies that are temporarily wounded, i.e. whose stock sells at a discount. Earlier this year, when the global CEO of Toyota (NYSE: TM) was being grilled on Capitol Hill for selling cars to people who confused the brake with the accelerator, the company’s stock sank. But some fleeting bad PR can’t negate a decades-long reputation for value and quality. A few weeks after our demonstrative congressmen and senators finally pulled the curtain on their combination political theater/witch trial, Toyota stock had quietly gained 15%.
Around the time Toyota emerged from a bruising at the unfair hands of public opinion, British Petroleum (NYSE: BP) made Toyota’s problems look trivial. BP traded at $60.48 the day the Deepwater Horizon spill began. Today it’s at $36.52, a 60% drop. The rig’s manufacturer, Transocean (NYSE: RIG), has fallen from $92.03 to $50.04 over the same period, a 46% decline. Fortunately for Transocean, it’s in an industry with few players. Also, most people had barely heard of it since it doesn’t sell directly to the public. (When was the last time you bought an oil rig?) This distinguishes Transocean from BP, which plasters its logo everywhere and goes out of its way to embed itself in the public consciousness. Thanks to that insistence, almost everyone identifies the Gulf of Mexico spill with BP more than they do Transocean.
Both BP and Transocean have otherwise healthy financials that can normally withstand a one-time event. Then again, Deepwater Horizon is some event. But a wounded company isn’t a doomed company: despite the Exxon Valdez disaster, ExxonMobil went from pariah to the world’s most profitable company in just a few years. Johnson & Johnson rebounded after the Tylenol scare of 1982 and came back stronger than ever. There are several ways to murder a company along with its stock: obsolescence (Atari), poor economics (General Motors) and rampant crime (Enron) are three of the most efficient. But for a temporarily disabled company with a history of success and goodwill (in the general sense, not the accounting sense)? A resurgence is more likely than you think. Don’t confuse a broken bone with a bullet wound through the cranium.
One more time: there’s always value somewhere in the stock market, but very rarely can you make money simply by buying into the market as a whole. In fact, the times when the market (as a whole) rises fastest are when the gains are most dubious and tentative – case in point, the dot-com bubble and ensuing crash. More accurately, there’s always value in the stock market among particular entrants. Finding the ones whose stock prices have suffered for no better reason than that of public perception is as wise a place as any to start.
What do you think? Are companies like BP and Transocean good deals now? Would you not invest due to moral conflicts?
Greg McFarlane is an advertising copywriter who lives in Las Vegas and Lahaina – testament to the power of entrepreneurship. He recently wrote Control Your Cash: Making Money Make Sense, a financial primer for people in their 20s and 30s who know nothing about money. Buy the book here (physical) or here (Kindle) and reach Greg at greg@ControlYourCash.com.
ISA Rules says
Well, it was Warren Buffet who said that you should buy when the market is fearful, and be fearful when the market isn’t (well, not in those exact words but you get the drift). I use these opportunities to average down my purchase price, as long as the company is one that I am still happy to invest in (i.e. I believe in the fundamentals etc). If it isn’t, then I would have sold my holding anyway!
In the case of BP, I can’t see the company going under and will hold for the long term. It isn’t going to be pretty in the short term, but that’s not what any stock market investment should be about (stock trading is a different matter).
Great article. BP seems extremely undervalued right now.
Jeff @ sustainablelifeblog says
I definitely agree with this. Some of these stocks are bargains compared to what they were. If I had the money, I’d be investing in BP right now.
Greg McFarlane says
Thanks for the kind words. The only thing I’d be afraid of, although it’s a pretty remote risk, is a government takeover of BP. Some politicians are yammering about this, apparently because they believe the feds would sell gas with the same cold efficiency with which they run passenger trains and enforce immigration law.
I think a gov’t takeover is very unlikely. They have enough on their hands with GM and AIG.
Matt SF says
I agree with much of the sentiment here and that it’s best to maintain think long term when pursuing a “buy on the dips” strategy, but I think one important point was not brought up…
BP is just one press release away from another stock correction!
That might sound scary, or sexy if you think the stock will bounce, but the fact is, BP would not give any color upon the safety of it’s dividend when directly questioned today (06/04/2010), has only guestimates about future liabilities to oil spill victims, and not allowing future dollar bills to allow us to become blinded by today’s events, BP still hasn’t stopped the original problem of crude oil polluting the Gulf of Mexico and potentially the eastern U.S. seafront.
Please bare in mind, I’m not trying to be overly critical, and with great risk comes great reward. but with great risk also comes significant loss of principal.
If the 2008-2009 stock market crash taught us anything, it’s to take management’s word on dividend safety and balance sheet worries with a grain of salt and not to get caught up in these “value traps”. So as far as BP’s stock is concerned, it is one falling knife I’ll gladly let bounce around on the floor a few times before reaching for the handle.
Good points. We really have to look at everything and ask ourselves what the potential value can or would be in the future given all scenarios.
Budgeting in the Fun Stuff says
We didn’t buy any BP or Transocean, but we did just throw $4000 into the market last week since the mini-crash made Conoco, J&J, McDonald’s, and Intel yummier. We’re big on high dividend yield stocks that have a history of growth…why not buy when they’re on sale?
Absolutely! If you’re in it for the long run then you don’t have to worry about the short-term corrections.
I wouldn’t put a dime In BP. According to an engineer, who managed to get off the Deepwater rig alive, BP consistently ignored safety problems all along the way. On 60 Minutes someone also claimed that BP operates an even bigger rig elsewhere that also has potential safety problems having to do with not getting the correct permits while it was going up. Add to that, the company’s initial attempt to foist the blame for the spill on the rig manufacturer and I see the BP management as far too dicey to bet on.
I think a lot of people will avoid BP on moral/safety points, and I don’t think they would be wrong.
Billy S says
Wrong, BP will bounce back. And these people who invest now will not be dissapointed a year from now
Financial Samurai says
It’s just hard to know whether it’s the right time to buy or not.
Take this week for example. Dow is below 10,000.. S&P edging towards 1,000. Do we buy now after the 10% correction or no? WHO KNOWS? Nobody knows for sure.
People thought the Dow was going to 2,000 when it broke 7,000 recently. Nope.
Again, nobody knows!
If you are buying for the short-term then you can easily get blasted on a price drop after you buy. But if you think the company has strong prospects and you are holding long-term then you can really find a bargain.
Donald Vidrine says
BP is probably the best stock to buy right now. When gas goes up to $5 or $10 a gallon, everyone will wish they hadn’t complained so much. The cleanup will take time and BP is doing the best they can, as a company.
I’m not sure that BP is doing the best that they can.