If there is one overriding principle to remember when investing it is this: the most difficult time to buy a stock is often when the experts are telling you not to.
As a value investor I am frequently interested in the stocks of great companies that are out-of-favor. And because they come with baggage they are frequently the target of many negative stories. Bad news is the companion of investors who are interested in buying stocks when they are inexpensive. Everyone can tell you why the company is cheap; they are not nearly as effective at telling you when it will cease being cheap. In fact, most investors won’t start talking about the stock again until the company has fixed the problems and the stock has appreciated well off the lows.
We will take a look at two great growth companies who stumbled and ultimately recovered. Both are from my own holdings; one I bought way too early (which means I bought after the stock went down, then it went down a great deal more) and the second I purchased at just about the lows in the stock price. By sticking to my discipline and staying with both stocks I generated performance in excess of the market; one stock did better than the other to be sure but both did significantly better than the market. Buying the stocks of out-of-favor, well-managed companies is harder than it looks in the face of the incessant chatter of the naysayers but doing so–following Intelligent Investing Rule #1, sticking with your discipline–will provide excellent returns over time.
Let’s begin with the fallen-angel growth stock I bought too soon: Starbucks (SBUX). Buying early is one of the occupational hazards of being a value manager. When a growth company disappoints investors, the sentiment quickly changes from love (price appreciation) to hate (price depreciation) to indifference (price stagnation). It is important for the value manager to remember that growth investors can sell out of a holding much faster than the value crew will buy in. In fact, because growth investors are often momentum driven they may exit an entire position in a stock if they even sniff trouble. When the earnings miss or a new product or distribution glitch manifests they run–don’t walk–for the exits. The value manager’s dilemma is to decide when to get in. Sometimes we are too eager. When I got a chance to buy SBUX in April of 2007, I did. The stock was down 30% from a recent high of $40.00. I waited for it to stabilize around the $31.00 level and began accumulating my holdings. Then the financial crisis hit and the market sunk like a stone dragging Starbucks with it until the stock finally hit a low under $10 per share. An unmitigated disaster you might think.
Normally I would buy more as the stock went down but I was busy with grad school and two kids graduating from high school in those two years and I, frankly, wasn’t paying close attention. But here is the great thing about buying great companies. You don’t have to know the exact day the stock hits bottom. You don’t have to be right about every detail. You just have to stick to your discipline and let the company management do the heavy lifting.
Below is the price performance (including dividends) of Starbucks from the day I bought it (4/27/07) compared to the S&P 500 over the same period also including reinvested dividends.
Though I bought SBUX far from where it ultimately bottomed, I still generated a return of 12.73% per year since April 27, 2007 well in excess of the S&P 500’s return of 3.53% over the same period. Had I bottom-picked the stock toward the end of 2008, I would have received an annual return of (gulp) 57.11% versus 17.29 for the market. A far superior return, indeed. But getting it mostly right and generating a steady return over time is our objective and despite my mistake I did just that.
The point is that stock investing is about generating consistent, excess returns over time, not necessarily about securing cocktail party bragging rights. Remember Intelligent Investing Rule #1: Having any investment discipline is better than having no discipline at all; once your investment strategy is established, never deviate.
Next post we will examine a value stock I bought near the price bottom.