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Thank You Mr. Market
Posted by: gurufocus (IP Logged)
Date: March 22, 2007 10:58PM

Today I'd like to follow up on my March 16th thoughts and make the case for AVERAGING DOWN.

I always seek value and believe in what Ben Graham taught: there are no good or bad stocks, just cheap or expensive. That's where the margin of safety and using the markets fluctuations to your advantage.

Earlier this month I spoke about two of the sub-prime mortgage companies that have suffered incredible declines and incredible comebacks. The two companies were Accredited Home Lenders (LEND) and Fremont General (FMT).

I'd like to offer a case for Averaging Down. Or in layman's terms, buying more of the stock you already own when its value has depreciated considerably.

Let's assume you owned both LEND & FMT one week prior to their sudden drop in value, which would be on February 26, 2007. FMT was roughly $12.50 and LEND was $22.50. Even here both companies looked cheap and maybe you bought $10,000 worth of stock. Your Account would look something like this... not accounting for ticket charges...


800 shares of FMT @ $12.50

440* shares of LEND @ $22.50


From the 26th of February until the 13th of March both companies lost 50% and 72% respectively. Now let's also assume you're not a market timer and you didn't get in when the initial bottom occurred on the 13th and instead AVERAGED DOWN the following day.


NOTE: When I recommend averaging down it must be with the same "dollar amount" not "share amount," which would lead to the following...

[I'm using the opening prices on March 14th]

1480* shares of FMT @ $6.75

2100* shares of LEND @ $4.75

Had you have AVERAGED DOWN at this point you would end up with the following:

2280 shares of FMT

2540 shares of LEND

Your actual cost is $20,000 per company, but fast forwarding to today shows just how effective this can be, especially when you have the right game plan.

2280 shares of FMT @ $9.83** = $22,412.40

2540 shares of LEND @ $12.37** = $31,419.80

A $40,000 investment behind the two companies ($20,000 in each) using the AVERAGE DOWN strategy has yielded a 34% return in less than a month!

THANK YOU MR. MARKET… for all your irrational behavior!

*Rounded Down to nearest round lot trade size

** Noon prices for both stocks

Education and practice are two very different things. You may know a lot about the game of basketball, but does that mean you would be able to suit up in the Final Four?



Stocks Discussed: LEND, FMT,
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Rating: 3.8/5 (8 votes)



Re: Thank You Mr. Market
Posted by: mla (IP Logged)
Date: March 23, 2007 01:56AM

Cool, I'm doubling down on New Century tomorrow ;-)


Stocks Discussed: LEND, FMT,
Rate this post:

Rating: 3.3/5 (3 votes)



Re: Thank You Mr. Market
Posted by: saga364 (IP Logged)
Date: March 23, 2007 02:43AM

Hi,

I have a slightly different view.

Averaging down is good. Even I have averaged my stocks down to reduce my holding cost. But there are certain things that one must take care of.

1. The company you have put your money in should be fundamentally a good company and price fall must be irrational (not logical - YES NOT LOGICAL!!!!). In other words if the stock prices of chicken hatcheries is down because of bird flu (irrational reason), makes sense to average the cost down. And if price is down because the industry has been made obsolete (logical reason), don't average down (eg: pagers, CD manufacturers etc.)

I am from India and when Bird Flu struck us last year, all the hatcheries stocks tanked and there was nothing wrong with the business. It made all the sense in the world to get into hatcheries and poultry farm businesses.

2. Once it's made sure that market price is down because of some irrationality, another thing to keep in mind is upside potential. How soon can market realize that it was being irrational? For example bird flu sooner or later has to be cured and people would not stop eating chicken. Return to mean would thus happen in predictable amount of time. If in any case, return to mean takes longer than predictable amount of time, IMHO, averaging might be a bad idea. Personally I would not average down. It would be like putting more weight on a sinking ship (trying my hands at churning out one liners like WEB).

3. Finally averaging down must also consider the biggest cost of all - the opportunity cost. Averaging down is made possible only because market is down or some unrelated thing is affecting investor behavior and confidence (butterfly in New York cooks up a storm in Sahara). In these times, there could be other companies available even cheaper with higher upside potential. Better check out other opportunities before averaging down.

Please point if I am incorrect somewhere.

I have also posted this online @ [pseudosocial.blogspot.com]

Thanks


Stocks Discussed: LEND, FMT,
Rate this post:

Rating: 3.7/5 (3 votes)



Re: Thank You Mr. Market
Posted by: pigsgetrich (IP Logged)
Date: March 23, 2007 07:14AM

Well "doubling down" should only be used when the market has a the type of volatility (*spelling?) it did over the last week. The week we saw a lot of the mortgage lenders get hurt. It's also only beneficial if you are buying into companies that are solid. Imagine the investors that bought into Enron or Worldcom and then doubled down... they aren't too happy right now! However, I am sure both of those stocks had rebounds in the short term while speculations surrounded them.

MLA you may have missed the boat, maybe wait till next time! :) There is always a next time!


Stocks Discussed: LEND, FMT,
Rate this post:

Rating: 3.2/5 (5 votes)





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