One of the biggest challenges investors will ever have to deal with is the challenge of when to buy a stock. The challenge of buying a stock is so tricky because it is often impossible to know the right time to press buy.
It is the same with selling a security.
When to sell
It is often difficult to know when it is the perfect time to sell the stock even if one thinks the situation has changed significantly and the investment thesis is no longer relevant.
But at least when one comes to sell a stock, there is something to sell. There is a binary outcome; either one sells the stock or one does not.
When one is buying a security, there are other outcomes to consider. There is the opportunity cost of not acting at the right time. There is also a risk of making a knee-jerk decision or having other financial liabilities that could influence the overall outcome.
If one has a cash lump sum, one has lots of financial flexibility. This same level of financial flexibility does not exist when one is invested.
It is even more challenging to know when to buy a security during periods of extreme market volatility. The current market situation is a great example.
Periods of uncertainty
The global geopolitical and economic situation is incredibly uncertain. This might have presented some interesting opportunities to snap up shares at discounted valuations, but we don’t know what the future holds for stocks in the global economy. It is impossible to say if equities have fallen as far as they will, or if they could fall further.
If there is a severe economic depression as a result of high oil prices, equities could fall significantly from current levels. In this scenario, investors who decided to buy today may regret that decision.
Unfortunately, there is no formula investors can use to determine the best time to buy a security. The only weapon we have in our arsenal is research.
Building a detailed investment case for any equities we may like ahead of time is the only way we can prepare. Planning for any eventuality is the best defense we have against uncertainty and unpredictable market environments.
When to act
If one already has an in-depth investment analysis of a particular security, the time to act will be clear.
If my analysis shows a stock has an intrinsic value of $250 per share and the stock falls to $200 per share, then it is cheap based on my assessment of intrinsic value. If a stock is cheap compared to the estimate of intrinsic value, and there is a wide enough margin of safety baked into the stock price and the intrinsic value estimate in the first place, then that is reason enough to buy.
Trying to predict if markets will fall further or rise imminently could be a waste of time and effort.
Of course, this formula does start to unravel if the business is going to suffer from any outside impact, which may also be affecting markets.
For example, if I believed a company was worth $250 per share, but 10% of my valuation was based on its investments in Russia, then I would have to make this adjustment to account for the current geopolitical situation.
Plan ahead
I will be able to make this adjustment if I prepare ahead of time. If I don’t prepare ahead of time, it will be impossible for me to reflect the changing situation in my valuation, and I will be flying blind.
As such, the answer to the question of when is the best time to buy a security is relatively simple. The best time to buy is when one believes the stock is trading at a significant discount to one’s estimate of intrinsic value when a suitable margin of safety is applied. It has nothing to do with the market's direction over the next couple of years or the macro or geopolitical environment.
It is based purely on intrinsic value. The only way to come up with an accurate intrinsic value is with research. There is no shortcut for this process.
