Conscious Investor Knowledge Base

What if the price has not dropped to my target price?

Our rational mind tells us that if the price is above the target price, then you should not buy. But sometimes there is more to this than first appears. After all, we have put all this effort into analyzing a company, worked out a margin of safety, and then calculated a target price. It can be disappointing if after this we can't take the final step in actually purchasing some stock.

Despite the importance of establishing and staying within your guidelines, sometimes you just want to get started. You have done your homework on a particular company and everything checks out. Now you just want to invest some money in it. But when you calculate the target price with your margin of safety you find that its price is too high. This can be a disappointment that takes some of the enjoyment out of investing.

Suppose you are thinking of investing $10,000. Instead of putting it all into your chosen stock at an unsuitable price, you could just use a part of it. Strictly speaking, this is going against what we have been saying--namely waiting for the right price.

But investing is more than numbers. It is also a mind game. If holding back becomes too stressful, you may end up suddenly putting the lot into the stock. Or even worse. Suddenly putting it into a stock that you have not even researched properly.

I remember it happened to me. When I was starting out I was carefully following the investment guidelines I had developed by studying Buffett and the other great investors. But none of the stocks I was looking at had prices near my target prices. Yet I was so keen to invest more of my money in the stock market.

Then I received a phone call from someone who I thought was a very successful investor. He said that he had been researching a stock and it was a sure thing. He was so confident of it that he encouraged me to even buy call options expiring in three to six months.

After a cursory consideration of the stock, before I knew it, I was on the internet buying shares in a company that I barely knew anything about. As I have now seen many times since, the price went up a few dollars over the next two weeks. And then it started heading down.

Fortunately I managed to sell without too much of loss. Within a year the company was bankrupt. There are analogies with eating. Cutting out a particular food often results in excessive tension and perhaps a sudden binge on the forbidden food. Or, more likely, you show great strength in resisting the strawberry cheesecake at home in your family environment. But, before you know it, you find yourself sitting alone in the airport lounge with the remains of a large Cinnabon sticky bun in front of you. Whereas a small amount of the forbidden food right at the start might not have done much harm and would likely have helped you be more balanced towards the rest of your diet.

There is second factor in the case of investing. It is much more important to invest in quality companies, even if you pay above your target price, than to invest in companies that don't pass our investment criteria as described in the previous sections. Overall, investing in great companies at the wrong time is preferable to the wrong companies at ideal times.

Consider two people investing $10,000 per year in Bed Bath and Beyond each year for the past ten years. Suppose one person always invests at the worst time each year, the time when the stock is at its highest. In contrast, the second person always invests at the best time each year, the time when the stock it at its lowest.

In the first year this would mean that the first person would have paid $4.44 per share and the second person would have paid only $1.84, around 40 percent of the high price. In the second year, the highest and lowest prices were $4.13 and $2.84.

After ten years the portfolio of the 'low" investor would be worth around $851,000. The portfolio of the "high" investor would be worth around $423,000. Of course, $851,000 is a lot better than $423,000. But both are excellent results. And in practice, no one is going to always invest at the worst time and no one is going to always invest at the best time. (Of course, with Conscious Investor, on average your investment time is going to be much closer to the optimal time.)

A similar result holds for ARB in Australia. If two investors follow the same investing pattern that we just described, the "low" investor would have $750,000 at the end of ten years and the "high" investor would have $490,000.

In contrast, if two people followed the same investing pattern with Ford Motor Company, their wealth at the end of ten years would be a dismal $111,000 and $68,000. The point is that it is usually better to invest in great companies, even if your timing is a bit out, than in the majority of companies that are wealth destroyers, no matter when you invest in them.

A third factor is that by investing a portion of the money allocated for a particular company, many people find that this sharpens their motivation and ability to monitor and understand the performance of the company. It sets things up for the possibility of a more sizeable investment later on. Buffett does this. In a television interview in 1993 in Omaha he said that buys 100 shares of many companies. Small investment in companies that interest him ensure that he gets the company reports on time while waiting for the opportunity to make a major investment at the price he has settled on.

Putting these sections together means that, yes, when it comes to our full investment, remember to work within your guidelines. But at the same time, there can be good reasons to put a small amount of your money into great companies, even if the timing is not completely optimal.




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Last Updated
1st of July, 2008

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