Your stock has fallen, should you buy more? - The 5 Minute WrapUp by Equitymaster
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Your stock has fallen, should you buy more?

Jan 23, 2014

In this issue:
» Joesph Stiglitz discusses income inequality in the US.
» Morgan Stanley lowers gold target for current year
» RBI sets aggressive inflation target
» True unemployment in the US is much worse than believed
» ...and more!

In a thread started by us in our recent initiative - the Equitymaster Club - we asked members to discuss their biggest mistakes in the year gone by. And there was one concept that popped up a couple of times; that is the practice of 'averaging out'.

We thought it would be a good idea to discuss the same in today's issue of the 5-Minute Wrap Up.

One buys stocks in anticipation of certain returns. And since stock prices fluctuate, they do fall below one's buy price. Sometimes, way below! And so, to lower one's overall average buy-in price, it is common for investors to purchase more of the same company's shares at lower prices.

This is where the concept of 'opportunity cost' comes in. The same is the cost of an alternative that must be forgone in order to pursue a certain action. It's the benefits one could have received by taking the next best alternative action.

This applies very well to the area of investing.

In the words of Charlie Munger - "Everything is a function of opportunity cost. The concept of a hurdle rate makes nothing but sense, but a lot of people using this make terrible errors. I don't think there's any substitute for thinking about a whole lot of investment options and thinking about the returns from each."

As explained very clearly, it would be wise for investors to compare their prospective investments with other opportunities available around. Similarly, we believe before averaging out, investors should look at putting additional money into the same stock in a manner that he would do when he is considering a new investment i.e. by comparing it with other available options. This would include comparing the investment to one's favorite investment idea (that one would already be holding), a practice followed by Buffett and Munger.

While averaging out is a common error made by many, realising the same is the first step towards correcting one's investing process. Gauging the reason for the decline in price of the fallen stock would be the key here, we believe. If the reasons are seemingly temporary, then one could consider investing in the same stock albeit after looking at other options around. However, if the decline is due to fundamental changes, then pouring money into the same stock would be like catching a falling knife.

What is your take on the concept of 'averaging out'? Let us know your comments or share your views in the Equitymaster Club.

P.S. - We would like to remind our valued readers that registrations for the The Equitymaster Conference 2014 are set to close in two days i.e. on 25th January 2014. And from what we have been told, there are very few seats left. So make sure you register for the same before it gets too late!

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Questions for the Co-Heads of Research

As you are aware, our Co-Heads of Research - Tanushree Banerjee and Rahul Shah, are making a presentation at the Equitymaster Conference.

The Conference is titled - Beyond Uncertainty. And it is to be held at the magnificent Taj Mahal Palace Hotel, on 1st February.

Post the presentation, they will also be replying to queries from the audience. So if you have any questions for them, please send them now!

Rahul & Tanushree will try their best to address them.

 Chart of the day
With the new year just having begun, growth estimates from various agencies have started to flow in. And from what it seems like, India's days of slow growth are behind. In other words, growth is expected to only accelerate from here on.

Today's chart of the day shows the country's economic growth estimates for the next two years that have been made by various agencies. And they seem to paint a rosy picture. Sure, expected growth levels are not likely to reach the pre-2008 days; nevertheless, they are expected to be higher than those of the world's largest economies.

Are India's slowdown woes over?
IMF - International Monetary Fund; WB - World Bank; IR - India Ratings;
MA - Moody's Analytics; * Estimates for CY14

The factors behind such estimates are various. Broadly, they include a global recovery, formation of a new government in India which would lead to improving the investment scenario and an overall recovery in the industrial sector. However, a lot will depend on how things pan out with the developed economies and the money printing agendas of the world's largest central bankers. Not to mention the outcome of the general elections which are a few months away. And if FM P. Chidambaram is believed, India could bounce back to the pre-recession mark of 8% in a couple of years from now.

Whether it's 6%, 7%, or 8%, there are a lot of ifs and buts to the estimates. We believe that investors would do well not to entirely base their investing decisions on such broader numbers. Sure, a bounce back in economy would do well for most sectors, but this should not influence one's bottom-up approach to investing in quality businesses, as the latter themselves tend to have traits to ride out difficult and uncertain times.

Imagine a situation where you work for 40 years non-stop and then at the end of it all, don't have any salary increase to show for it. Shocking, isn't it? Well, if the well-known economist Joseph Stiglitz is to be believed, this isn't a figment of anyone's imagination. This is the fate that has been suffered by an average American when the US median salary is taken into account! Even the World Bank has numbers up its sleeve to further expose this anomaly. It argues how between 1988 and 2008, the top 1% in terms of income saw its income grow by as much as 60% whereas the bottom 5% barely saw any growth at all.

Clearly, the policies used to fuel economic growth in recent years have been a total disaster when it comes to promoting income equality. And therefore it is time to turn over a new leaf. Unfortunately, there doesn't seem to be any real effort on the ground to address this. Even after 2008, as much as 95% of the total gains from the recovery have gone to the top 1%. Looks like it's going to take nothing less than a full blown social revolt to set things in order!

For over a decade, gold had a tremendous bull run before the precious metal suffered a correction in 2013. What more, it is likely that these losses could be extended in 2014 as well. That is why Morgan Stanley has cut its 2014 gold target by around 12% to US$ 1,160 an ounce. One of the reasons why gold found so many takers was the loose monetary policies of central bankers around the world. As the value of paper currencies began to be questioned, gold came to be regarded as a tangible, real asset having value. It was looked upon as a safe haven and a hedge against inflation. The tide turned against the precious metal in 2013 when the US Fed declared its intention of tapering the QE program. As equities began to evince interest, gold lost ground.

As per an article in Money news, Morgan Stanley is of the view that there is more pain to come for gold because US equities will continue to perform strongly. We believe that while the Fed has decided to reduce its bond purchase program, interest rates still continue to hover near zero. Besides, whatever recovery has been seen in the US economy has been the product of Fed policies. So once the Fed withdraws support, there is the possibility of the economy slumping once again. This may prompt the Fed to loosen its strings again. Which is why we believe the case for gold remains strong from a longer term perspective. And any correction should be looked upon as an opportunity for the metal to form part of one's portfolio.

High retail inflation, one that is gauged using the Consumer Price Index (CPI) has been the biggest contention between the RBI and the government. Over the past few months, the RBI has not particularly heeded to rate cut pressures from the government. The central bank on its part has now decided to keep CPI as the benchmark inflation index. Here too the RBI panel has targeted to bring down the CPI to 8% in twelve months. Again by mid 2015 this should come down to 6%.

With such aggressive inflation targets, there is hardly any headroom for easing liquidity. Therefore any hopes of rate cut in the near term stand quashed. The monetary policy review on January 28 too may be a non event. However, we believe that by keeping inflation control as its core focus, RBI should be able to address growth concerns over the longer term

How do you know if an economy is doing well? You look at macroeconomic data right? But what if that data is not a true representation of the ground realities? What if it is deliberately distorted to propagate a rosy picture?

As per an article in Moneynews, this seems to be the case with the US economic data. The true unemployment in the US as per certain estimates is 37.2%! This is significantly higher than the 6.7% unemployment rate pegged by the government for December 2013. What is the reason for such a big difference between the two numbers? The problem with the government figures is that it takes into account only the unemployed who are searching for a job. But what about people who have been unable to find a job and have then given up? The article claims that even official inflation numbers are misrepresented because of questionable accounting techniques. Lastly, the misery index too seems to be way higher at 14.7% than the 7.5% figure as per government data. It must be noted that the misery index adds together both unemployment and inflation. At close to 15%, the misery index is the worst in nearly four decades. Taking into account all these factors, the US economic recovery may indeed seem dubious.

In the meanwhile, Indian stock markets were trading above the dotted line after opening the day in the red. At the time of writing, the benchmark BSE Sensex was up by 17 points (0.1%). The sectoral indices were trading mixed with capital goods and FMCG sectors leading the pack of gainers, while stocks from the oil and gas and auto spaces were not in favour. Most of the Asian stock markets were trading lower led by Hong Kong and Singapore. The European markets opened on a mixed note.

 Today's investing mantra
"Even when the underlying motive of purchase is mere speculative greed, human nature desires to conceal this unlovely impulse behind a screen of apparent logic and good sense." - Benjamin Graham

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3 Responses to "Your stock has fallen, should you buy more?"

vasant upadhyay

Feb 2, 2014

averaging may not be always good however to go on buying shares at lower prices of company with good fundamentals and strong corporate governance may result in medium to long term gain


vasant upadhyay

Feb 2, 2014

averaging out is not always good but if you have purchased share of the company improving b/s every year with good governance may benefit you in medium to long term


G M Kandoi

Jan 23, 2014

i would average out if the fall is not due to any fundamental changes if observed some thing wrong happening we would prefer to book loss. what is your opinion on averaging Ranbaxy

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