Buying when the price is right.

When you have a good idea, make sure you bet big.  At other times, don't bother.  Enjoy the things you like, stay inactive if you must.

Just thinking of an analogous situation.  You have been eyeing the house in a neighbourhood.  The house is up for sale, priced at $800,000.  It has been in the market for some time.  The other houses in the neighbourhood had previously been transacted for any price between $600,000 and $800,000.

You have inspected the house and you estimated the fair price for the house based on your assessment to be  $650,000.

Suddenly the economy turned bad.  More houses were up for sale in the neighbourhood.  The prices started to fall.  A house was priced $700,000.  Two months later, another house was in the market for  $730,000.  Then another for $750,000.   The sellers were not keen to lower the prices by much from the quoted price. 

More hardships hit the economy and the community.  No new houses were up for sale, but the buyers literally were not visible.  The prices quoted previously came down, but not by much, except one.  This one house was priced at $600,000 for a quick sale.  The seller was making an urgent sale to obtain cash for various reasons. 

And what did you do?  You waited hoping that the price would drop further.  Perhaps, the seller might sell at $570,000.  You waited for the seller to agree.  You waited. 

Then the news came, the house was sold to another for $600,000.  And how did you feel?  You felt you have missed out on a good deal.  For the next 5 years, the houses in the region never reached this price.  All the houses were priced or transacted around $700,000.

It is difficult, perhaps, close to impossible to buy at the bottom.  There are bargains when the market is on the way down and also on the way up.  The ability to value an asset is important.  As long as the price is below the "intrinsic value" and given an appropriate margin of safety for the risks appropriate for the particular asset, you can buy with conviction. 

Isn't this scenario applicable to buying shares? 

Don't wait for the best price on the way down (Will you ever know when or what will be the lowest price, other than retrospectively?)  or  only pick buy stocks after the prices have swung up from an obvious bottom (Can you predict the short-term volatilties?  The possibilities of the prices swinging up and down over a short period cannot be predicted?  Did you buy when the market swung up from the bottom of March 09, or did you wait thinking that the rally may not be sustainable and the market might go down further?)

Often the shrewd investors wish to buy good quality stocks cheap?  When the prices dropped, some waited hoping for a bigger bargain.  Then the price swung upwards, and that momentary opportunity was lost.  Of course, the consolation is that there will always be another bargain the next time around.

Keeping a proportion of your wealth in cash is always a good thing.  When the opportunities to buy bargains present (and this is always a certainty in the stock market, though perhaps, only about less than 5 times a year), you can then take a big bet.  And here is the point:  Buy when the price is already at a significant bargain to your "fair or intrinsic value".  Once that price is there, buy and buy and buy.  You have all the reasons to buy as you are already buying with a margin of safety to the "intrinsic value."   Of course, if the price dropped further, you can buy more. 

However, be prepared to see the price going further downwards - market prices often overshoot on the way down (and up).  Have conviction in your valuation (assuming you have done the homeworks).  Be patient.  Be very patient.  Be prepared to hold the stock for 2, 3 or 5 years  to realise this objective.  Short term price changes can be volatile and unpredictable.  Provided that you bought only good quality stocks at reasonable or bargain prices, you should, given time and patience, eventually realise a prospective gain.

The importance of only buying good quality stocks cannot be overemphasized.  These are the stocks with good businesses that will over time build value.  These values will eventually be reflected in their share prices.  Even if the prices were to drop below your buying price, given time, the business will generate value pushing the price back to your buying price.

As Benjamin Graham taught, it is not easy to profit consistently by timing the buying. However, one can have high probability of profiting by buying good quality stocks based on price - always buying below the intrinsic value with a margin of safety.

Footnote:

Warren Buffett called the bottom of the market only a few occasions in his long investing career.

• On one occasion, the market continued to go down further for 3 years after his call.
• In the recent severe bear market, he called to buy in October 2008. The market continued its downtrend to bottom in March 2009. Those who bought in October 2008 would have to hold on to losses soon after they bought. However, when the market rebounded from the lows of March 2009, and assuming they have held onto their investments to now, they would have made substantial gains to-date.