The time to BUY is actually when shares have been beaten down by the market.

Why the panicking crowd has got it wrong
– again – and how you can profit

Let's face it, even the most optimistic analyst would say that the volatile conditions of 2011 are likely to continue over the next year or two.

Whatever our politicians might hope for, the eurozone's problems of high national debts and a tepid economic recovery aren't going to go away any time soon.

So, what's an investor to do?

Sadly, history already tells us what many investors are doing: cutting and running, deciding that the stock market isn't for them, and taking their losses on the chin.

Research shows that time and time again, private investors pile into equities at too high a price...when shares have already shot up way too far... And they get out at a price that's too low... often just before they start to recover again.

If that's not wealth-destroying, then I don't know what is.

For example, UK investment author Tim Hale has pointed out that in 1984-2002 – a bull market when the equity markets turned $100 of spending power into $500 – private investors turned that same $100 into just $90⁸.

A 2007 study of UK investors over the period 1992-2003 found that the returns of private investors were around two percentage points a year lower than the funds that they were invested in...⁹

These feeble returns are all thanks to the fuzzy thinking of a crowd that follows their emotions, rather than using clear-headed analysis.

They wrongly believe that you buy shares when they're going up and you get out of the market when they're hitting rock bottom.

Here's why this is wrong – in fact, the time to BUY is actually when shares have been beaten down by the market.

That is, of course – if you know what to look for...

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Why You Should Buy When Share Prices Are Low

A Lesson From History:

'The Buffett Buy Signal' –
Why You Should Buy When Share Prices Are Low

Warren Buffett has made millions from going against the crowd and buying when share prices are low, not when they're heading up.

Here are some examples...

1968

During a high point in the markets, Buffett complained about how he was having trouble finding "first-class investment ideas". He held onto that view until 1974. From June 1968 to October 1974, the S&P 500 fell 37%. For the decade starting in June 1968, the S&P lost 2.6%.

1974

Buffett changed his tune as the market fell. In late 1974, he made his famous comment that he felt like "an oversexed man in a harem" – meaning simply that he was awash in investment opportunities. The S&P 500 rose 11% per year over the next five years and 10% per year over the next decade.

During that bear market, Buffett bought shares in the Washington Post Company because he believed they were a bargain. Since then the price has soared by more than 100 times – and that's before you factor in dividends.

1979

When the market slumped between 1977 and 1979, most investors got cold feet. Buffett toldForbes that stocks were still the way to go. The S&P 500 returned 9% over the next five years and 13% over the next 10.

Of course, that's Warren Buffett. He's a legendary and fabulously wealthy investor. How can the ordinary investor today tell the genuinely cheap shares from those that deserve their low price?

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Investor's Checklist: A Guided Tour of the Market

The list below covers just about every corner of the market.  It should help you wade through the different economics of each industry and understand how companies in each industry can create economic moats - which strategies work and how you can identify companies pursuing those strategies.

Over the long haul, a big part of successful investing is building a mental database of companies and industries on which you can draw as the need arises.  The list below should give you a jumpstart in compiling that mental database, and that will make you a better investor.

• Investor's Checklist: Health Care
• Investor's Checklist: Consumer Services
• Investor's Checklist: Business Services
• Investor's Checklist: Banks
• Investor's Checklist: Asset Management and Insurance
• Investor's Checklist: Technology Software
• Investor's Checklist: Technology Hardware
• Investor's Checklist: Media
• Investor's Checklist: Telecom
• Investor's Checklist: Consumer Goods
• Investor's Checklist: Industrial Materials
• Investor's Checklist: Energy
• Investor's Checklist: Utilities

It is easier for companies to make money in some industries than in others. Some industries lend themselves to the creation of economic moats more so than others, and these are the industries where you'll want to spend most of your time. The economics of some industries are superior to others. Hence, you should spend more time learning about attractive industries than unattractive ones. Every industry has its own unique dynamics and set of jargon - and some industries (such has financial services) even have financial statements that look very different.


Ref:  The Five Rules for Successful Stock Investing by Pat Dorsey

Investor's Checklist: Health Care

Developing drugs is time-consuming, costly, and there are no guarantees of success.  Look for companies with long patent lives and full pipelines to spread the development risk.

Drug companies whose products target large patient populations or significant unmet needs have a better chance of paying off.

Make sure you have a big margin of safety for pharmaceutical companies with mega blockbuster drugs that make up a large percentage of sales.  Any unexpected development can send cash flow, and the stock price, reeling.

Unless you have a deep understanding of the technology, don't invest in biotech startups.  Payoffs could be large, but the cash flows are so far out and uncertain that it's easier to lose your shirt than win big.

Don't overlook the medical device industry, which is full of firms with wide economic moats.

Cash is king for firms that rely on development (pharmaceuticals, biotechnology, and medical devices).  Make sure firms have enough cash or cash from operations to get through the next development cycle.

Keep an eye on the government.  Any drastic changes in Medicare/Medicaid spending or regulatory requirements can have a deep impact on pricing throughout the sector.

Managed care organizations that spread risk - whether through a high mix of fee-based business, product diversification, strong underwriting, or minimal government accounts - will provide more sustainable returns.  

Ref:  The Five Rules for Successful Stock Investing by Pat Dorsey


Read also:
Investor's Checklist: A Guided Tour of the Market...

Investor's Checklist: Consumer Services

Most consumer services concepts fail in the long run, so any investment in a company in the speculative or aggressive growth stage of the business life cycle needs to be monitored more closely than the average stock investment.

Beware of stocks that have already priced in lofty growth expectations.  You can make money if you get in early enough, but you can also lose your shirt on the stock's rapid downslide.

The sector is rife with low switching costs.  Companies that establish store loyalty or store dependence are very attractive.  Tiffany's is a good example; it faces limited competition in the retail jewelery market.

Make sure to compare inventory and payables turns to determine which retailers are superior operators.  Companies that know what their customers want and how to exploit their negotiating power are more likely to make solid bets in the sector.

Keep an eye on those off-balance sheet obligations.   Many retailers have little or no debt on the books, but their overall financial health might not be that good.

Look for a buying opportunity when a solid company releases poor monthly or quarterly sales numbers.  Many investors overreact to one month's worth of bad same-store sales results, and the reason might just be bad weather or an overly difficult comparison to the prior-year period.  Focus on the fundamentals of the business and not the emotion of the stock.

Companies also tend to move in tandem when news comes out about the economy.  Look for a chance to pick up shares of a great retailer when the entire sector falls - keep that watch list handy.  


Ref:  The Five Rules for Successful Stock Investing by Pat Dorsey


Read also:
Investor's Checklist: A Guided Tour of the Market...

Investor's Checklist: Business Services

Understand the business model.  Knowing if a company leverages technology, people, or hard assets will provide insight as to the kind of financial results the company may produce.

Look for scale and operating leverage.  These characteristics can provide significant barriers to entry and lead to impressive financial performance.

Look for recurring revenue.  Long-term customer contracts can guarantee certain levels of revenue for years into the future.  This can provide a degree of stability in financial results.


Focus on cash flow.  Investors ultimately earn returns based on a company's cash-generating ability.  Avoid investments that aren't expected to generate adequate cash flow.

Size the market opportunity.  Industries with big, untapped market opportunities provide an attractive environment for high growth.  In addition, companies chasing markets perceived to be big enough to accommodate growth for all industry participants are less likely to compete on price alone.

Examine growth expectations.  Understand what kind of growth rates are incorporated into the share price.  If the rates of growth are unrealistic, avoid the stock.  



Ref:  The Five Rules for Successful Stock Investing by Pat Dorsey



Read also:
Investor's Checklist: A Guided Tour of the Market...

Investor's Checklist: Banks

The business model of banks can be summed up as the management of three types of risk:  credit, liquidity, and interest rate.

Investors should focus on conservatively run institutions.  They should seek out firms that hold large equity bases relative to competitors and provision conservatively for future loan losses

Different components of banks' income statements can show volatile swings depending on a number of factors such as the interest rate and credit environment.  However, well-run banks should generally show steady net income growth through varying environments.  Investors are well served to seek out firms with a good track record.

Well-run banks focus heavily on matching the duration of assets with the duration of liabilities.  For instance, banks should fund long-term loans with liabilities such as long-term debt or deposits, not short-term funding. Avoid lenders that don't.

Banks have numerous competitive advantages.  They can borrow money at rates lower than even the federal government.  There are large economies of scale in this business derived from having an established distribution network.  the capital-intensive nature of banking deters new competitors.  Customer-switching costs are high, and there are limited barriers to exit money-losing endeavors.

Investors should seek out banks with a strong equity base, consistently solid ROEs and ROAs, and an ability to grow revenues at a steady pace.


Comparing similar banks on a price-to-book measure can be a good way to make sure you're not overpaying for a bank stock.


Ref:  The Five Rules to Successful Stock Investing by Pat Dorsey


Read also:
Investor's Checklist: A Guided Tour of the Market...

Investor's Checklist: Asset Management and Insurance

Look for diversity in asset management companies.  Firms that manage a number of asset classes - such as stocks, bonds, and hedge funds - are more stable during market gyrations.  One-hit wonders are much more volatile and are subject to wild swings.

Keep an eye on asset growth.  Make sure an asset manager is successful in consistently bringing in inflows greater than outflows.

Look for money managers with attractive niche markets, such as tax-managed funds or international investing.

Sticky assets add stability.  Look for firms with a high percentage of stable assets, such as institutional money managers or fund firms who specialize in retirement savings.

Bigger is often better.  Firms with more assets, longer track records, and multiple asset classes have much more to offer finicky customers.

Be wary of any insurance firm that grows faster than the industry average (unless the growth can be explained by acquisitions).

One of the best ways to protect against investment risk in the life insurance world is to consider companies with diversified revenue bases.  Some products, such as variable annuities, have exhibited a good degree of cyclicality.

Look for life insurers with high credit ratings (AA) and a consistent ability to realise ROEs above their cost of capital.

Seek out property/casualty insurers who consistently achieve ROEs above 15 percent.  This is a good indication of underwriting discipline and cost control.

Avoid insurers who take repeated reserving charges.  This often indicates pricing below cost or deteriorating cost inflation.

Look for management teams committed to building shareholder value.  These teams often have significant personal wealth invested in the businesses they run.



Ref:  The Five Rules for Successful Stock Investing by Pat Dorsey


Read also:
Investor's Checklist: A Guided Tour of the Market...

Investor's Checklist: Technology Software

The software industry has economics few industries can match.  Successful companies should have excellent growth prospects, expanding profit margins, and pristine financial health.

Companies with wide moats are more likely to produce above-average returns.  But superior technology is one of the least sustainable competitive advantages in the software industry.

Look for software companies that have maintained good economics throughout multiple business cycles.  We prefer companies that have been around at least several years.

License revenue is one of the best indicators of current demand because it represents how much new software was sold at a given time.  Watch for any license revenue trends.

Rising days sales outstanding (DSOs) may indicate a company has extended easier credit terms to customers to close deals.  This steals revenues from future quarters and may lead to revenue shortfalls.

If deferred revenue growth slows or the deferred revenue balance begins to decline, it may signal that the company's business has started to slow down.

The pace of change makes it tough to predict what software companies will look like in the future.  For this reason, it's best to look for a big discount to intrinsic value before buying.


Ref:  The Five Rules for Successful Stock Investing by Pat Dorsey



Read also:
Investor's Checklist: A Guided Tour of the Market...

Investor's Checklist: Technology Hardware

Information technology is an increasingly important source of productivity in advanced economies.  In 2002, IT accounted for nearly 50 percent of total U.S. investment in capital equipment, up from 20 percent three decades ago.

Technology innovation means that hardware firms can offer more computing power at an increasingly cheap price; thus, IT can be applied to more and more task.


Because of rapid innovation, technology hardware companies tend to generate rapid revenue and earnings growth.

At the same time, competitive rivalry is often strong in tech hardware.  Moreover, demand for technology hardware is very cyclical.

Technology, by itself, does not constitute a sustainable competitive advantage.  hardware companies that develop economic moats are more likely to succeed over the long term than companies that rely on a lead in technology.

Examples of moats among technology hardware firms include low-cost producer (Dell), intangible assets (Linear and Maxim), switching costs (Nortel and Lucent), and network effect (Cisco).

A company with a sustainable competitive advantage should be able to effectively fend off its rivals and maintain significant market share and/or sustain above-average margins over an extended period of time.


Ref:  The Five Rules for Successful Stock Investing by Pat Dorsey



Read also:
Investor's Checklist: A Guided Tour of the Market...