Buy Quality on Pullbacks, Not Stocks in Their Death Throes

Start by admitting some 'bargain' stocks will never bounce back

In these turbulent times, a lot of fear is undoubtedly out there. The vast majority of investors are running for the exit or at the very least taking shelter in “safe” investments like Treasuries, high-yield consumer-staple stocks or gold.

But there’s a small group of folks willing to take a few chances, believing some good stocks are oversold and trying to buy their way into the bargain of the century.

Don’t do it. Bottom-fishing is for suckers right now.

To be clear, some high-quality stocks have surely sold off a bit, and this may not be a bad time to get in. For instance, Apple  (NASDAQ:AAPL) is one that I personally have bought. Back in May, I snapped up AAPL at around $550. But that’s not exactly “bottom fishing,” since Apple started 2012 at $405 and was trading around $335 a year ago. It was just a small but short-lived pullback.

I have other similar stocks on a watch list. For instance, if the market craters, I would love a chance to get Coca-Cola (NYSE:KO) for under $70 before it splits 2-for-1.

But when I refer to bottom-fishing, I mean it as a pejorative phrase. Think dumpster-diving rather than perusing a sale rack at Neiman Marcus.

Wall Street is littered with the carcasses of fixer-uppers gone wrong. Naïve swing traders sometimes think a big brand cures all ills and that “restructuring” actually means something.

Take Hewlett-Packard (NYSE:HPQ). I called this tech turd the embodiment of everything that’s wrong with Corporate America, and blasted the latest turnaround as another failed “restructuring” fiction. The stock is now below $20 a share for the first time since 1995. HPQ stock is -24% year-to-date, -44% in the last 12 months, and -57% in the last five years.

So… at what point was the right time to bottom-fish this monstrosity?

For a more current example, check out the drops in Research In Motion (NASDAQ:RIMM) and Nokia () Monday. BlackBerry maker RIMM fell 8% ahead of its earnings report. Nokia was down about the same. Both stocks have been cratering for a long time, too. Just take a look at this ugly table:

Reeves rimmnok Buy Quality on Pullbacks, Not Stocks in Their Death Throes

Plenty of people have been talking about potential in RIMM or Nokia for the last few years. Heck, even some writers at InvestorPlace have made “contrarian” calls on the stock as a swing trade opportunity. But all those folks who asked how much farther these stocks could drop keep getting the same answer: They can drop farther.

Much farther.

Contributor Charles Sizemore gets big honesty points for his excellent mea culpa about Research In Motion just last week, admitting he had fallen victim to the dreaded value trap when he recommended the pick last July.

“In the end, the best defense against a value trap is emotional discipline,” Charles wrote. “Look at your investments critically and don’t make excuses when they fail to perform.”

That was great advice for RIM, considering Charles already made his buy call on this pick. But the same discipline is necessary for any potential investment, too. Don’t just wish away the negatives or view a company with rose-colored glasses. Think pessimistically and ask how bad things could get if you turn out to be wrong.

Take my Apple buy, for instance. I didn’t buy because I believed that absurd $1,000 talk from Piper Jaffray. I bought because I figured even if the market cratered, the forward P/E of 10 coupled with the stock buyback and dividend plans gave me some stability. Plus, the fact that Apple itself is seen as a safe haven is in the stock’s favor. Worst case would be a botched iPhone event in the fall and an ugly equities market scaring folks out of even Apple, sending it as low as $400 in a doomsday scenario.

Think it would be crazy for Apple to go that low? So do I. But at least I entertained the possibility for a moment before placing a buy order.

As you bottom-fish for bargains, keep this exercise in mind. Take the opposite point of view and go worst-case scenario. Either it will scare you straight, or make you feel justified in your call.

You may not even have to be as apocalyptic as I was on Apple. Hell, just mulling the idea that the status quo for HPQ, RIMM or NOK may never change should be enough to make some traders think twice.

And that kind of cold realism can help you avoid a loser in the days ahead, too.

Think Abercrombie & Fitch (NYSE:ANF) is going to bounce back from its 52-week low and recent store closure news? Change your viewpoint and consider what the future holds if there’s no light beyond this short-term profitability boost (and read Dan Burrows’ recent bearish article on ANF).

Patting yourself on the back for buying Facebook (NASDAQ:FB) at $26? Eager for more gains now that it’s in the $30s and the IPO pessimism has faded? Well, just make sure you’re honest with yourself… because as the lock-up ends, 1.7 billion shares will become eligible for insider selling. We also haven’t seen a single quarterly report or earnings call yet. The downside risks are real.

All stocks have risks. And in this challenging market, you have to start first by acknowledging what kind of damage you’d be left with if your turnaround hopes never transpire.

There’s a difference between a high-quality company trading at a discount and a fire-sale company that’s on the verge of the junk heap.

Jeff Reeves is the editor of InvestorPlace.com, and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP. As of this writing, Jeff Reeves was long AAPL.


Article printed from InvestorPlace Media, http://investorplace.com/2012/06/buy-quality-on-pullbacks-not-stocks-in-their-death-throes/.

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