#3: Dumpster Dives
I wrote at length about this kind of pickpocket investment in my recent article “Buy Quality on Pullbacks, Not Stocks in Their Death Throes.” The idea is simple: There’s a big difference between a good stock that has had a bad run and an ugly stock that you’re hoping will just get less worse.
In a bear market or a sideways market, it’s tempting to talk yourself into why a downtrodden name is a good bargain based on a rock-bottom P/E ratio or a strong history of outperformance in the past. But never fool yourself into thinking that a stock that has gone down dramatically can’t go even lower.
Consider Research In Motion (NASDAQ:RIMM). Shares peaked at $150 in 2008. They finished 2011 at around $15. Still, many investors were convinced that the BlackBerry maker wasn’t dead. It still had a footprint in enterprise with many business connections even if consumers preferred Apple (NASDAQ:AAPL) and its iPhones. It had well over a billion in cash to make some moves and operating cash flow of nearly $3 billion.
Well, pity on you if you thought it was oversold. RIMM lowered estimates and delayed its BlackBerry 10 launch, causing the stock price to be cut in half again to under $8 and proving Research In Motion can indeed go even lower.
The moral of the story is that if sentiment is ugly and secular trends clearly are against a stock, don’t fool yourself into thinking that the market has somehow miscalculated the value of an investment. You’re better off buying a stock you believe in on a pullback.
Or, to turn a phrase, shop the sale rack at Neiman Marcus instead of Dumpster-diving.