#3: Dumpster Dives
I wrote at length about this kind of pickpocket investment last year in an article called “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 BlackBerry (BBRY) — previously Research in Motion. Shares peaked at $150 in 2008 and finished 2011 at around $15. Still, many investors remained convinced the company wasn’t dead. Well, pity on you if you were one of them. BBRY shed more than 30% in the last month alone thanks to ugly earnings, ugly sales of its hyped BB10 smartphone and an ugly tablet strategy — if you can even call it a strategy.
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.