However, many institutions can’t or won’t buy stocks trading for less than $10, with a market cap below $1 billion and/or that don’t trade several million dollars worth of shares each day. Without the potential for institutional ownership, a quick rebound in prices becomes less likely.
Does the company have a sustainable competitive advantage? For a stock to turnaround we need the company to thrive, not survive. That’s not possible without a sustainable competitive advantage. So stick to companies like Apple (Nasdaq: AAPL) that are light-years ahead of the competition in terms of design, market share, new product offerings and/or technology.
In the end, don’t kid yourself. Detecting a value trap is no easy task. Even the best investors occasionally get snared. Think Bill Miller (with Countrywide and Freddie Mac (NYSE: FRE)) and Carl Icahn (with Yahoo! (Nasdaq: YHOO) and Advanced Micro Devices (NYSE: AMD)).
But at the very least, these 10 questions will ensure you never buy blindly, or on price alone.
Happy bargain hunting,
Lou Basenese
Today’s Investment U Crib Sheet
“How do you catch a falling knife without hurting yourself? You don’t.”
It can be tough to watch an asset go into a freefall. Especially if you just purchased it at a price you felt couldn’t possibly go any lower. It can be harder to watch when the rest of your portfolio does the same. However, that doesn’t mean you shouldn’t look for undervalued investments.
Our third Pillar of Wealth is perfect for bargain hunting.
Pillar 3: Understand Position Sizing
Knowing how much to invest in each and every situation is crucial to building long-term wealth. Position sizing ensures that even if a number of your investments turn sour, you’ll never lose your shirts.
As a guideline, we recommend investing no more than 4% of your equity portfolio in any particular stock. If you want to be conservative, invest less. If you want to be aggressive, invest more - but not too much more.
This strategy makes sense in your transaction amount as well. By building up a new position over a couple of trades you can minimize the risk that your initial purchase was at the high of the day, week or year. It allows you to utilize dollar-cost-averaging to lower your cost per share. However, it’s your personal preference on how far apart to spread purchases - minutes or days.
Position sizing defines exactly how much of any stock you should buy… and limits your losses from ill-timed purchases.
The Four Pillars of Wealth are the foundations of our philosophy and the basis behind successful investing. Quite simply, it works. And it’s why Alexander Green went over our fourth Pillar of Wealth on Monday. To get his five basic steps you can take to reduce your taxes this year, check out Investment U Issue #894, Tax-Managing Your Portfolio: There’s Still Time to Cut Your 2008 Taxes.
