Can I buy Stocks at Current Market Price – at Premium?
The above question can be framed differently as “Do I wait for next Downturn for Cheaper Valuation?”
When you are building your portfolio towards a long term sustainable wealth creation, there are multiple aspects that you need to focus on. As individual investors, it is very easy for us to get carried away with the individual stock wins. But when we look holistically, including wins and losses, then we realize who is the real winner. That’s why I say, for DIY investors, sustainability is key in portfolio management. Over the years, all the retail investors I have interacting with, most of us focus too much on stock picking, or stock selection. This is similar to what an employee does of executing blindly now knowing how it is related to overall company strategy.
The first lesson you should learn in investing is “not stock picking”, but how you can maintain and sustain what you have (safety of capital). By this I do not mean going with bonds, FDs, or government certificates. What I mean is invest in a way, where you believe there is relatively less risk of losing your capital.
One way to minimize risk is to buy cheap. Buying stocks at cheaper value will not give you 100% downside protection. But it will reduce the likelihood of your losses. OR in worst cases, it will reduce your losses. In my process, I calculate fair value which I am willing to pay. Almost always, this fair value comes very low. Such low values are, typically, seen during market downturns. The question arises:
- Do I keep waiting or continue to anticipate the next downturn?
- It may take long for next downturn?
- What about the many missed opportunities “now”? If I do not buy now, I may miss it?
- Some companies are good and hence will never be at TIPBlog’s fair valuations?
- Are current prices good enough? I do not need 50% margin of safety. I am good with 20% margin of safety?
All above questions are valid. At the same time any answer that you give could be right or wrong depending upon the context. So I cannot answer these for you. But I will try to answer this in the context of, “building my long term portfolio”.
In an earlier post, I discussed three different approaches to stock buying process. I buy stocks or add to existing position over a period of time. I do that in multiple lots. Let me discuss this will some examples.
Adding to existing position
Early 2009, I added to my existing positions in ONGC, LNT, HDFC Bank, Reliance Capital, and NTPC. When I first invested in these companies, they were at a very low price. For example, let us say, they were at 100. These companies have grown in last few years. Their profitability, cash flows, revenues, etc… have changed significantly. So it would be dumb on my part to expect that they will again go back to same valuations of 100. These could be at 200. What I need to do is look at the them again or keep them following. I need to keep evaluating and updating to see whether these companies continue to meet my buying objectives. In this case I am looking for (a) increasing dividends (b) increasing capital appreciation of 12% minimum (c) and few others qualitatively metrics. The point is my fair valuation will keep increasing and hence it can help me in decided when to add (if any).
I put such companies in my buy list when I agree that these companies continue to meet my buying objectives. But they are typically higher than even the new fair valuation that I calculated. What if the current market price is 200 or 300. So when and at what price point should I buy?
Do I buy above fair valuation? Why?
To make sense out of anything, there has to be starting reference point. In this case (or any other buying decision I use), the reference is the fair value range. My fair value calculation is more of “I am comfortable in paying that much to buy the shares”. This is not necessarily intrinsic value or book value. But buying in this range should give me positive returns, how much? I don’t know. Over the years, I have observed that it has sufficient margin of safety already built in. I hope this makes clear what it is my frame of reference. I will use Clariant and ABCIL as example to discuss making a buy decision.
The fair value range for Clariant was 361 – 432. DCF was 597. The recent market price is 600+. The fair value range is pretty narrow.
- If I get to buy in fair value range, then it is great (oye, bale! bale!). I would expect good return over time.
- In addition, the DCF is much higher than fair value range. This indicates good dividends and relatively higher premium for shares in market. In this case, buying closer to higher value of 432 should also give a good positive returns. Dividends is likely to add to my absolute returns.
- Again, do I have to keep waiting for next downturn? Probably not. Should I buy small lot with premium? how much premium? The farther I go from 432 the lower my returns would be. But I still expect to have positive returns assuming dividends and PEs continue to follow historical standards.
- For these types of companies, when I am buying shares for first time or adding to existing, I am usually open to buying a small lot at a premium of 10% to 15% of my fair value. This is because, I do not expect to sell them in near future. I would happily add to them at next buying opportunity. This level premium on a ‘small lot’ would not dent by absolute return over time.
The fair value range for ABCIL was calculated as 77 – 120. DCF was 41. Now this fair value has a pretty large range. My buy price point will have significant affect on my absolute return over time.
- If I get an opportunity to buy at 41 or below, then it great (again bale! bale!). At that point it is grossly undervalued, so I would jump in.
- In addition, buying at 41 would give very good returns. The reason for DCF being low is because dividends are almost non-existent and its stock earns low single digit premium.
- But then there is perennial question of, do we need to keep waiting for market downturn so that we can buy? Buying at 77 or above is very likely to give positive returns but percentage will vary. The higher your buy price, the lower your returns. As you buy closer to 120, the likelihood of negative returns increases.
- For a company like ABCIL which has had botched history, I would like to buy as close to 77 as possible or may be even lower. The higher I buy, I will have to tone down my expectation or be prepared for negative returns. Each individual has to decide what is good for him/her.
- For these types of companies (ABCIL, HDIL, etc) I would buy much closer to low side of my fair valuation. I would avoid buying at high side of my fair valuation. Furthermore, I am also more open to sell them when I start believing they have much higher than my fair valuation. I classify these type of companies as opportunities. They are not for long term buy and hold objectives. I will be discussing more of these types in future.
To clarify, I am not saying ABCIL and HDIL type of companies are bad. I am not saying they will vanish or give bad returns. But they do not fit into my long term buy and hold objectives. I will not buy them at premium. I am not likely to add them. I am likely to buy them only once. Finally, I am open to sell them.
To Summarize….
Earlier post of stock buying process showed three different approaches that I use in my portfolio management process.
- Systematic fixed capital time-based investing: I had used them for building my fixed income portfolio of savings, FDs, government bonds, etc. I do not use as of today because I am fully allocated to fixed income.
- Buying in small lots: I use this actively for building my long term buy and hold portfolio.
- Buying one time: I have not been very active with this approach because it did not make sense in what I was trying to achieve. I expect to use this for opportunity portfolio. As an example, if you are following @TIPguy on twitter or TIPBlog’s Fan page on Facebook, then you may have read my update. I recently initiated a “decent” position (not a starter position) in Camphor and Allied Products.
What process do you use? Buy at once? Or Buy in lots? or Do you buy at premium?
ABCIL, Camphor allied products, clariant, fair value price, Fair Value Range, risk, stock buying process, stock picking, stock premium, when to buy
One important aspect you have forgot to mention here is that any investor before entering stock market should have Fixed instruments. I prefer 50% to be in fixed instruments, 5% gold, 10% liquid cash, 10% real estate and 25% Stocks and MFs. (Of course backed by Health Insurance and Life Insurance). Since now only 25% of his money is in stocks, even he is well prepared for the worst market crashes.
Phani: I will pretend I did not read your comment. I am new investor and even I know this is not a personal finance blog. can you please comment related to the topic only? I propose to remove this comment, any votes?
It would be good if the comments are related to topic….. but it is okay as reader can skip whet evr is not needed
. I agree to TIP and I had mentioned that in the comment section of the topic (which lead to this topic) that TIP will be monitoring the investments made, regularly to see if any of the good buys are back…. Gradual accumulation should be followed to build up the portfolio…. And I wold prefer to even go for a 50-50 accumulation for any opportunistic style of buying as well, if at all I am buying… 
as TIP said it is personal comfort….. But would be advisable not to try to make a missed opportunity by giving a high premium….
Hello Young,
I agree, it is always better to have comments (generally) related to topic. That way conversion/discussion goes somewhere. Otherwise it goes in tangent.
Yeah, your question, including few others were very similar. So it is better to combine them and write a post.
Best Wishes,
Hello Raju,
I remove/censor only indecent language or irresponsible comments or links. Readers are free to post their comments. Having said that I also agree with you and Young@Market that it is best and more efficient to have related comments.
Best Wishes,
Sorry for the tangential comment.. my whole point was that if you have planned your rest of the finances well, it would be good to invest in high growth stocks with that 25% of amount you plan (which usually have high beta too) that way in worst case say if there is a broad market crash and your stocks do fall in value, you are not too worried. Sorry for being more on personal finance side.. I have a personal finance blog so i am kind of stuck in that mode.
I do my fair value calculation based on historical performance of the company that I’m planning to buy (based on ROC) as explained in http://www.shyamscolumn.com and prefer to buy stocks at not more than 10-15% premium and use my personal judgement in deciding what % premium I’m willing to pay for the stock. And yes, I do buy in small lots, not lumpsum.
Hello Arun,
Good to know. Very similar to what I described, except that your FV calculation is little different.
Best Wishes,
Hi TIP Guy,
One perspective i would have liked to understand in the section ‘adding to existing positions’ is. Apart from the lows of 2009 what other time’s did you add to your existing positions ?
Do you add only when the market presents such rare opportunities as in early 2009 ?
What intrigues me is, once you are done with your analysis of a company and it meets your portfolio objective why not add more from time to time. Probably that will require you to do a fair value calculation every now and then (once a year ?) and find out if it’s available for a price you would like to pay. But isn’t that a hell lot easier than entering a new company ?
Regards
Raja
Hello Raja,
Do you add only when the market presents such rare opportunities as in early 2009 ?
Not necessarily. I think my first lots in NTPC and LNT were during regular time period (not market downturn). And almost all others during downward trend, and not at lowest or uptrend. It depends much more on market price, irrespective of market levels. Having said that, it is highly likely that price gets lower/depressed during downturns only. But that’s just a co-incidence.
On adding to the same company from time-to-time….
Simple reason. Risk Management. Diversify enough to a point where I believe it has balanced risk return characteristics. Cannot define risk/return in numbers because its subjective. I know for sure, the risk is very low, but it will happen. Just don’t know how/when. I have to remain prepared for that low probability event of collateral loss. I do realize that as I have increased number of companies, eventually some will fail like negative returns, or low returns, etc. Can’t say which one? One oil spill and ONGC will be toast! TIC’s holdings may crash and burn, or HDFC Bank can go kaput? who knows? 100% success is myth. My goal is to limit max exposure to 5% only. So even if it goes to zero, effect is not significant.
Best Wishes,
Hi,
what is your openion on holding companies….which hold stakes in multiple child companies…e.g. bajaj holding…they provide diversification …or it is always better invest in company which itself is master in the business world in whichi it working…kind of monopoly…
Thanx,
Chetan Sadanand Raut
Hello Chetan,
No bias. I am open to buying shares of holding companies, assuming they meets my objectives, clears my screen and evaluations.
Best Wishes,
In terms of investing I have been investing from last 5 years… I have good record or so i think.. my portfolio has indeed became 5 fold (including dividends) from 2005 Feb to 2010 August. (I have sold nearly half of them). The stock strategy that worked for me is the following –
1. 40% PSU Stocks with good yields and lower P/Es
2. 60% High Growth stocks (Mid cap and Large Cap only)
I am recently very impressed by the cheap valuations of PNB Gilts (PSU stock) and bought huge quantities accumulated from last 20 days or so. I hope Tip Guy reviews this stock.
Hello Phani,
Congratulations on your 5 fold growth! Thanks for sharing your stock strategy. How do you define what is mid-cap?
I may not review PNB Gilts in near immediate future.
Best Wishes,
One of the reasons why I had good success might be purely because I have bought the stocks in Early 2005 and 2008 Dec – 2009 Feb, both times when market was hugely undervalued and was at historical low levels. I follow around 70-80 stocks and some of them I even followed for years before purchasing. I track news regularly, I try to make sense of the business in my own way.
The five mandatory parameters I use to buy/choose a mid-cap or a large cap stock are
1. Low P/E
2. Consistent EPS Growth YOY (I don’t believe in quarterly changes)
3. Stock Price <= Book Value
4. Good management
5. Low Debt on books
For example –
Bought Large Cap Tata motors at 120 Rs before Nano got launched even though the JLR sentiment weighed heavily on this stock, I knew the Euphoria will be rocket high once Nano will be launched… And it indeed gave me bumper returns
Same with Voltas, bought it at 37-38 range in 2008 october, sold it recently around 150.
Same with Punj lloyd (bought it at around 75 range), sold it all around 220-270 and then started accumulating it again around 110-120 recently.
NMDC around 140 and sold it around 300-375 range
I dont time the market… but when market is very bearish, I plant my excess funds into stocks.. (which is 25% of my total assets always). As I said before I believe in shielding oneself by investing 75% of your assets in fixed instruments.
By gods grace I make good salary so I am never in need of those funds in bear markets.
Most of my stock picks were made by following the news very closely and I never purchase any stock if its over priced even if its growth prospects are good.
I accumulate in lots and I sell in lots. My strategies are fairly simple, I start purchasing if i believe in a stock and fundamentals of that stock are good and if its cheap and i purchase in market downturns. Its probably luck, but I keep my patience for the value to grow and I dont believe in short term profits.
Please delete my comment… probably I am not in the same league as others who are posting comments here… I am sorry for ever trying to post here…