When it comes to toying with your emotions, there’s probably no place worse than the stock market.
That’s because our instincts and built-in tendencies serve us poorly as investors.
There’s even a growing field to study and explain these “behavioral biases.” Some are well-documented, like herding. That’s where investors just follow what everyone else is doing (which is a bad idea, of course).
But there’s another instinct I’m seeing a lot more of lately. And like all the others we fall prey to, when followed blindly, it can do real damage to your portfolio.
That is: the urge to buy something on sale.
Whether it’s a true savings or one fabricated to trigger our buy-now impulse, sales are hard to resist. Companies know this. Sales events are baked into our calendar! There’s the Presidents Day sales, Fourth of July sales, Memorial Day discounts and the granny and grandpa of them all … Black Friday and Cyber Monday.
Right now, with the recent plunge in many growth stocks, the Wall Street “SALES” signs are flashing brightly.
But here’s why not all sales are created equal.
A Falling Price Doesn’t Equal Value
Grabbing an item on sale makes us feel good. Like my new rocker chair to sit and watch my daughter’s all-day lacrosse tournaments. Or Tesla that’s suddenly 11% cheaper than it was just last week.
But when it comes to stocks, that is a dangerous assumption to make. A stock that appears to be on sale doesn’t mean it’s undervalued.
And something that has fallen a lot can keep dropping.
Take Amazon (Nasdaq: AMZN), for example, during the dot-com bubble. After the stock peaked around $107 at the end of 1999, it took just four months to see the stock cut in half. After that, it proceeded to drop another 89% before bottoming at $6 per share (it’s up 51,992% since that bottom if you’re curious).
My point is, don’t look at stocks that have taken a recent beating and think you’re getting a bargain. Instead, go hunting for the real gems.
4 Steps to Find the Real Bargains
Before taking the plunge on a stock that’s well off its high, here’s a checklist to determine if it’s truly on sale or likely to see further declines.
Step No. 1: Check the valuation: Despite the pullback, many growth stocks still trade at historically high valuation multiples. Be sure to assess valuation relative to both sales and earnings.
Step No. 2: Analyst revisions: For a stock that has seen a diving share price, how are future estimates evolving? If Wall Street analysts are slashing their financial estimates for the next couple years, there’s a reason the stock is down.
Step No. 3: Don’t catch a falling knife: Stay away from stocks that are in free fall. Instead of trying to catch the exact bottom, wait for the stock to show improvement in relative strength against the broader stock market.
Step No. 4: Follow The Bauman Letter: That’s where Ted and I do all of the research and analysis for you so emotions and biases have less of a negative impact on your investing success.
So, if you’re tempted by the many growth stocks that appear to be on sale right now, thoroughly evaluate the company’s valuation against its prospects before you hit that “buy” button.
Remember Warren Buffett’s words: Price is what you pay, value is what you get.