It’s an age old question. When to actually purchase stocks. Here are some thoughts.
1. Buy when you have the money.
Can’t buy stocks when I don’t have the money, that’s for sure. I won’t buy on credit or on margin. Some people do. But in my view, stock prices are so volatile that one can easily get over-extended and end up in a perilous situation. I’d rather sleep well at night.
And buying when I have the money is the name of the game for dollar cost averaging.
2. When criteria shows the particular stock is not over-valued
No one really wants to overpay for anything. So we look to see if a stock is overvalued. One, of many measures, is “the multiple,” also known as the Price Earnings Ratio (PE). It is the relationship between the price of a company’s stock and the quarterly earnings per share. One way to think of it is how many quarter’s worth of earnings would it take to purchase one share. A PE of 20 means it would take 20 quarters, or five years, of earnings to pay for one share.
A stock with a high PE means it would take many more quarters of earnings to buy one share. A low PE indicates less quarters would be able to buy one share. When a stock has a high PE, it is said to be “overvalued” or “expensive.” When a stock has a low PE, it is said the stock is “undervalued” or “cheap.”
Of course, have a low PE does not automatically make a stock a good value. And a high PE does not always translate to difficult times ahead. But in general, it pays to know the state of the stock’s price relative to the company’s earnings.
3. When the stock price is below historical norms
Since stock prices vary all the time, it may be of interest to know its price history. A high price may or may not indicate future potential, and a low price may or may not be a warning sign. But for a stable company with a good business and good prospects, a temporary lower price may mean a buying opportunity, all things being equal. Of course, things are never “being equal.” If the stock returns to its previously normal range, then having bought at a temporarily low price may prove to be a good opportunity.
For dividend investors, a temporary low price is often a good opportunity. When prices are low, dividend reinvestment buys more shares. For the reasoning behind this statement, this post: Why I Consider Buying In A Declining Market Can Often Be A Good Thing.
I keep a list of the prices below which some of the stocks I own would be considered a bargain. I compare the day’s prices with the numbers on my list so I can know how close or far these stocks are from my desired entry point. And in the case of a major selloff like we experienced in March of this year, having this list saved me from time consuming research in the heat of the moment.
4. When there is Blood in the Streets
Following the advice of this famous quote is not for the faint of heart. There is always the possibility that the blood will continue to flow indefinitely. But it is also said fortune favors the bold. The trick is knowing one’s own attitude: if one purchases stocks in those circumstances and prices continue to decline, what would you do?
5. Lump sum v. dollar cost averaging
If one comes upon a lump sum, is it better to invest all at once, or invest a portion at a time? Some research has gone into this question. While some research suggests the lump sum investing will outperform dollar cost averaging, it also comes down to temperament and goals. It is also appropriate to remember that time in the market beats timing the market.
When do you invest? Let me know here.
The illustration of a paroquet (parakeet) is from a polychrome woodblock print and a Meiji era copy (ca. 1900) of an original design (ca. 1771) by Itō Jakuchū (1716–1800), a Japanese painter of the mid-Edo period.
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