This article with an additional example using Tencent (OTCMKTS:TCEHY) first appeared in the Seeking Alpha Marketplace service DGI Across North America.
Have you ever missed out on high-flying winners? Have you ever been stuck in a (seemingly) losing stock for a long time? I’ll use Amazon.com (NASDAQ:AMZN) and CVS Health (NYSE:CVS) as examples for illustration.
How to Build a Position in Your Favorite High-Flying Winner
An investment in Amazon 10 years ago has become a 24-bagger. In other words, it delivered returns of roughly 37.5% per year. That said, we’ve been in a bull market since 2009.
In a correction, it’s possible that Amazon stock could fall 30-50%. In a normal market though, one of the best ways to build a position in a high-flying stock like Amazon is buying it periodically.
Some investors wait to buy stocks on dips. However, you’ll notice that in the last few years, dips in Amazon stock didn’t occur very often.
Source: Google Finance with author annotation – Potential buy points when using the “buying on dips” strategy
If you waited for a dip in Amazon stock in June 2017, you wouldn’t have gotten one until April 2018. However, by then, the stock had already appreciated +40%.
At this point in the cycle, I’m leaning more towards buying high-flying stocks on a correction, whenever it may occur. Share in the comments below if you have a different opinion.
How to Build a Position in a Value Stock
Sometimes stocks can be in a downward trend for an extended period of time. For example, CVS stock peaked in the summer of 2015 and went on its downhill journey for multiple years.
Source: Google Finance – CVS stock peaked in 2015 and declined for a number of years.
CVS finally reached a more reasonable multiple of about 15 in late 2016 when it hit roughly $85 per share. But it didn’t stop there. It kept on falling and traded at as cheap as a P/E of about 10, which equated to roughly $63 per share at the time.
Source: F.A.S.T. Graphs
The stock recently broke above its trend line. So, it’s looking optimistic for CVS, except that it’s running in to a resistance in the low $80s (See Figure A below). It needs to break above this resistance to head towards $90, which it could reach over the next 12 months if it continues this trend.
Source: Finviz – CVS broke above trend line
Figure A – CVS experienced higher highs and higher lows while it consolidated, which gave it strength to break out in August and early September.
For a value stock, such as CVS, with stable earnings, investors might begin building a position in it when it trades at a discounted P/E. Start with finding the normalized P/E of a stock. Then, aim for a discounted multiple to buy the stock at. However, there’s no guarantee that you would get to buy the stock at the desired valuation.
Looking at the F.A.S.T. Graphs above, we can take 15 as a normalized P/E for CVS. Interested investors may begin buying the stock at a multiple of 15 or at a discounted multiple of 13, 11, or …
Alternatively, you can wait until the downtrend ends. However, usually, that’s very clear in hindsight, but not at all clear when it happens. And often, there are fakeouts, such that the downtrend seemed like it ended but it actually didn’t.
For dividend stocks, you can also set a minimum yield that you’re comfortable with to begin buying the stock. For example, you might set a minimum yield of 3% for CVS.
Here’s CVS’s yield history:
CVS Dividend Yield (TTM) data by YCharts
Since the U.S. market has been in a bull run since 2009 (by the way, this is the longest bull run in the U.S. market’s history yet), it’s probably not a bad idea to hold more cash on hand if the situation allows it.
That’s why I thought of writing this article to illustrate ways of building positions in a stock.
If you like what you've just read, consider subscribing via the "Subscribe Here" form at the top right so that you will receive an email notification when I publish a new article.Disclosure: At the time of writing, I’m long AMZN, CVS, and Tencent.
Disclaimer: I am not a certified financial advisor. This article is for educational purposes, so consult a financial advisor and or tax professional if necessary before making any investment decisions.
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