Wednesday, August 6, 2008
When Stocks Decline After You Buy Them
Sometimes when stocks drop after you've bought them it's because you've made a mistake: you bought stock in a troubled company (e.g., OPMR), or you bought stock in a good company at the wrong time after ignoring the relevant macro trend (e.g., BBSI), or you bought stock in a good company but at the wrong price (e.g., at a too-high multiple).
Stocks can also decline after you buy them even if you've made none of those mistakes. A recent example for me is Exxon Mobil (NYSE: XOM). When I bought Exxon, it was benefiting from the relevant macro trend (the secular bull market in energy), and it was trading at an enterprise value/forward earnings multiple of about 9x. I tend to view an EV/forward earnings multiple in the single digits as a conservative price for stock, considering that market average P/Es declined to 10 at the end of the last secular range-bound market in stocks (see graph above, via Vitaliy Katsenelson; for more info on his thesis, see this post, A Secular Range-Bound Market? Vitaliy Katsenelson's Thesis). I purchased XOM at $86.69, and today it is trading at $78.33, partly due to the recent correction in oil prices, which has put downward pressure on a lot of oil stocks (e.g., the oil royalty trust I mentioned that had hit a 52-week high of $107 per share in June, BP Prudhoe Bay, closed at $81.89 today. Fortunately, my average cost on this one is under $60 per share).
It's never fun to watch stocks drop after you buy them, but when those stocks belong to well-run, profitable companies such as Exxon1, that have good prospects, are trading at cheap valuations, and have virtually bulletproof balance sheets, I'm not fazed. I'm content to hold these sorts of stocks, and in some cases would consider adding to them. I'm a little less sanguine when more speculative stocks I own decline.
1Note that Exxon's mega cap size isn't what gives me confidence in the company. I have similar confidence in other, much smaller, companies thats stocks have declined since I bought them, e.g., Hudbay Minerals (TSX: HBM.TO), and Heidrick & Struggles2 (Nasdaq: HSII) that are also profitable, trade at cheap valuations, have virtually bulletproof balance sheets, etc.
2Heidrick & Struggles, incidentally, reported a solid second quarter today, beating consensus earnings estimates by 6 cents.