Theory: Gains Vs Losses

Is investing at lower prices the best strategy? Let’s say, a stock is priced at “x” today and is expected to perform better in long term. The analyst in you says, that it would be 5x by the end of the fifth year due to several long term performance measures taken by the company. Given that the performance of the stock would improve over the long term, you have two strategies in hand: purchase the stock at lower levels as of today and then wait till it appreciates or buy at a future date when performance improves. You are also aware that till performance kicks in, the stock is bound to be volatile and may give negative returns. What would you do?

Well. I would do this. If I’m sure of the fundamentals of the company and believe that the company is reasonably (or lowly) priced as compared to its peers, then I would go outright and buy the stock. Why would I do this considering the fact that the stock will be volatile in the short term?

The reason can be better explained with an example. Let’s say, I buy stock “x” at Rs 100 and expect a 20% compounded return on the stock in the long term. Now, due to market sentiments the stock dips to Rs 50. The stock posts a notional loss of 50%. Now, let’s say I buy the stock at Rs 50 and sell it at Rs 100. My gain is 100%. The theory is the gains would always outperform the losses.