Buying the dip

Travis Clark, Marketech CEO

Market volatility can be both the best friend and worst enemy of a share market investor, but it is always worth keeping an eye out for a market dip. In reality, isn’t that what share trading and investing is all about – finding a good entry price?

Buying shares in companies at all time highs, or after a big run-up, means that you are banking on continued momentum and not necessarily getting value. It can also mean you’re getting in at what could be the top of the mountain, not the bottom, and I’m usually a lot more worried at the top of a mountain – than the bottom.

While ‘time in the market’, not ‘timing the market’, is a common view, if all an investor had done over the last 20 years was wait for the roughly once-annual market correction, and only bought high quality companies for a recovery trade, then sold out…and waited again…. they would have not only made a lot of money but also carried a lot less stress worrying about the next sell-off. (Not that past performance is any indicator of future performance…or that we would recommend this strategy.)

It’s the selling that’s often hardest, especially in a bull market.

In a bull market you can find yourself holding something where all the stars are aligning. Management can’t put a step wrong. They are profiled in the media espousing the long-term growth story, how profits or revenue will keep growing, showing off their latest trophy property, doing the lifestyle photoshoot. The stock keeps growing and growing and now you’re too afraid to sell! The retail army is speaking as one voice, cheering the continuation of wealth for all.

Then, inevitably, something ‘less than fantastic’ happens and the stock pulls back a bit – or a lot. Unbroken strings of good luck will only happen consistently to a lucky few, and no stock will continue to go ‘only upwards’ for ever as it rides the market and economic waves. In bad situations you could see institutional investors dump it, the short sellers attack, and often the retail army will capitulate and sell near the bottom.

What is a company worth?

Even in a bull market there will be sectors or individual stocks that dip. Gold stocks will come off on the back of a weak gold price. Iron ore stocks will come off on the back of a weak iron ore price. High risk stocks will come off harder when the blue-chip market sustains some hits. But some stocks keep on dipping and some rebound.

So, what is a company worth? We know the share price is just what you pay, but there is no line on the chart that shows you what a company is worth. That would be very handy!

Price-to-earnings is the simplest view of comparative ‘worth’.

We currently feed in live market data from both IRESS and Refinitiv, and to create a price-to-earnings number they take the last 12 months of profit and divide it by the share price, which we display in the ‘Fundamentals’ section of the platform.

A negative PE means the company lost money last year, and sometimes that’s an accounting issue, or a one-off loss. But, broadly speaking, a negative PE probably denotes a much more speculative company as you are punting that they will turn it around one day.

This is a simple, but also quite flawed, comparative metric. The PE number by itself isn’t enough. You have to compare it to other similar companies with similar growth rates, and with its historical PE’s, and also take into account the outlook of the company in the next few years. Which is where speculation is required.

The general market conditions will also move PE’s – more speculation, more retail investors, cheap money will lift all valuations of all things – because as they say, a rising tide lifts all ships. And if the whole tide goes out, then they can all drop too, regardless of quality.

So then what is a fair PE number?

Theoretically, a stable company with stable earnings should have a lower PE when compared to one ‘on the grow’, as the amount of money you make from a growing company should be more over the longer term. Makes sense to pay more for a growing income stream than a flat income stream.

But also remember that a ‘growth’ company can, by definition, be a higher risk. The PE is usually higher as people will pay more for that growth. If things go bad, that also means there’s more to fall from the higher PE of a growth company to a lower PE of a less-growth company, as well as the actual market punishment for the new disappointment in the first place.

So that’s the tricky part about buying the dip. Trying to work out how bad it gets takes a lot of crystal ball gazing, and not a small amount of luck.

Finding the good dips

In a bull market, good dips are harder to come by, but they are often easier to trade as people will ‘buy the dip’ – as long as it is not a fundamental change to the company outlook. Everything is easier in a strong market, but also, riskier, as everything can be somewhat overvalued and have further to fall.

Whether on the cusp of a broader sell-off, or whether there are just a few normal ‘dips’ along the way won’t be known for some time. But now you know about PE’s and about how there are a lot of other factors to consider, it’s worth considering some of the other ‘market’ signs are there that it’s THE bottom of a dip.

Here’s a few to monitor:

  • Massively and extendedly oversold Relative Strength Index = you’ll need technical indicators on your charts.
  • A capitulation low on abnormally high volume = you’ll need volume data over extended timeframes and candlestick data.
  • Intraday bounce after a meaty sell-off = need to look at intraday data, with candlestick charts and live-streaming.
  • The seller depth is heavy near the market price and that pressure keeps selling down the price, then it seems to thin, with buyers then cautiously putting in small buys, then larger buys, then all of a sudden taking back control and paying up = you definitely need live streaming expandable depth!

So with hundreds of thousands of new, thirsty traders using little more than a line chart, many with 20-minute-delayed pricing, or rapid-firing their ‘website refresh’ button to get a live price in a fast moving market, and a market starting to set up ‘sell-off bounce’ trades, surely its time to wonder why you don’t have all these features, if you don’t.

Marketech