Everyone loves a good deal and hunting down the best buys. We’re used to snapping up good deals on household items in stores and on online platforms.
Technology stocks have been the market darlings for years now, but their prices have corrected in dramatic fashion so far this year. The question is: are they now a good bargain?
Should I average down on tech stocks?
To average down on a stock simply means to buy more shares of the same stock you own after it has fallen in value. When this is done, it lowers the average price level where you bought the stock.
Investors who double down on a company’s stock when its share price tanks, see it as a good bargain.
For example, If you had invested at Grab’s IPO price of US$11.01 and the current stock price dropped to US$2.58, investing the same amount of money into Grab would give you more shares, while bringing down your average price drastically to US$4.18.
Big Tech counters, such as the FAANG stocks, have also been falling with the general tech sector, as the chart below shows. For more on why growth stocks have been faltering, click here.
Lowering your average entry price
The idea of buying more shares at a third of the price you previously paid may seem appealing as the price to break even for your investment is a lot lower. In the earlier example, it presents the hope that it would be much easier for the share price to recover to US$4.18 than the entry price of US$11.01, given the big drop in share price.
Belief in company fundamentals
Despite the drop in share price, you might still believe in the fundamentals of the business. The assumption here is that any short-term volatility is not indicative of the long-term intrinsic value of the company.
“In the short run, the market is a voting machine but in the long run, it is a weighing machine.”
- Benjamin Graham, father of value investing
After all, this is how Warren Buffett invests: looking for companies with sustainable competitive advantages and that are building an investment moat. Tech companies such as Netflix, Grab and SEA have disrupted the industry they are in, and have tried to push themselves into market leadership positions acquiring significant market share. If the assumptions behind the high growth of the business remain, any losses would be assumed to be short-term in nature.
The odds are stacked against stock picking
Yet research has shown that it is difficult to beat the market by stock picking, even when buying securities at a discount. Buying at a bigger discount relative to other investments has not shown to automatically improve your investment success.
Not all companies live to succeed
It may seem like the tech giants are infallible given their market position. But it is important to look back in history and appreciate that many large companies fail as the market changes.
Listed giants such as Kodak, Nokia and Yahoo, which were once multi-billion behemoths, had their businesses restructured and sold off in parts, before being delisted at a fraction of the prices they were traded at in their heydays.
The table below by Dimensional shows that over a 5-year rolling period, 21.3% of all US common stocks were delisted. Over a 20-year rolling period, that figure exploded to more than half (52.4%).
High risk of missing winners, sticking to underperformers
Research has shown that most stocks underperform the index performance, with only a few companies driving the performance of the entire index. This positive skew in returns is the historical norm, not an anomaly, as shown in a study by S&P Dow Jones.
We may think that we’ve secured a good buy for a stock now trading below the price we bought it at. But as seen from the chart, there are many companies underperforming the average return of 227%, with the median company only achieving 0%-50% return over a 20-year period. There are no sure bets.
Irrational behaviour can set in
Stocks selling at deep discounts are also called value traps: they seem attractively valued but are ultimately poor investments. Investors may be dumping the stock because the companies are going through a big shift in business fundamentals — and for the worse. With growth stocks, a “growth trap” is a risk to watch too.
Buying downtrodden companies is similar to a “selling winners, buying losers” investment approach, a behavioural model known as prospect theory that was developed in 1979. As we tend to feel the pain of losses more strongly than the pleasure of gains, we are more inclined to double down on our losers.
Get the best chance of success with diversification
In this period of market volatility, we can take this time to reassess our risk appetite, and improve our investment approach. It is important to understand the inherent risk of picking single stocks. With the global index — the MSCI All Country World Index — down around 16% year to date (as of 19 May 2022), the entire market is now trading at a discount.
As Jack Bogle, founder of Vanguard, succinctly puts it, don’t look for the needle in the haystack. Just buy the haystack. Averaging down on index funds or broadly diversified portfolios offers a safer bargain buy.
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