“Steve, since the market is up so much lately, I’m looking for stocks and sectors that have been left behind,” a smart friend of mine said last week.
“Oh no,” I thought. “That is exactly the wrong thing to do.”
I understand what he’s hoping to do… I understand that rationally it makes sense.
But investing doesn’t work that way.
Think about Apple (AAPL) versus Research in Motion (RIMM) as an example. Since the summer of 2009, shares of Apple, which makes the iPhone, are up 400% and shares of Research in Motion, which makes the BlackBerry, are down 80%.
[ad#Google Adsense 336×280-IA]Any time along the way, you could have said, “Well, Apple is up, and RIMM is down, so I’ll buy RIMM.”
And any time along the way, you would have been wrong.
In my True Wealth newsletter, we’re up 42.8% in ROM, a tech stock fund we bought last March. (Apple actually makes up 22% of ROM.)
We rode Apple and the other major tech stocks all the way up. And we’re still holding them.
We have not bought RIMM… even though I’m sure there’s an argument that it’s cheap. So why not sell Apple and buy RIMM?
Legendary investor Warren Buffett has explained it best in the past: “I would prefer to buy an outstanding company at a fair price rather than an ordinary company at a cheap price.”
He wasn’t saying this about Apple and RIMM specifically… he was speaking in general terms.
Over the last year, Apple has been an outstanding company at a fair price. RIMM was an ordinary company at a cheap price. And look what happened. Buffett was right…
In the September True Wealth, I reiterated my buy on Apple and the other tech giants, making the case that they were “outstanding companies” at “fair prices.” I published a list of the tech-stock fund’s top holdings and their price-to-earnings (P/E) ratios:
Apple’s forward P/E was nine. RIMM’s was five. Since then, Apple is up nearly 60%. And RIMM has lost nearly half its value.
The message is simple… Don’t make the mistake of buying ordinary companies at cheap prices. Instead, buy outstanding companies at fair prices.
Look… this has been an amazing bull run in stocks. If a stock DIDN’T rise in this bull run, something is wrong with it… It is “cheap” now for a reason.
Most people think that it’s safer to buy a “cheap” stock – one that didn’t participate in the big run higher. They think that there’s some safety there… They think that it can’t fall as much as the ones that ran up, simply because it doesn’t have as far to fall.
I can see how you can think that… But having been a participant in the markets for two decades, I know this isn’t how it works. Buying the previous underperformers doesn’t provide you any protection at all from a market bust.
When the bust comes, they all come down… Heck, if anything, people want to keep the “outstanding companies” (as Buffett called them) and quickly dump the “ordinary“ companies.
Once the market has run up like it has, the temptation is to look for deals among ordinary companies. Resist that temptation… Trust me, it doesn’t work.
Learning this lesson was hard for me. I burned myself a few times looking for bargains after bull runs before I got it.
It doesn’t have to be hard to learn. Now you know it. Don’t let yourself get burned by it, too…
Source: Daily Wealth