What To Do When You've Missed the White Whale

By David Sterman
October 15, 2010

Back in 2003, the head of my company boasted that his new investment in Apple (Nasdaq: AAPL) was going to make him loads of money. The rest of us didn’t quite agree. Apple was moving farther into the background in the battle against Microsoft (Nasdaq: MSFT), and its nascent iTunes business was off to a rocky start. By the time I saw the light in 2004, Apple's shares had already risen from $15 to $30 and I waited for a pullback as I assumed that a +100% gain is invariably met with profit-taking. I’m still waiting, as shares of Apple just moved past $300.

We've all let a great one slip away. Here's some guidance for those of you having doubts about pulling the trigger on the company you're most interested in.

Forget the Past
Investors' biggest mistake is looking to the past for entry points into a stock. A stock may have been cheaper a year earlier, but business may also have been less robust back then. Instead, you should look at every stock as a snapshot in time: Where does the stock's value stand right now in relation to future expectations? Stock markets gyrate and it's logical to wait for the market to give you entry points. Individual stocks tend to move in a particular direction for a greater period of time.

Check the Assumptions
If you really like a stock but it has sharply risen in value recently, you need to know what has changed. In the case of Apple, a new hot product (the iPad) that came out when the stock was $200 led many to believe that shares could find support from another pillar of sales growth. Conversely, a stock that has been rising simply because the broader stock market is firming up could be a signal that a pullback is coming. Shares of Macy's (NYSE: M) have risen sharply in recent months on hopes that sales and profits will rebound when the economy starts growing again. That may or may not happen, but this would probably be a lousy time to hop on the Macy's bandwagon on hopes of an upturn that may not materialize.

Dollar-Cost Averaging
Let’s face it, if a stock has already made a nice move, it's hard to have 100% confidence that you're still buying a great investment. The majority of individual investors tend to buy into a company right when its share price has peaked. So much for buying low and selling high.

In an effort to avoid getting in at the top, investors that have a bit of uncertainty should tiptoe into a stock through a process known as dollar-cost averaging. Rather than make a big bet all at once, you make smaller investments and periodically add to them on a regular basis. You'll miss some of the upside as the stock goes up, but you may also get shares at a cheaper price if your instinct that a pullback is coming is correct.

Become an Expert
You may not have the time to follow lots of stocks, but you surely have the time to know as much as you can about at least one stock. If a company like Apple or Google (Nasdaq: GOOG) strikes you as a great idea, then you need to spend the time reading up. If you put in enough time following the stock on the major investing websites, you'll know as much about it as anyone else.

Price Doesn't Matter

Investors have a clear aversion to high-priced stocks. The investment newsletter industry has all kinds of publications focusing on stocks trading below $10. But prices really don't matter. Apple may have seemed expensive when it was trading at $80, and $2,400 only got you 30 shares. Yet that investment would be worth nearly $10,000 today.

Need more proof that price doesn't matter in the long run? Consider this logic exercise: You and I both have $3,000. With that money, you buy 10 shares of Apple, while I buy 120 shares of Microsoft. The price of both companies goes up +10%. At the end of the day, both of our investments are worth $3,300. It doesn't matter if you use the money to buy one share or 1,000 -- a +10% gain will always be the same. Don't let a high price scare you away, especially if your research tells you the company still has a lot of future potential.

The Long-Term View
The most important question you need to ask yourself is whether you think this company is a long-term keeper. Many hot young companies tend to flame out, and investors mistakenly assume that last year's +40% revenue growth will continue in perpetuity. In fact, companies experiencing the fastest growth are often the very ones that hit a speed bump and see revenues slump in subsequent years.

Your potential investment need not always be a great growth story, but you need to be convinced that it is not simply a fad. That was a concern with Crocs Shoes (Nasdaq: CROX), which was a favorite stock until sales growth suddenly turned negative. Crocs has once again become a growth target, but only after losing some investors more than -90% of its money.

Don’t Get Too Attached
If, after evaluating all these factors and taking the information into account, you still don't see the right entry point, maybe it's time to move on to something else. Don't get emotionally attached to something and try to force it where it doesn't fit.

You just might get lucky and find the stock cheaper down the road when the market goes through one of its periodic stumbles. After all, Apple fell from $180 in the summer of 2008 to just $80 in early 2009. For anyone that had studied the stock but never pulled the trigger, that was a rare window to hop on the bandwagon. Shares are up nearly than +300% since then.

Sometimes the best option is to walk away and use the knowledge you gained from doing all that research to find your next perfect investment. Make a list of the characteristics that drew you to the company in the first place. Was it the company's constant innovation? The unique way it encourages its employees to spend time developing personal projects that may become the next big thing? The way its products have such mass appeal? Go back through your list every few weeks, or whenever you need some investing inspiration. It might lead you to an even better investment down the road.

 

P.S. Soon after writing this article, I came across my own White Whale: Cree (Nasdaq: CREE). I decided to cover the stock on our sister site, StreetAuthority.com, and you can read it here: A Second Chance to Buy an Industry Game Changer.