Blogs > Your Money

Dave Patterson and Erin Preston, a father-daughter team of Certified Financial Planner® licensees, provide thoughts and suggestions on a broad collection of personal finance topics.  Information provided in this BLOG is intended to be of a general nature and may not be appropriate for all situations.  Readers should consult with their own financial advisors before relying on any information contained herein.

Friday, July 3, 2009

Will Investors Ever Learn?

In our recent post titled “There’s No Silver Bullet in Investing”, we talked about how typical it is for investors to want to buy a stock just because its price is low. Surely a low price must mean it’s a good buy! And, you don’t have to invest very much to make a killing! That’s what they’re thinking.

A low price by itself means nothing. Just because a stock once sold for $100 a share and now sells for $15, provides no basis for buying the stock. You need to do some research to determine what the outlook is for the company’s earnings. What’s the competition doing? The price is often low because the company has some problems. Can they overcome those problems? A high-priced stock might have significantly better potential.

A recent report by Turner Investment Partners discussed its analysis of the recent market rally. Their analysis showed that the smallest and cheapest stocks have gained the most since the rally started in March of this year. Their report stated:

“To us, the spectacular rally by small-cap stocks represented the investing equivalent of Newton’s Third Law of Motion: any action produces an equal and opposite reaction. For example, one-quarter of the small-cap stocks in the Russell 2000 Value Index lost 65.5% or more in the 12 months prior to the rally, then rebounded with a vengeance.”

In other words, a substantial portion of the recent rally has been the result of investors buying low priced stocks. What do you suppose is the chance that the majority of those buyers did any significant research before buying? Certainly there were many that did. And a good portion of the rally included large and mid-cap stocks, as well. But many likely were looking for bargains. And with prices so low, how could they possibly go wrong? I guess investors will just never learn!


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