The Wall Street Journal-20080130-Common Sense- When Markets Fall- Bargains Are There for the Taking- Battered Stocks Offer Opportunity Over the Long Term

Return to: The_Wall_Street_Journal-20080130

Common Sense: When Markets Fall, Bargains Are There for the Taking; Battered Stocks Offer Opportunity Over the Long Term

Full Text (721  words)

SmartMoney

It's buying season on Wall Street.

After two very brief, unconvincing 10% corrections last year (in August and then in November), the market indexes crashed through those barriers last week, grazing bear market territory.

But as I have been saying for some time, this isn't the time for hand-wringing over the declining value of your portfolio. It is time to identify some bargains and do some buying. Which is what I did last Wednesday. An advantage of writing this column is that I feel obliged to act on the advice I dole out. It is one thing to have an idea. It is another to act on it, and to put your money on the line.

There was no real timing involved in my decision to buy on Wednesday, other than the fact that the Nasdaq had crossed my latest buying threshold. This turned out to be exceedingly lucky, because Wednesday was the day that the market plunged, then abruptly reversed course. The Dow Jones Industrial Average soared, closing up nearly 300 points.

What did I buy? As I mentioned last week, the recent plunge hasn't discriminated much, dragging down most stocks and sectors. This has been one of those rare opportunities to indulge your stock-buying wish list. Stocks you've always wanted to own but seemed too expensive. Beaten-down value stocks. They were all on sale.

In the first category, I was able to buy Google and Apple at huge discounts to their recent highs. Apple was down nearly 10% during intraday trading alone on Wednesday when I bought it after the company issued a disappointing forecast (despite reporting record earnings). I mentioned these stocks as bargains last week, and since then they dropped even more.

I've devoted numerous columns to my belief in Google's prospects, but perhaps I should elaborate on my more recent optimism about Apple. It's simply that I believe Apple is evolving from an interesting but not-very-profitable hardware manufacturer into a natural monopoly based on the success of its iPod. A natural monopoly is every long- term investor's dream. I've noticed that iPod rivals are failing to make any dents in Apple's dominance -- just as Google competitors have failed to cut into its high market share.

This suggests that the iPod isn't just an attractive commodity. It's successfully being extended into phones and, I predict, will someday be the center of an integrated and seamless network of communication device, laptop, desktop and big screen for which we'll be downloading product (songs, games, television, news, movies) from the iStore.

I also bought more Valero, a stock I've mentioned before as being undervalued both on price-to-sales and price-to-earnings ratios. As a gasoline refiner, Valero has been squeezed by narrowing margins, a condition I don't expect to persist. Tesoro offered an equally compelling value, but because I already owned Valero, I added to that position. (I checked some of the integrated majors and other oil stocks, but, except for the refiners, energy stocks weren't down that much.)

I also added some in-the-money Oracle calls (a call is an option to buy a security at a specific price) and added to my holdings in emerging markets, which were badly battered last week.

At this point I felt I had spent enough. How much is enough? That's up to you to decide, but here are some guidelines. Given that we've now had two 10% declines in succession, you need to keep some cash in reserve for further declines. The most conservative approach would be to invest 10% of your cash reserves. That way, you'll never run out of buying power. But that's pretty extreme. The Nasdaq is unlikely to drop even the 80% it did after the tech bubble burst. Last week, I spent 20% of my cash, which leaves room for more 10% drops.

Last week's purchases are now showing significant gains, especially after Monday's rally. But I don't measure my performance in the short term. The market may well drop further. But someday it will hit new highs. And that's when these purchases at bargain prices will really pay off.

---

James B. Stewart, a columnist for SmartMoney magazine and SmartMoney.com, writes weekly about his personal investing strategy. Unlike Dow Jones reporters, he may have positions in the stocks he writes about. For his past columns, see: www.smartmoney.com/commonsense.