I Love Catching Falling Knives


FALLING KNIFE DEFINITION: A slang phrase for a security or industry in which the current price or value has dropped significantly in a short period of time. A falling knife security can rebound, or it can lose all of its value, such as in the case of company bankruptcy where equity shares become worthless. A falling knife situation can occur because of actual business results (such as a big drop in net earnings) or because of increasingly negative investor sentiment.  Source: Investopedia

I do like the falling knives! I usually find the best opportunities in the companies who’s stocks fall hard, some deserve it, but sometimes is unwarranted panic selling. I got many of my current holdings this way. I bought the bulk of my Merchant’s during the last economic crash when all banks were being sold no matter how safe/dull their business practice was. Cisco (CSCO), Keurig Green Mountain (GMCR), GE (GE) Google (GOOG), eBay (EBAY), Apple (AAPL)… I bought my stakes in all of these when people were overly pessimistic on them.  

Why Catch Falling Knives?

Often, you will have companies have some bad news, maybe an earning or sales miss, an unexpected one time expense… temporary problems even though the company’s business is sound, the stock will drop hard. This makes for a great opportunity.

Some of the ones I’m looking to buy now are Staples (SPLS), Merchant’s Bank (MBVT), 3D Systems (DDD), Stratasys (SSYS), Amazon (AMZN), AT&T (T), Verizon (VZ), Sierra Wireless (SWIR) – either for the fact that they have fallen a bit, but still have sound fundamentals based on the current price or have decent dividends which help keep a floor on further downward pressure with great potential for upside.

But generally right now I’m putting together a nice list of potential ideas while keeping a wait and see attitude, waiting for the right time to strike.

MBVT is one that I’ve consistently held a core position while trading around it. I like it at $28.50 or less usually. At the last stockholder’s meeting (which I still need to post my write up on) they mentioned they are in the process of completely upgrading their computer system which will increase efficiency, customer service and lower overall cost. However, the whole cost of this upgrade is expensed this year so it could scare people (which it looks like is already happening) that just look at the numbers… could create a nice opportunity there.

Stock Market Pullback is Good for the Market

stock-market-downThe recent stock market drops are a good thing for the overall market.  I think the recovery has been too fast and based somewhat too much on the fed temporary easing… it has to end sometime.  

It’s about time for the markets to show strength on their own merits.  

Some smaller pullbacks now are better than another much larger crash later in the year.  Consider the pullbacks now as a good opportunity to sell some positions where the current price is high compare to the value of the business and make some buys of stocks that are selling at a discount.

There’s usually always some good deals in the market and they often become better deals when the overall market is going down hard. Make of list of companies that look attractive and judge them based on their current and future business prospects compared to the current price.

 I’ve already started too and plan to buy more if prices continue to go down more.

If you’re still nervous, consider investing in solid companies with reliable dividends.  For example, I like Merchant’s Bank (MBVT) with an over 4% dividend.  They are rock solid and have consistently paid a dividend for years.  Worst case scenario the stock plummets and I still get my 4% on my original investment and plus I get to buy more for a larger dividend.

Other stocks with decent dividends are Intel (INTC), Cisco (CSCO), Microsoft (MSFT) and GE (GE).  All of which I have current long positions in.

Investment Strategy for Stocks

My primary strategy is to create a list of companies that I have at least some personal knowledge of.  Which mainly for me would be companies I either personally use, do business with in some form, or at least are in industries I have personal knowledge of.

Recently, I’ve made purchases of Cisco (CSCO), which I believe fits my strategy, not as strongly as I would like, but enough to be considered.

I then determine what I believe the value of the business based on a variety of factors. Then I wait for the price of business to drop below this value I’ve determined. Once reaching a target price below the business value that reflects the risk or uncertainty of my value of the business I buy if my assumptions have not changed.

Because my target prices are usually quite low to the current market price, most of the time my purchases are made upon a severe pullback in the market or some overreaction to current news for a particular stock, which is the case with CSCO.  The price has continued to drop since I bought my original purchase and additional blocks.  I am reluctant to add more, as with any purchase, I must allow that my assumptions could be wrong about a business, which is why I try to diversify enough to allow for some error.  In the case of Cisco, at the current price, I would definitely be adding some more if wasn’t already such a large percentage of my portfolio.  It’s a great price to initiate a position if you don’t already have one.

I guess what’s important is to have a strategy that you do really believe in and one that doesn’t cause you to be alarmed when your picks drop a lot.  When I first started investing in the 90s, that was the problem I had.  I liked a stock I bought when I bought it, but when it went down, I would get scared because as it turned out I didn’t really believe in the methodologies I was using.  The difference now, is I’m not scared with the fluctuations of stock prices… only with actual business decisions that I disagree with over time.

At this time, I believe that there are some nice possibilities right now in big tech… Hewlett Packard (HPQ), Intel (INTC), AMD (AMD), Microsoft (MSFT), and SanDisk (SNDK) are some potentials that I may consider initiating positions or adding to existing positions.  Big tech in general seems to be really out of favor right now due to temporary reduction in tech spending, which will rebound at some point, it’s just a matter of time. If you believe in the continual progress of technology, the internet, cloud computing, high speed internet, more services being offered online, you have to be bull on big tech in the long run. 
For example, I’ve held off from making extra tech purchases for some time now, due to economic uncertainties, but I will have no choice but to upgrade my computing equipment as it’s either wearing out or going obsolete and I imagine there are many other individuals/firms in a similar situation.

I believe the market is really overreacting on this one and taking a very short term view, creating some good opportunities for the long run.

Cisco Systems Inc (CSCO) – Buy

We bought more shares in Cisco (CSCO) today at 19.429/share.

The Bad News

The selling today is an overreaction to the some negative news reported yesterday regarding their recent earnings report. They had a smaller gross margins (.90% less than expected) and the CEO’s outlook was more negative than expected.  Chambers sited concerns in weaker IT spending by local, state and federal governments as a major concern in the near future.

The Good News

However, the good news is:

1. Revenue and earnings beat estimates.

2. Revenue is still growing.

3. Cisco will be soon starting a dividend (1-2% projected yield)

4. With $40 billion in cash, which easily covers long term debt, the company isn’t going out of business anytime soon and has plenty of money to weather economic downturns and fund continued development.

5. One of the reasons their margins are down is because they are rolling out some new products and it’s typical to have some margin pressure in the beginning of any new production introduction.

6. There will be continued demand for internet/networking services and Cisco dominates the enterprise routing and switching market. The switching costs to other competitors is high giving them a good wide moat for their business. Long term demand oulook looks great as internet usage growth continues.

7. Therefore, I believe most of “Bad News” is already priced in to the stock at the current price.

Buy When Everyone Hates a Stock

When everyone hates a stock can be the best time to buy if the reaction to news is very short term focused and if the company is still strong with good long term prospects and the price is good compared to current earnings, which I believe is the case with Cisco.

However, because of the strong negativity right now, it’s very well possible the price will continue to go lower before recovering.

It may be a good idea to buy in stages if you are concerned about this. This way if you buy a 3rd now and if it goes down more you can buy another 3rd then and if it goes lower still, buy the remaining 3rd.

If it goes up at least you got some when the price was cheap.

I wouldn’t expect the price to go too much lower, possibly retouch the 52 week low of $19/share, but who knows how badly the market will overreact.

In the long run, I’m not very worried on this one.