Buy Low, Sell High Illusion
While this may not pertain totally to this thread, I believe the information will help you in your investments, and your evaluation of AOL for the long-term.
This is one of the oldest pieces of investment advice on record. It sounds so basic that one could hardly argue with it. The real question is, however: Will it help you improve your investment results? The answer is, probably not. Following this advice keeps you in the wrong stocks most of the time. The reason is quite simple. Good stocks are almost never really cheap compared to the other stocks at any given time. Of course, in bear markets, most stocks are bargains, but good stocks will be relatively more expensive. You generally have to pay more for quality. If you look for price only, you will inevitably wind up with less quality. This actually applies to almost everything.
Most sophisticated investors are also aware of the fact that if you bought every new high and sold it three months later, you would make a lot more money than if you did the opposite, buying every new low and selling it three month later.
The explanation is obvious. The reason a stock makes a new high is the perception of many investors that the stock is a good investment that will go higher. Conversely, the reason a stock makes a new low is the perception of many investors that the stock is a bad investment that will go lower. In spite of this, many investors are looking for stocks that are making new lows to pick from.
There is another school on Wall Street that adheres to another Wall Street adage: buy high, sell higher. In my opinion this makes more sense for many reasons, both fundamental and technical. If you search for your buy candidates among new highs, you will invariably stumble onto companies that have exciting fundamentals, turnarounds, new management's, new products and new markets.
Technically, a new high implies no unhappy stockholders are ready to sell, since they all have a profit in the stock. There is no overhead supply waiting to get out of the stock, which would keep pressure on the price.
Just think of the opposite, a new low, where almost everybody has a loss (except for the shorts) and is thinking about cutting it by selling the stock. The long term holders, who may still have a marginal profit, wonder whether they should protect what profit they have left by doing what everyone tells them to do, which is, "sell the stocks that are going down".
In his excellent book, How to Make Money in Stocks William J. O'Neil, the founder of Investors Business Daily and a legendary investor himself, tells how he came upon the strategy of buying new highs. (By the way, I highly recommend his book. I believe it is the best book you can find on the subject). O'Neil states that he witnessed hundreds of institutions, over a quarter of a century, which concentrate on the so-called undervalued theory of stock selection underperforming the better money managers.
In 1960, O'Neil did an in-depth study of the three best performing mutual funds for the previous two years. The Dreyfus Fund was the performance leader, beating its competitors in some cases by more than 100%. After looking at over 100 new stocks in the then tiny portfolio over the previous couple of years, he made a stunning discovery.
"Every single new stock was purchased at the highest price the stock had sold for in the past year. In other words, if a stock bounced from $40 to $50 for many months, Dreyfus bought as soon as it made a new high in price and traded between $50 and $51. The stocks also formed certain recognizable chart patterns before they went into new high ground."
How to Make Money on Stocks
As incredible as it seems, you can improve your investment success by substituting, "buy high, sell higher" for "buy low, sell high". The biggest problem you have in implementing this rule is psychological.
On May 1, 1990, I finally bit the bullet and bought Microsoft at 27 times earnings for $57.25. A year later, Microsoft was up about 100% in a market where the Dow stayed flat. The stock also split. If I had the guts to pay the multiple when I started the HCTR Portfolios, I could have purchased Microsoft for about $10 adjusted for splits. My problem was psychological; I was not willing to pay 25 times earnings at the time. I had little excuse for not buying it, since I had no question about Microsoft's potential.
How dumb can you get?!
The caveat here is, of course, if you buy a stock at a new high you have to know what you are doing. The new high puts the stock technically into the right position for a move up. Now you have to make sure that the fundamentals justify your investment. Some new highs are near the end of a trend. It is usually easy to identify those overvaluations. Nothing grows to the sky. You must be careful though, if a stock has had a high multiple for the last five years and its earnings are growing fast, you can assume that the stock will have a high multiple in the next few years.
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