Take a trip to any mall these days, and you'll see gigantic signs advertising sales and deep discounts. In fact, some of the discounts are so generous that you could conceivably walk out with twice as many clothes for the same amount of money you spent just a few years ago. In other words, you're getting more bang for your buck.
The same phenomenon has been a pleasant side effect of this most unpleasant market (the S&P is still nearly 25% below its record high in July 2007) -- you can buy more shares than you could before. (Unfortunately, there are no advertisements guiding you to the big stock sales.)
In a July 2008 shareholder letter, Bill Miller recalled a conversation with Warren Buffett in which the Oracle of Omaha "then made the perfectly sensible point that as we are all net savers, we should be happy if stock prices declined a lot more, so we could buy even better bargains."
Be a net saver
If your existing holdings are deep in the red, you can take solace in the fact that you're not alone. Many respected professional money managers are down over the past three years -- Miller, Bill Nygren, Ron Muhlenkamp, et al. But these investors know that it's not time to pack it in. It's time to, as Miller recently noted, "Go back to thinking long term" and seize on today's great market opportunities.
That sounds good in theory, but the application is trickier. For instance, what stock would you buy today with, say an annual IRA contribution of $5,000?
I'm guessing most investors wouldn't know how to answer that. That's why it's critically important that you always keep (and constantly maintain) a watch list of potential investments.
After all, finding great businesses is hard enough. Finding a great business simultaneously with a good price is downright improbable. So do the research up front to find the businesses you'd want to own, and keep a list of buy-around prices so that you're locked, loaded, and ready to go when the right price presents itself.
All we need is just a little patience
Those opportunities may take a long time to come about. For example, our Motley Fool Million Dollar Portfolio team of analysts had been watching Costco Wholesale since the service began in 2007. Yet with Costco shares trading at $60 to $70 over the next year or so, it was simply too much to pay for the stock, despite Costco's strong balance sheet and obvious competitive advantages.
Fast-forward to March 2009. Near the very bottom of the market and after two years of patiently waiting for the right price, the team was able to start a position in Costco at $45.60, about 38% cheaper than its May 2008 high near $73. Might that 38% savings make a huge difference? You bet.
Consider the difference in performance:
If Costco Goes to $80 ...
If Costco Goes to $40 ...
|Purchase at $73||9.6% gain||45.2% loss|
|Purchase at $45||77.8% gain||11.1% loss|
As you can see, buying at the lower price not only magnifies any upside, but it also reduces downside risk. Value investors will be quick to note that this is a classic example of buying a stock with a wider margin of safety.
Aim small, miss small
Having a watch list of five to 10 great companies you'd love to own, paired with buy-around prices, will make you a much more prepared investor -- and that preparation will most likely improve your returns. If you haven't yet constructed a list, or if you just need some new ideas, start today. To get you started, here are seven S&P 500 constituents with a return on equity over 15% and a price-to-free cash flow ratio under 15:
Return on Equity
Price-to-Free Cash Flow
|Hewlett-Packard (NYSE: HPQ )||21%||11.7|
|Cisco Systems (Nasdaq: CSCO )||19%||14.1|
|Wal-Mart (NYSE: WMT )||23%||13.9|
|Target (NYSE: TGT )||18%||9.8|
|Medtronic (NYSE: MDT )||25%||10.1|
|Corning (NYSE: GLW )||20%||8.5|
|United Technologies (NYSE: UTX )||21%||14.2|
Data provided by Capital IQ, a division of Standard & Poor's, as of Nov. 3.
Although not all of these stocks are necessarily deep values at this point, they're definitely worth adding to your watch list.
Always be prepared
Fortunately, the market goes on sale from time to time, and those are the moments that provide us the chance to buy proven businesses and hold them for the long run. Keeping a watch list and some spare cash allows you to pull the trigger on these rare opportunities when they arise.
If you're looking for some thoroughly vetted stock ideas or a support community to help make you a more prepared investor, consider joining our Million Dollar Portfolio service. You'll get an all-access pass to follow the team's decisions on how to allocate the Fool's own money in recommendations from the Fool's other premium services. Just enter your email in the box below to get started.
This article was originally published on Aug. 6, 2008. It has been updated.