Cheap isn't good enough
There are fewer feelings more agonizing than looking back at a stock and seeing that it has risen 100% since you pegged it as overpriced and refused to buy. That's doubly true if you spent your dough on some "screaming bargain" instead, only to watch it get cheaper and cheaper.
Today, we're going to talk about indulging the dark side. But excuses first: In theory, I'm a proponent of buying stuff only when it looks cheap. So cheap, you can smell it. You can see the footprints on it from where the Street trampled it during the rush for the exits.
In practice, I'm a bad, lustful lout. I realize that if I invest this way all the time, I will most likely miss out on some of the market's biggest success stories. Companies like Toyota (NYSE:TM) and Intel (NASDAQ:INTC) have never really looked cheap, but both have beaten the market soundly over the past decade.
Of course, buying cheap is always the best bet. Studies show that you'll do better buying stocks at low P/E ratios and low price-to-book ratios, so long as you have the guts to hang on to them for years.
More than money
But let's be honest: Managing your investments is about more than budgeting your bucks. It's also about keeping a grip on your psyche. A seven-digit brokerage account balance isn't worth much if you've got ulcers and you spend your nights staring at the ceiling. Just as a risky investment is no good if it keeps you up until the wee hours, so an entirely "safe" portfolio isn't worthwhile if it keeps you hankering for more.
Maybe you're not as obsessive as I am, but I can't help wondering "what if?" and worrying about whether I'm using too tight a screen from time to time. The trick is finding a way to reconcile the risk-averse, cheapskate half with that part of you that hankers for the spicier meatball.
Scratching that itch
Here's my cure: the palliative position. (From here on out, let's call it the PP, because it sounds naughty.) No, I haven't gone all holistic medicine on you. Webstur's Dictionary defines Palliative as "an overtly snooty word that sounds good next to the word position and really just means 'relieving of symptoms, especially pain, but not a cure.'"
And that's pretty much what the PP is all about. It won't change the fact that you might have paid more than you wanted for a company, but it does get you a front-row seat, so that if things keep on keeping on, you will feel like you're part of the action.
3 simple rules for paying too much
While I'm willing to shell out for the top-shelf goods from time to time, I won't buy just anything this way. The only reason you're paying up is that you believe that what looks expensive to you now will, with hindsight, someday prove to have been cheap. But that is not going to happen with just any company. Here are a few ways to get the most for your dollar.
1. Buy the best in show: Don't bother overpaying for second-tier goods. You don't pay Porsche prices for a Pontiac Firebird. If you must overpay, do it only for businesses that have clear leads on their competitors, businesses that set the standard in their industry and sector. If you're talking about electronics retailers, that would mean Best Buy (NYSE:BBY), not CircuitCity (NYSE:CC). Computer guts? You'd have to take Intel over AMD (NYSE:AMD). Cutting-edge movie fun? The top dog is clearly Pixar (NASDAQ:PIXR), not DreamWorks Animation (NYSE:DWA).
2. The only problem is the price: Slackening revenues, dwindling margins, management scandals? This stuff demands a discount. Remember, lots of investors with amazing track records simply say we should never pay full price. Never! So, if we're going to break that rule and pony up the premium, we should shell out only if there's nothing going wrong. Don't buy bruised bananas here.
3. Keep it small: There's no reason to break the bank when you know you're not getting a bargain. I like to keep the PP to a one-third or one-fourth position, as measured by my usual standards. I've broken this rule in the past and have endured some sorry, red returns as a result. Remember, you can always get more if it gets cheaper.
Foolish bottom line
The PP is not just a way to ease your mind. It's also a way to expand your horizons and stay better informed. If you have a little money on the line, you're much more likely to pay closer attention to a business. That, in turn, will give you an edge for knowing whether "too expensive" will someday turn out to have been cheap. It will also keep you in touch with the real buying opportunities that eventually happen to even the best of companies.
For related Foolishness:
- Another investing tip: Find relentless growers.
- The feel-good portfolio. How about the anti-portfolio?
- To get the best ideas, sometimes it pays to be agnostic.
If you're looking for investment ideas unfettered by overly strict rules, take a free trial of Motley Fool Stock Advisor . You get market-beating new ideas, plus a look at past picks, including some of the premier properties mentioned above: Pixar, Best Buy, and DreamWorks.
Seth Jayson has many coping techniques all aimed at keeping the hot side hot and the cool side cool. At the time of publication, he had shares of Pixar but no position in any other company mentioned. View his stock holdings and Fool profile here. Fool rules are here.
