It's always fascinating to read stories about average, everyday people who built fortunes by regularly investing small amounts over long periods of time in companies such as Home Depot (NYSE:HD), Caterpillar (NYSE:CAT), and McDonald's.
If you worked for these companies, and/or regularly "trickled" money into them over the years, this is quite feasible -- Home Depot, Caterpillar, and McDonald's have returned roughly 16%, 8.3%, and 12.3% annually over the past two decades or so, respectively -- even after taking into account the significant losses Home Depot and Caterpillar have experienced in the past few years.
But you can also get market-beating returns by buying into great companies at more opportune times -- whenever the stock goes on sale. Rather than regularly investing small, fixed amounts, investors can use the simple method of buying a stock in portions to manage risk and boost returns. And now would definitely count as one of those opportune times to buy cheap stocks.
First, find a solid business
Of course, every situation is different, but big returns on investments always come on the backs of fundamentally strong businesses. And if you're confident that you've purchased shares in a great company, why wouldn't you consider buying again, particularly if the stock price is significantly below intrinsic value? Especially in pessimistic markets (like today's), fundamentally strong businesses can be bought for good prices -- or even downright outrageously cheap.
For large, stable companies, buying more shares when the outlook for them is bleak can be especially rewarding. For instance, buying more British American Tobacco back when investors' pessimism over tobacco lawsuits was at its peak would have juiced your returns considerably -- the stock has returned more than 905% from its low in 2000.
In a more recent example, stock in wireless technology giant Qualcomm (NASDAQ:QCOM) traded flat for nearly two years as major legal disputes with Nokia (NYSE:NOK) weighed on shares despite continued, fundamental growth at the company. Once the dispute was settled, Qualcomm's stock jumped more than 25% as the pessimism melted away.
For younger, riskier companies, a strategy of acquiring shares in portions is a smart play. It limits your initial outlay and reduces your exposure to significant drops should the company falter or broader economic conditions change.
For example, look at top retailer Best Buy. The company's stock soared several hundred percent in the late 1990s, only to be whacked more than 60% from the market's peak in March 2000 until the end of that year. While most investors were licking their wounds and kicking themselves for not selling sooner, sharp investors who saw long-term value and competitive advantages in Best Buy were taking advantage of the pessimism.
Buying more shares of Best Buy near its lows at the end of 2000 would have earned you 195% on that new money. That's an impressive gain, especially considering the nearly 40% haircut Best Buy shares have experienced in the past six months.
Buy again
Other companies, such as Garmin (NASDAQ:GRMN), j2 Global (NASDAQ:JCOM), and Intuitive Surgical (NASDAQ:ISRG), have experienced big drops in share price at some point, only to come roaring back. Investors who focused on the underlying businesses, rather than the stock prices, were more likely to turn the event into an opportunity.
The final caveat with this method is to ensure that you aren't throwing good money at a truly deteriorating company -- hence the importance of understanding the underlying business. In their Motley Fool Stock Advisor service, David and Tom Gardner track all of their investments and re-recommend promising companies when the price is right.
If you'd like to see which stocks they recommend you buy again -- and again and again -- you can click here and get a 30-day trial of the service for free.
This article was originally published Feb. 12, 2007. It has been updated.
Fool contributor Dave Mock buys pogs again and again -- more for sentimental than intrinsic value. He owns shares of Qualcomm and Garmin. Garmin is a Motley Fool Global Gains selection. Nokia, Best Buy, and Home Depot are Inside Value recommendations. Intuitive Surgical is a Rule Breakers selection. Best Buy is a Stock Advisor recommendation, and the Fool owns shares of Best Buy. The Motley Fool's disclosure policy keeps a shopping list handy.
