Investing Lessons of 2008: Cheap Can Get Cheaper

2008 was a crazy year and nobody knows for sure what 2009 will bring. We’ve spent the past month reflecting on 2008 and making predictions for 2009. Be sure to check out all of our coverage, including more Investing Lessons of 2008.

There's one concept that investors have a particularly hard time wrapping their heads around: the notion that a stock's falling price doesn't necessarily make it cheaper.

You can see that disconnect in action today, as presumably opportunistic market-watchers pick at some of this year's most-battered equities. How can buying a stock at half of last year's price not be a better deal? How can the term averaging down not ensure that you're getting more bang for your buck by adding to an existing position at a cheaper entry point?

If 2008 teaches you anything, as you watch your stocks head lower -- and lower still -- it's that cheap isn't just in the eye of the shareholder. The fundamentals matter, and sometimes your portfolio deserves a good beating.

Moving targets demand careful aim
"Value" is perpetually getting redefined. At several points over the past year, investors figured that enough was enough. They boldly jumped back into hammered financial-services and homebuilder stocks, figuring that those equities' historical lows were too juicy to pass up.

That proved a bad bet -- a moment of lucidity that was actually closer to stupidity. Brief rallies got snuffed out, and the carnage continued amid even bleaker news in the credit markets. Ridiculously tempting yields cratered as struggling companies slashed their dividends.

If a share price heads lower -- accompanied by things like liquidity concerns, business-model erosion, or shrinking cash flow -- it's actually not getting any cheaper.

When it comes to price cuts, stocks aren't the same as retail goods. Seasonal apparel will hit the clearance racks at the mall when it's no longer in demand, but at least you know those clothes will still be sturdy and comfortable the following year. There's no such guarantee that a stock's lower price will come with a brighter future.

Have a nose for the pros
I don't follow Wall Street prognosticators blindly, and neither should you. However, they do provide a refreshing indicator of perceptive momentum. When analysts are raising estimates on a particular company, they've probably sussed out a winning investment. Optimistic revisions are one of the best ways I know to single out great stocks.

If you buy into that theory, then shouldn't the inverse be true, too? Stocks getting hosed down by analysts have a great chance of performing poorly in the near term. Sadly enough, that's been happening a lot lately. Even many of Wall Street's darlings are staring at lower forward earnings projections than they were just a few months ago.

Source: Yahoo! Finance.

Yes, even companies like Apple and Intuitive Surgical, which have routinely trounced analyst expectations, find Wall Street's finest talking down their near-term prospects. That's why falling stock prices aren't like pennies -- or even penny stocks -- from heaven.

The fall and fall of your portfolio
There are a few silver linings in the carnage. Bottom-line revisions go both ways, and quality companies will bounce back first. Corporations with healthy balance sheets that are trading closer to book value may be compelling purchases, even before the profit projections turn higher.

However, the ultimate lesson is that you can't just buy a stock and assume that anything below your cost basis is a bargain. Fundamentals can fade. Models can falter. And what appears cheap today may be sorely expensive in retrospect.