We've all looked at the winners and losers in our portfolios and thought, "woulda coulda shoulda." If I woulda sold that dog sooner .... I shoulda bought more of that rocket when it was cheaper -- then I coulda been a contenda!
Yet if we're ever going to achieve our goal of a million-dollar retirement nest egg, then we must learn something from these woulda-coulda-shoulda moments. What kind of lesson does a lost opportunity teach?
To explore that theme, let's use a company that's been on my radar for a while, fragrance distributor Inter Parfums (NASDAQ:IPAR), home to some well-known nose candy like Burberry Brit for Men, Christian Lacroix, and Diane von Furstenberg, and a competitor to the likes of EsteeLauder (NYSE:EL) and Elizabeth Arden (NASDAQ:RDEN).
Over the past year I've written a few articles warning investors that the company's declining sales growth rate gave off a rancid odor suggesting the stock was overvalued. It was a somewhat prescient call, because its price dropped some 35% in the intervening months. But because I was too focused on the precise price I wanted to pay for it, I missed my chance with Inter Parfums. Since I last wrote about the company in April, the stock price has gone up about 37% and has been up as much as 47% in intraday trading. Wouldacouldashoulda.
So how do we step back and see the wider picture? How do we make sure that we don't miss the next runaway stock?
The lesson of "less is more"
Every month in Motley Fool Hidden Gems, the Fool's small-cap stock newsletter, Tom Gardner shares his Lynch-inspired investment philosophy. Put into practice, Tom's philosophy has guided Hidden Gems to 31% returns, vs. 7% returns by the S&P 500 over the same time period.
One of those lessons -- one that would have helped me avoid missing Inter Parfums -- is the "buy-in-thirds" method of stock acquisition.
Let me explain. If you normally invest $1,500 in a stock, instead divide that money into three neat piles of $500. For your initial investment, use one of the piles to buy as many shares as the $500 will allow. The other portion (two-thirds) is reserved for when your stock goes on sale.
If the stock suddenly runs away from you, and doubles, triples, quadruples -- heck, if it becomes a vaunted Peter Lynch 10-bagger -- you at least have some money riding on it. Had I done that with Inter Parfums, I'd be sitting on some profits instead of watching from the sidelines. Sure, it's not as much as if I'd invested the whole wad at once, but buying in thirds would've limited my downside risk. Most of the time, we're not going to have a stock that rockets away from us without ever touching earth again. That's particularly true of small-cap stocks, which are more volatile. But in risk there is reward.
Look at FormFactor (NASDAQ:FORM), which was recommended in Hidden Gems by, well, me and fellow Fool Tom Engle. We liked the company's innovative Microspring technology and its leadership position in the advanced wafer test probe card market. Though a relatively new public company, its technology has already surpassed larger and older competitors such as Kulicke& Soffa (NASDAQ:KLIC) and Japan Electronic Materials. When we recommended the stock last June at around $21 a share, we believed the company could double in value in three to five years, but shortly after our recommendation, the stock turned south. By the end of August it had fallen to $18 a share, and a month after that is was down to $16, a full 23% off our recommended buy-in price.
In that scenario, the rest of the "buy-in-thirds" strategy comes into play. You choose a percentage below your original buy price -- be it 10%, 15%, or 20% -- and as your stock hits that range, you put another one-third of your investment dollars into it. Should it fall some more, you round out your investment with that final third. This also lowers your total cost.
For example, buying $500 worth of FormFactor at $21, then buying another $500 worth when it fell 10%, would give you a total of 49 shares, but at an average cost of just $20.41. Putting the final one-third into play when the stock was off 20% would've given you another 30 shares, with your average cost per share dropping to just $19. Yet your total $1,500 investment would today be worth $2,054 -- a 37% increase. More important, it would be worth 11% more than if you had used the full $1,500 to make your initial purchase. The "buy-in-thirds" strategy ensures that you don't overpay for a stock and allows you to enjoy extra profits. Had I used that strategy with Inter Parfums, I wouldn't have missed its recent run-up.
A similar strategy would have worked just as well with other Hidden Gems recommendations Portfolio Recovery Associates (NASDAQ:PRAA), a consumer debt-recovery outfit, and FARO Technologies (NASDAQ:FARO), an industrial measuring device manufacturer. Their volatile stocks would have given investors an opportunity to buy in increments at several different times. The original recommendations are up some 55% and 133%, respectively, beating the paltry gains of the market over the same time frame.
Volatility is your friend
Volatility can make investors anxious, but the "buy-in-thirds" strategy uses volatility to your advantage. You know small caps are going to have some wild rides, and by keeping some powder dry, you're ready to jump in and scoop up shares as they go on sale.
It's a simple four-step process:
- Decide the total amount you want to put into each stock.
- Divide that amount into equal thirds.
- Determine the percentage declines from your initial buy-in price that will fill in your investment.
- Sit back, wait, and enjoy the profits.
All you need to do now is find a company worth your investment dollars. If you don't have time to spot good investments on your own, put Tom Gardner and the Hidden Gems team to work for you with a 30-day free trial. Tom and his analysts thoroughly research each company recommended and put them through their paces with more than 70 criteria for consideration. Click here to learn more.
There's now no more reason to ever say "woulda coulda shoulda." Now you can be a contenda!
Fool contributor Rich Duprey owns shares in FormFactor but no other stocks mentioned in this article. The Fool has a d isclosure policy.
