- Perceived ‘discounts’ obtained by waiting for a stock’s price to drop are often less than anticipated due to missed dividends
- Is the discount obtained from waiting for a stock to drop worth the risk of not owning it at all?
- This article will show how waiting just 3 quarters for a 5.5% discount erodes the real discount by 2.2%
- Investors waiting for a price to drop are fighting against time and the market.
“The market is overvalued”
“A correction is looming”
“We’re going into recession”
These are some phrases I’ve become used to reading, especially over the past few months.
Some ‘investors’ it would seem, are putting of buying shares due to their perceived valuation of the market.
But investors should always remember that;
“Time in the market beats timing the market”
Why you shouldn’t try time that market
When I first started investing, I went at it – trying to time the market and shares.
I would insist, for example, that I would only buy a stock, let’s say ‘stock x’ if it dropped from £1 to 90p (a 10% discount).
But what I soon realised is that most shares wouldn’t drop, and the market correction that I was predicting along with many analysts just wasn’t happening.
In fact, market corrections have been predicted for over two years now.
We’re still waiting.
If it’s undervalued buy it – even ‘if it has further to drop’.
Let’s take a real life example.
A friend of mine really wanted to buy some shares in Kraft Heinz in January last year. The shares, having just come back from a price below $70 looked attractive, but he told me that he’d wait until the shares dipped below $70 again before buying in.
That never happened and now the shares sit at close to $90.
A great company with an attractive yield missed, simply for a few $.
A current example is Flower Foods which currently sits at just above $15. At this price, the stock has a dividend yield of 4.2% and is trading at low p/e multiples compared to its history.
Yes, the company currently has a few issues but I was amazed to see investors saying they are “waiting for the price to drop further”.
Some speculators have noted a current legal issue facing the company and the way it employs its drivers as a factor for further price reductions.
This is a dangerous strategy which ignores the fact that the shares are currently overvalued. There’s a very simple message for these investors;
Let’s take a look at how much is saved by waiting for a mear 5% drop in the price of a stock.
Flower foods at $15.71 vs Flower foods at $14.85
Let’s say an investor will only buy Flower Foods below $15. I bought in at $15.71, therefore if the investor manages to predict the market (against the odds it would seem) and buy in at $14.85 then he/she has achieved a 5.5% right?
Here’s why that number is in fact only 3.3%
Point one shows the shares at $23.50. At this price, I would not have considered purchasing the shares, deeming them to be too expensive.
At $15.71 on February 12th , the share’s are looking undervalued and I decide to pull the trigger and buy. (Let’s say 100 share to keep the maths simple).
Scenario 1 Buying in February ($15.71 a share)
In March I receive a dividend of $0.145 per share.
March income = $0.145 x 100 = $14.50
I reinvest the dividends on the 18th of March (payment date) to purchase 0.77 share’s of Flower foods.
In June I receive a dividend of $0.16 per share.
June income = 0.16 x 100.77 = $16.12
I reinvest the dividends on the 23rd of June to purchase 0.9 shares of Flower foods.
In September I received a dividend of $0.16 per share.
September income = 0.16 x 101.67 = $16.27
I reinvest the dividends on the 8th of September (for illustrative purposes as dividend is paid on the 9th) to purchase 1.07 shares of Flower Foods.
I now have 102.74 share’s of flower foods for my initial $1,571 investment.
Scenario 2 – Buying in August ($14.95 a share)
On August 11th share’s drop below $14.95 so investors who waited for the shares to drop below $15 buy.
They buy 100 shares for $1,495.
The investor receives the September dividend of $0.16
September income = $0.16 x 100 = $16
The investor reinvests the dividends to purchase 1.05 shares of flower foods.
The investor now has 101.05 shares of flower foods for their $1,495 investment.
Cost per share;
Me: 1,571/102.74 = $15.29 a share
Investor 1: 1495/101.05 = $14.79 a share
3.3% saving in favour of ‘investor 1’
So, it appears that taking the risk of the share price increasing has saved investor one a mere 3.3%,
But, extend this over a few more quarters and the margin of discount decreases.
Here was an example of three quarters of dividends, what if the wait was over 6 quarters.
The lesson is simple, the longer the time period, the more the cost of not investing is.
I like to be sure, so why not lock in that undervalued dividend paying stock and get your money to work!
This time investor 1 got lucky. But will Flower foods drop below $13.50 or $10. Who knows? Frankly, I don’t want to wait to find out.
The longer one waits before buying a dividend stock, the more the cost of not investing becomes.
The above example begs the question, Is waiting for the price to drop really worth risking a guaranteed purchase of an undervalued company?
Isn’t it better to lock in a deal and put my capital to work with a 4.2% yield as opposed to the close to 0% I’d get in the bank at current interest rates?