Buy Low And Then Buy Higher

Ian Cassel Blog, Educational 33 Comments

How many times have you looked back at past investment decisions and thought, “What the heck was I thinking?!”. Don’t worry, that happens to everyone, even the professionals. Early on I started keeping an investment diary to track my thought processes and experiences on every investment I’ve owned.

You can’t become a great investor overnight because its most important lessons can’t be taught, they have to be experienced

When I read through the diary I see commonalities amongst the winners and losers. The types of companies, management teams, share structures, etc. However one of the most glaring things that correlated to performance was how I bought my positions. All my winners had one thing in common, I was always averaging up. Most of my losers had one thing in common, I was always averaging down.

My buying strategy has evolved over the years. Early on I would pile into positions too quickly after naively believing what management would tell me. Overtime I realized giving up a small amount of upside to de-risk the investment was well worth it. I normally buy my positions in thirds as my conviction grows. If something doesn’t check out along the way I’m not stuck in a huge position.

I buy my first third after extensive due diligence and after talking to management. I dig through all the filings, industry journals, place some calls into customers, suppliers etc. Think of this as passing the smell test. I’m also making sure I have ample margin of safety.

Margin of safety = if your investment thesis is completely wrong you will still make money

I buy my second third after traveling and meeting management at their head quarters. I want to see what their offices look like, the interaction between management. Is it a dictatorship or a democracy at the management level? Can I find an employee who hasn’t been told “to be nice to me” and ask them questions? Does the company do the little things well? Do they pay attention to detail? What do they drive? What are their motivations? etc.

I buy my last third after the management team does 25% of what they say. The majority of microcaps over promise and under deliver. You make money on the ones that under promise and over deliver. It takes time to make sure you are betting on the right jockey. They need to prove this to you by executing, so buying this last third might not happen for months. With most of my winners, I bought this final third 100%+ higher than my first third.

My personal investment philosophy is to buy microcaps that I think can be 5-10x in a few years. It might sound insane, but I don’t buy stocks where the peak potential return is less than 100%. I’m trying to find and buy undervalued companies that have the potential to get very overvalued. That is my margin of safety. If I’m initially buying a $0.50 per share stock, I’m likely buying it because I think it can be a $5.00 stock in a few years. So who cares if I’m buying my last third at $1.10 after the investment has been greatly de-risked by management execution. Even after these small microcaps double, lets say from $10 million market cap to $20 million, they are still very under followed and not even on institutional radars. In all my big winners, I was constantly averaging up.

We’ve all heard investors say in a boastful tone, “XYZ stock is down again today, thank you very much Mr. Market for a great buying opportunity!”

We’ve all been there, so we all know they are full of SH!T. Averaging down never feels good. There are some instances when averaging down makes sense, but constantly averaging down never makes sense.

This one lesson of constantly averaging down was taught to me very early, in a rather extreme way. When I turned 18 years of age I took control of my college savings and decided to invest it. This was 1999-2000, the peak of the Dot Com bubble. A broker convinced me the next big thing was a recent smallcap tech IPO called Ibasis. I don’t remember the exact prices, but I believe I bought my first shares at $35, bought more at $25, more at $17, more at $10, more at $4, and sold everything close to $1. In a matter of 12 months I lost close to 90% of my college savings that my parents saved for me over 20 years. Luckily I was working full time and I was going to a cheap college, so I could continue to pay my tuition. Over the years that followed I would be taught this lesson over and over again. Investing is a life long education and its teacher is loss.

When you find yourself constantly averaging down it’s normally a sign that your ego has taken over. You’ve convinced yourself you have to be right, but you forget that being broke and right is the same thing as being wrong. Your ego clouds your judgment and slows your thinking. Many investors have gone broke trying to prove the market wrong, and you certainly aren’t going to prove yourself right by throwing good money after bad.

Successful investing isn’t about being right all the time; it’s more about the ability to identify when you are wrong quicker.

Andrew Stanton of Pixar sums this up even better – “Be wrong as fast as you can”.

Investing is tough because you have to constantly anticipate how other peoples thinking is going to change before they know it themselves. This means you have to buy investments early, before the investment is obvious, but there is a thin line between being early and being wrong. If you are constantly buying the stock lower it is likely the latter. If you find and buy great investments, you’ll likely be making subsequent purchases at higher levels. This is something to be proud of.

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Comments 33

  1. Ian,

    Great post ! Your thoughts on averaging up with your winners are spot on. So many times I have convinced myself that the numbers are lying, and tried to “nurse” losers. I would like to add that if you read a companies 10Q or 10K and there are numerous footnotes with options, convertible offerings and warrant disclosures I click the delete button.

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  2. Great post Ian. Good read with coffee on Sunday morning. For me no company is to expensive as long as there is satisfied returns. Therefore entering late in the game or averaging up make sense to me.

    Biggest challenge is to find good start up companies, it’s like finding your great love 😉

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  3. Another great article Ian. It’s a taken me years to refine my strategy and experience has taught us both many of the same lessons.

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  4. Superb article Ian. I’m often impressed by the way your separated blog posts are all connected one to another as if they were one single fabric. Especially this one.

    Keep on writing!

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  5. Thanks Ian

    A great article that we can all relate to. My biggest winners have been when I average
    up, and need to keep that approach in mind. “Don’t get sore, buy more” adage has given me
    the greatest pain. Thanks. again.

  6. Well said…have been doing this and wish to say something…its not the stocks that make money..its the plan of investment into per above I mostly hold stocks where buy price is lower..average. Buy cost…that is my margin of safety…and true it works for stocks where u see it 5-20 times….it a first fundamenta and then technofundamental…it’s about cutting losses and staying with winners.. As I say poor retail investors try to book profits.. And smart try to cut losses..and residue is profit

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  7. very nice piece. The details about what info can be gotten by visiting are extremely valuable.

    I like “be wrong as fast as you can”, and what has worked for me when I am wrong is to try to get out as fast as I can. This works most of the time because price is a matter of psychology in terms of what should be the price is based on a frame of reference of recent prices, so if I sell out quickly it generally reaches a support level quickly close to recent pps,from buyers who haven’t yet realized this thing is going down. The crowd will follow quickly with selling because once a micro starts to break down it becomes very clear very quickly.

    One of the things that comes across about your approach is how methodical it is. Not everyone has your discipline, and I find that what works for me is to test how I feel about a stock by buying some. I call it a tracking position, because it teaches me like nothing else how I really feel about that stock. I take losses often doing this, but it usually doesn’t take me long, and sometimes it works very well and at the least helps put into perspective what I like about the stock I am sticking with. Livermore called it sending out patrols and it is useful not only in exploring a position but in trading around it.

    For me the story is the thing, am I interested in the business and the mgt. enough to follow it closely. With young companies the story can change frequently and I’ll go up and down in my position depending on how the story is playing out. I don’t mind losses along the way if at the end of the day I am confident in the story, and at that point averaging up is how I can make money.

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  8. Great article. Averaging down has probably hurt more than help me. The mental anguish alone almost makes avg down not worth it. Turnarounds are pretty sweet though.

  9. Excellent article Ian thanks. Like usual I find myself offering views that may seem contradictory, even though I am in basic agreement. Yes, put money into success and take money out of failure, and as investors we will all encounter lots of both. Our ability to limit losses and let winners run is what they pay us for.

    Stocks go up and down for basically three reasons (1) the ability (or lack thereof) of a company to create wealth for its owners, (2) the general direction of the market — even the share prices of good companies go down in a down market, and the shares of lousy companies go up in good markets, and (2) random noise — a big holder needs (or wants) to sell for unrelated personal reasons, adverse short term developments (companies are run by humans who make mistakes, encounter obstacles, make long term investments that require major investment in the short term and show no results for a period of years, and that applies to good managements and bad), misunderstanding (the whole sector is out of favor and the subject company is believed to be susceptible to same forces) or misunderstanding or poor analysis. One doesn’t have to look far to see smart people doing stupid things (Vietnam, Iraq–as write this in the background I’m listening to NPR broadcast a story about Fukushima–a facility designed by nuclear physicists).

    All kinds of ebbs and flows are constantly going on that affect short term pricing. In the long term, stocks tend to reflect their ability to create value for their owners. In the short term, good stocks go down and bad stocks go up. And that’s what makes what we do interesting.

    Right now the market seems to be making three assumptions (1) interest rates will remain low so high P/E ratios are justified, and (2) business conditions are buoyant enough that substandard credits should not command risk premiums, and (2) in the event of adverse developments in the banking system and credit markets, the Fed will again bail us all out–the risk of collapse, of depression, is therefore zero. Extrapolating recent trends into the indefinite future is a human tendency.

    History, however, a study of history, would lead the dispassionate observer to be cautious when the market is at all time highs, and bold after precipitous declines.

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      Thanks Rod. There really are so many ebbs and flows as you say. I was looking at a stock today that’s been at a $100m market cap fully on the back of this bull market we are in. In a neutral or bearish market when the “tide goes out” it would be hard pressed to even be in business. As you said, it’s also what makes the markets so fascinating.

      It’s important to be cognizant of the market conditions but it can’t divert you from making money. There are two opposing groups that are equally annoying, perma bulls and perma bears. They will each be right at some point but they will be broke and right. When markets get extended to the upside it just means I’m not finding as many good ideas, and I’m fine with that. Maybe you reduce exposure a bit, but that’s more a function of the valuation of the companies you are in too. I find it to be such a “feel” game, and not as quantitative as most people like to make it.

      1. I’ve been early sometimes by years, and sometimes accused of being a perma bull or bear. I started out as a stockbroker in Calgary Alberta in 1980 trying to sell undervalued, deeply depressed US stocks to newly-rich oil tycoons. I remember my fellow stockbrokers thinking I was crazy — everyone in town seemed drunk on oil money. I warned of an imminent collapse of oil stocks, which ended up taking years, but it did happen, and many of those newly rich tycoons went broke and the young stockbrokers who were geniuses disappeared and became bartenders or taxi drivers or something.

        Then, when I got to Wall Street, and oil was trading at $8 a barrel, 80% of I wanted to sell US institutions and corporate acquirers was the stocks and mostly the bonds of distressed US energy companies. I took a beating for years, but when it worked it really worked.

        Now I’m afraid of this market and wonder how much of that is just my personality, and how much justified by the facts. I may be way way early in my concern.

  10. Thanks Ian.

    I did not understand why you would invest the first 1/3 rd prior to meeting management.

    Also, wouldnt it be better to invest the entire amount at the third stage when the risk is minimal?

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  11. This is exactly what I was looking for. this is what suits me. averaging up. But I was always skeptical if this is the right way. Not any more 🙂 thank u. i have always had people saying in TV and magazines who talked about averaging which was always average when it goes down. This article is an eye opener. From now on, I would never average down unless the conviction is too high (which is very seldom).

  12. I find it difficult to agree with the argument made in this post. If I am buying a company which has intrinsic value in the range of 10-15 and the price falls to 5 then I should check if the facts have changed. if not then I should buy more if circumstances and portfolio rules permit. If fundamentals have changed then I should sell. Of course this assumes one has a methodology to estimate “approximate estimate” of intrinsic value range of a stock.
    Now regarding your failed dot com investment…I think the stock was over hyped and over valued…at any price above 0. You could have bought the stock starting at 1 and averaged up all the way to 35 and lost lot of money subsequently. Many of the dot com stocks were not worth any thing… unless you are playing momentum strategy assuming the party will continue for some more time. But then the momentum usually works only for a shorter duration.

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      In my experience when a stock continues to fall and you find yourself averaging down over and over and over again, it’s usually a mistake. Grant it, I’m not a deep value investor.

  13. Thanks, Ian. The post highlight of your experience is buying during the upturn and avoiding buying during the downturn.

    I have been investing in the stock market for more than 17+ years- means I can talk thing of two about my experience. During dot com crash, I vividly remember buying stocks when they were going down. I followed on with the same during 2007/08 crash – buying while the market is doing down.

    Although, I must stress the fact the stocks I was buying were the one that I already owned for few years and I did (do) not start buying immediately when the prices started falling.

    Over the years, I came to a conclusion that if I am betting on right stocks, I can buy them when they are doing down. My best investments are made during that times.

    However, it is completely in contrast to what you have experienced.

    Personally, I never felt my ego coming into play. For me, the margin of safety comes from owning the stocks for many years, and the plummeting price will give me amazing opportunity to buy a great stock at the barging price. Of course, this can easily go out of the window if you are betting on the wrong jockey.

    Have you come across material from fellow value investor that supports your view or otherwise of buying during upturn or you are following what works for you?

    What provide you a confidence that the stocks are on upturn before you start buying?

    Thanks again for wonderful post.

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      Parag, thank you for the thoughtful comment.

      My perspective is based on microcap investing. Grant it, I’m trying to find great companies early, but “Great” isn’t always obvious early. In fact, in most microcap success stories you can really only say the business is “Great” after the stock has gone up 500%. Most microcaps are undercapitalized niche players that are smaller and more volatile than larger companies (small-mid-large cap) that have large enough businesses to weather a storm (bear market). This dynamic itself is why it’s important to have productive paranoia at all times especially when the stock is dropping over extended periods.

      It’s important to make investing decisions based on business performance, not stock performance, and knowing the distinction between external stock market forces driving a stock price lower (buying opportunity) versus business reasons you are not aware of (you should be selling). It’s imperative to know your positions better than most so you can make the distinction quicker than other shareholders.

      Your Q: What provide you a confidence that the stocks are on upturn before you start buying?

      My Answer: I don’t want you to think I care about the chart/technical analysis. I don’t. I’m just making the point that great businesses have great stocks, and if you buy into a great business you will be buying stock higher over time, not lower. I don’t care what the stock is doing when I initially buy. I look for companies that are undervalued that can get overvalued. Great businesses always get overvalued.

      1. I’d just like to add Parag that is sounds as if you have your emotions in check, which is a substantial part of being a good investor. It is definitely something I struggle with, and so I’ve tried to develop a system, in my case mathematical, to keep me out of really BIG doo doo, based on monthly closing prices.

        It works for me, if I follow it. Which is the other problem. But it sounds like you’ve got it together.

        Other than that, I think Ian is right. Stocks go up and down for rational and irrational reasons. The fact that the broad market average is going down when you add to your position probably means that (1) you aren’t paying a premium for a rosy consensus, and (2) on average, the price decline is likely irrational. Ian is buying good companies. He knows they are good and he has a considered opinion of value. So long term it probably doesn’t matter whether he buys lower or higher.

        1. Thanks, Ian, Rod for your response. Although you are explicit about your thoughts and ideas related to MicroCAP, I feel they resonate very well with me, even though I do not follow MicroCAP as such I follow small cap/mid cap. Thank you very much.

          I wish I had my emotions under control when I buy stocks when they are doing down in prices, but ever since I heard Warren Buffet quote “Buy when everybody else is selling…”, I buy stocks with more conviction as I know it works.

        2. Ian/Rod,
          I have come across this snippet from 100 to 1 in the stock market by Thomas Phelps.
          It is not exactly related to averaging up or averaging down but interesting perspective – and wise- from the author.

          (Page 115)
          Shooting where the rabbit was one of the most common investment error. I have said it before and shall say it again, Time after time, year after year, men who should think you were crazy if fired your gun at the spot from which a rabbit jumped a moment before, buy stocks that have advanced and sell stocks that have declined. Even security analysts are not immune to this malady. Too many of them, possibly reflecting the attitude of investors they are supposed to guide, tend to like stocks better the higher they go, and to become increasingly disenchanted with them as the price fall.

          The stock market is almost unique in that the way to attract buyers is to mark up the prices.

          1. To some extent I think that various points of view on buying on weakness versus strength are all valid and all invalid. Perhaps a point of view on the subject is an effort to simplify a complicated subject that doesn’t lend itself well to simplification. There are very successful investors on both sides of the discussion — ie Soros versus Buffett, for instance.

            The current stock price tells us what other investors think a stock is worth. The crucial issue is what do you think its worth, and how well considered is your opinion. If you are right consistently about your opinion of value, and buy when there is a margin of safety, it doesn’t matter what the stock is doing when you buy it, just what it has done between when you buy and sell.

            More importantly, at least in my own investment implementation, is removing emotion and working on logic. It is a constant battle for me. If I have a losing position, I want to hang on but feel more comfortable when I sell it. It is that desire for comfort that is the hole in the bottom of my bucket. I want to hang on to winning positions too, and often have bought something, seen it double and then sold at a subsequent loss. So for me (and not for others who have different inclinations) I’ve found I need a system that is proven to work in general, on average, in a variety of markets, and I use that system to determine buy and sell points before I enter the position, because I know myself well enough to know that when I’m in a position my tendency away from logic and toward emotion grows.

            For instance, yesterday I took this position:

            Bought DUST at $21.36
            End of day price at which I will sell to prevent my losses from spiraling out of control (I don’t use formal stop losses because many of the securities I invest in are very volatile intraday): $20.44

            The price at which I’ll sell at a profit varies based on subsequent price action, but I see a theoretical possible upside of $61.08.

            I set these before I enter the trade based on a formula quite close to the Richard Dennis Turtle formula.

            The only Microcap I own right now is Breeze Eastern (BZC) which I bought in early August at $13, (now $19.58) and while I plan to hold it for years, if it closes below $17.68 today, I’ll sell and reconsider from the sidelines, so these targets move as the stock moves, and I make the determinations after the market is closed, when I’m more rational. In fact I try, mostly unsuccessfully, to not even look at the market until after the close.

            Other investors may not need to protect themselves from themselves as much as I do, and my approach may actually cost them money.

            The crucial issue on all of these questions, to me, is do you know yourself and does your investment approach fit who you are.

  14. Dear Ian,
    Great article, thanks for publishing. For over number of years theory of value investing was confused by many investors including myself as averaging down. I found exact similarity in my winners and losers.
    It was only early this year when one of the stock -PRATIBHA INDUSTRIES taught the lesson which made me differnenciate between value investing and nuturing you Ego. Finally I cut it off the way you did it in collage days.

    I think that was a pretty good price to pay for realization.
    Thanks Ian.

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