I played state level squash for a while. You’ll see what this has to do with the share market in a second.
The game plan in squash is to control the centre of the court. A key strategy for that is to volley the ball as much as you can so it doesn’t go behind you.
Your opponent is always trying to drag you away to the corners.
I still remember the words of my old coach: ‘Volley the ball…until the one you don’t.’
What he meant was that while that strategy would work most of the time, it wouldn’t work 100% of the time.
You had to recognise the occasional difficult ball and let it go to the back of the court.
The same is true in stocks…
You see, the recent selloff in the stock market is a gift if you’re looking to add a certain share to your portfolio for the long term.
Take Alibaba [NYSE:BABA] for example. Think of it as the Amazon of China.
Arguably there is no better play on capturing the rise of the Chinese middle class — not to mention all of Southeast Asia — over the next 10 years.
In 2018, Alibaba went over US$210. It fell to as low as US$129 recently. That’s despite the fact that it’s still posting high revenue growth — bigger than Amazon’s.
My read, as of now, is that this is a market-driven selldown, more than a signal of long-term trouble for this specific business.
Now, I can’t tell you with any great confidence what China is going to do this year.
But I’m pretty sure its middle class is going to be a whole lot bigger in 2029 than it is now.
It’s a reasonable proposition to pick up some stock in BABA now if you’re prepared to hold for a long time.
On a shorter timescale, a reprieve in the trade war will repair sentiment towards China and Chinese stocks.
BABA could bounce off that alone. Another data point in support of BABA is that its ‘Singles Day’ last year smashed the previous record.
This strategy is known as buying the dip — and can be a very effective strategy long term, if you get it right.
But there’s a danger here, too. Some people refer to it as ‘catching a falling knife’.
Like my old squash coach advised, there are ones you just have to let go by.
For example, some Aussie stock buyers just got cut…
Cheap stocks — getting cheaper
Tamawood [ASX:TWD] is an Aussie homebuilder.
In November last year, it warned that its first half result would be down 15% on the previous 12 months.
The stock was around $4.50 at the time. It took a dip shortly after to $3.65.
Now here’s a case where you might be tempted to pick up some stock ‘on the cheap’.
Tamawood even rallied for a time after its big fall and appeared to be holding steady.
But experience has taught me to be very careful buying after a company downgrades its earnings.
Investors usually hate that. It can kill sentiment around the company for a long time.
You also need a damn good reason as to why its results could turn around so quickly.
In the case of Tamawood, the slowdown in Australian property is not over yet.
Yesterday it downgraded its earnings again. It lost 6% in yesterday’s trade.
None of this is a criticism of Tamawood. It’s simply operating in a tough market right now. The property cycle will turn upwards again — at some point.
The point of today’s Profit Watch is merely to observe the danger in buying a dip that’s riding a stock further down.
I’ve seen this elsewhere with property-related stocks…
An 85% wipeout here
Here’s another example. Real estate agency McGrath Limited [ASX:MEA] began life on the market in 2015 at a rich valuation of $2 a share.
The property slowdown caused it to issue multiple warnings and downgrades.
It now trades for under 30 cents.
Again, it’s a victim of a tough market.
One line of defence against catching a falling knife is to make a distinction between a selloff in the wider stock market to ones related to problems in the industry the company operates in. Sometimes it’s both!
BABA relates more to the former here, and Tamawood to the latter.
Now, I happen to think Australian property will return to the heady days of 2015 at some point. That means related stocks like Tamawood and McGrath could become very compelling buys down the road.
But I need some more compelling evidence to get in now.
You can spend a long time waiting for something to happen in the stock market. That can be difficult when you see other stocks moving elsewhere.
It’s okay to buy the dip at times. But a stock needs to be more than ‘cheap’.
As we can see from Tamawood and McGrath, sometimes there’s no stopping a stock getting even ‘cheaper’ again.