Trading with Focus – When to buy the dip

Poor Bobby Axelrod.

Actually, it’s too soon for spoilers. Let’s just say that he’ll be ok, and that a multi-billionaire’s version of a wipeout still ends with them having billions. So, I’ll redirect…

Poor Mark Zuckerberg.

As the CEO and sort-of founder of Facebook, The Zuck has a lot on his plate. Fresh on the back of allegations by a ‘whistleblower’ that Facebook’s management were aware of the damage that Facebook does to people’s self-worth, and that it is used to spread lies, now he’s suffered the tech entrepreneur’s worst nightmare. An outage.

I don’t know what’s worse – asking them to censor the internet, or that there had to be a ‘whistleblower’ to tell Congress that people are mean (but also largely stupid) on the internet. But, by far, my favourite part of all of this, as a share trader, is when the headlines say “Mark Zuckerberg lost $7 billion dollars in one day”.

We have tech outages from time to time, everyone does – its tech! So I sure hope that one day someone writes a headline about how I lost a few lazy tres-commas. But for the Zuckenstein, the Zuckosaurus, the Zuckmeister – it’s also not really true.

Here are some alternative headlines:

“Mark Zuckerberg is still worth at least 50% more than he was before Covid hit, after a slight dip.”

“Zuckerberg’s Facebook shares worth about the same as they were 4 months ago after coming off a bit recently.”

“Mark Zuckerberg’s biggest shareholding now on PE of 24x, down from just over 28x a couple of months ago, but he didn’t really lose any money as he never bought them, and he certainly didn’t sell any.”

But it is interesting to consider the dip. It’s always interesting to consider the dip! Surely that’s what share trading and investing is all about, finding a good entry price. And chasing stocks at All Time Highs means you are paying for momentum, not value.

It can also mean you’re getting in at what could be the top of the mountain, not the bottom, and I’m usually a lot more worried at the top of a mountain – than the bottom.

I’m often a dip buyer. I won’t buy Facebook though, but generally speaking I do love a good sell-off. If all I had done over the last 20 years was wait for the roughly once-annual market correction, and only bought high quality companies for a recovery trade, then sold out…and waited again…not only would I have had a lot more money but a lot less stress worrying about the next sell-off…

It’s the selling that’s often hardest, especially in a bullmarket.

All of a sudden you’re holding something where all the stars are aligning. Management can’t put a step wrong. They are being interviewed by every outlet as if the newest celebrity, espousing the long-term growth story, how profits will keep growing, showing off their latest trophy property, doing the lifestyle photoshoot. The stock keeps growing and growing and now you’re too afraid to sell! The retail army is speaking as one voice, cheering the continuation of wealth for all.

Then, inevitably, something ‘less than fantastic’ happens and the stock pulls back a bit. Unbroken strings of good luck will only happen consistently to a lucky few, and no stock goes up for ever as it rides the market and economic waves. Then the instos dump it, the short sellers attack, the retail army finally capitulates and sells near the bottom…

I would never buy Facebook shares, but its more of a social view for me than an investment view. And I don’t really understand its long term business model, and I think it’s a product in decline. But I have been consistently wrong about it for a long time. So, make no mistake, this is not advice one way or the other.

There will be a lot of stocks dipping right now. Gold stocks came off hard on the back of the gold price. Iron ore stocks came off hard on the back of iron ore. Meme stocks came off on the back of…reality. But some stocks keep on dipping and some rebound.

Let’s start with ‘value’. What is a company worth? We know the share price is just what you pay, but there is no line on the chart that shows you what a company is worth. That would be very handy.

Price to earnings – the simplest view. How much money are you going to make from the profits of that business.

This is a simple, but also quite flawed, comparative metric. We feed in live market data from both IRESS and Refinitiv, and to create a price-to-earnings number they just take the last 12 months of profit and divide it by the share price, which we display in the ‘Fundamentals’ section of the platform.

A negative PE means the company lost money last year, and sometimes that’s an accounting issue, or a one-off loss. But, broadly speaking a negative PE probably denotes a much more speculative company as you are punting that they will turn it around one day. Afterpay aint a Wesfarmers just yet.

The PE number by itself isn’t enough. You have to compare it to other similar companies with similar growth rates, with its historical PE’s and also take into account the outlook of the company in the next few years.

And the general market conditions will also move PE’s, as more speculation, more retail investors, cheap money and all the other pumpy things that have been happening will lift all valuations of all things – because as they say, a rising tide lifts all ships.

And if the whole tide goes out, then they all drop too, regardless of quality.

Fortescue is currently quoting a 3x PE, meaning if they continued to make as much money as they did in the last 12 months it would only take 3 years to pay off the share price. But the market is not convinced that they will maintain that profit, as the iron ore price has taken a beating and costs have gone up.

So always remember that a normal PE is backwards looking on the ‘earnings’ part and investors hate uncertainty – so a lot of traders have a strategy to get out, then reenter when the outlook firms.

By comparison Commbank is on 21x, meaning 21 years to pay off each share, but ANZ is only on 16x even though it’s a very similar business. Maybe CBA is growing faster, or maybe people just like CBA more (and always have). But poor old Fortescue is struggling to hold the bottom of the recent sell off and its only on 3, yet RIO is on 6.

So then what is a fair PE?

Theoretically, a stable company with stable earnings should have a lower PE when compared to one ‘on the grow’, as the amount of money you make from a growing company should be more over the longer term. Makes sense to pay more for a growing income stream than a flat income stream.

But also remember that a ‘growth’ company can be a higher risk – by definition – as the risk of disappointment is higher (aka growing pains). The PE is usually higher as people will pay more for that growth. If things go bad, that also means there’s more to fall from the higher PE of a growth company to a lower PE of a less-growth company, as well as the actual market punishment for the new disappointment in the first place.

A2 Milk is a good example. Grew and grew and grew, got a PE premium as people bet on more growth. Then when disappointment set in, each subsequent dip was not a buying opportunity…but a heartbreak. They are still profitable, but they aren’t getting the same love as they were when revenues just kept growing and growing, so it’ll take a while for them to rebuild that trust.

AKA, the truth kicked in, and it wasn’t as good as the speculation would have had you believe…

So, getting back to Facebook. The question I’d be asking myself is whether these recent issues are one-offs. If a bad day at the office was all that happened, then the profitability of the company shouldn’t be too badly tarnished.

Their current PE is at the lower end of their longer-term PE, but its unlikely that they have the same amount of growth in them as they have had before, when they were first getting people addicted. I guess that once everyone is addicted to crack, there’s less growth in the crack distribution market unless each crackhead uses more crack, and there’s only so much crack each crackhead can take before they stop using crack altogether.

But what if it’s got a major flaw in its tech stack? If it breaks down more often people might stop looking at the damn thing so often, then advertisers will not pay as much, then the revenue goes into decline. So a ‘dip buyer’ would be banking on this being a one-off, hoping it doesn’t affect their longterm and was just a kneejerk reaction.

Also, keep in mind that Facebook is the worst. Surely we need to stamp out all this mis-information, and start being nice to people online. Maybe all this continual pressure to stop being a cancerous drug on society will finally hit the mark. Then less people will use it, advertisers will walk away etc etc. Maybe Facebook will be the next Blockbuster Video, or maybe this really is just another dip. That I didn’t trade.

So that’s the tricky part about buying the dip. Trying to work out how bad it gets takes a lot of crystal ball gazing, and not a small amount of luck. Its harder to turn a big ship around, so if there’s lots of negativity a sell-off can gain steam – like happened to FMG.

In a bullmarket, good dips are hard to come by, but they are often easier to trade as people will ‘buy the dip’ as long as its not a fundamental change to the company outlook. Everything is easier, but also, riskier, as everything is overvalued and has further to fall.

So the chunky, heartbreaking dips that cause the staunchest supporter to completely hate the company and dump at an price are more likely to happen in a rough market, and they are the ones that can be the most lucrative, but also the most dangerous.

They are also harder to crawl out of because everyone in a bad market is losing money on everything. As the stock recovers people will sell into any small rally, as a smaller loss is better than a bigger loss. And there’s less buyers.

Whether we are on the cusp of a broader sell-off, or whether there are just a few ‘dips’ won’t be known for some time. But now you know about PE’s and about how there are a lot of other factors to consider, its worth considering some of the other ‘market’ signs are there that it’s THE bottom.

Here’s a few.

Massively and extendedly oversold RSI = needs technical indicators.

Capitulation low on abnormally high volume = needs volume data over extended timeframes.

Intraday bounce after a meaty sell-off = need intraday data, with candlestick charts and live-streaming.

The seller depth is heavy near the market price and that pressure keeps selling down the price, then it seems to thin, with buyers then cautiously putting in small buys, then larger buys, then all of a sudden taking back control and paying up = you definitely need live streaming expandable depth.

So with hundreds of thousands of new, thirsty traders using nowt but a line chart with 20-minute-delayed pricing, or rapid-firing their ‘website refresh’ button in a fast moving market, and a market starting to set up ‘sell-off bounce’ trades, surely its time to wonder why you don’t have all these features, if you don’t.

NOTE: Zuckerberg would definitely trade with Marketech, but I reckon if he wanted ASX shares he’d just buy the lot. Even after ‘losing’ all that money…

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This article was developed in collaboration with Marketech Stockbroking Pty Ltd (AFSL 486148), a Stockhead advertiser at the time of publishing. This article does not constitute financial product advice. You should consider obtaining independent advice before making any financial decisions.