Catching a falling knife

Disclaimer: The analysis is the expression and assessment of investments right now. They cannot replace individual counseling. Always research and evaluate the investments you are considering based on your investment strategy, risk, and time horizon. Therefore, following the recommendations, you are responsible for any losses you may incur.

In my opinion,  the key to becoming a successful investor lies in buying low and selling high. This strategy may sound simple, as most people aspire to follow it, but executing it can be quite challenging. In particular, determining when to buy a stock, even when its price has dropped significantly, can be a complex decision.

Have you heard of the term "value trap"? It refers to a situation where a stock's current price seems undervalued based on fundamental valuation parameters like Price to Earnings, Price Book Value, and Price to Cash Flow ratio over time. However, such stocks are not always worthy investments and can lead to losses. The main concern when dealing with these types of stocks is their low fundamentals. For instance, if a stock has fallen by 80%, the loss will still be 100% if the price eventually falls to 0. Therefore, it's important to analyze the company's liabilities and profitability to avoid investing in a stock that may go bankrupt or become a value trap.

A company with a healthy balance sheet and stable profitability is less likely to go bankrupt. Additionally, it's essential to consider the company's future prospects and the industry as a whole. If the company is struggling to generate a positive income due to competition, regulation, or lack of innovation, it may be a red flag. For example, Nokia lost its position as the top mobile seller due to a lack of innovation, and its income declined without any chance of hitting the same level as before.

When it comes to buying stocks at the lowest price possible, there are some things to consider. As a value investor, finding a stock at a bargain may feel like catching a falling knife. It can be difficult because in the short-term, the stock market is a voting machine that favors the most popular stocks. It's impossible to predict where a stock price is going to hit in the short term. However, a stock with great fundamentals, good management, and a bright future can provide a significant return. Finding a stock near its lowest price is close to impossible, but there are some valuable factors that can indicate where a bottom is likely to be.

Firstly, if the fundamental of a stock continues to increase, it's only a matter of time before the price becomes too cheap and the stock price rises. Secondly, if the managers recognize that the stock valuation is ridiculously low, they can act in two ways. They can buy stock themselves, which indicates faith in the company. The management is among the people who know most of the company, and if they are buying, the investor can be sure that the company won't go bankrupt anytime soon. The other thing the management can do is to provide a share buyback if the company has enough capital and believes there isn't a better option elsewhere.

Despite these factors, it's still hard to buy near the bottom, knowing that the stock won't decrease further. However, by looking at the company's fundamental and future outlook, the odds of avoiding a value trap increase. The act of the management can indicate that the company is significantly undervalued, and management finds it interesting at the current level. Additionally, if the stock price falls and the company's case is unchanged, the stock should only be even more interesting to invest in.