Focus On Fallen Angels–Patience is the Key

In my previous post, I suggested that investors watch stocks they are interested in before plunging in. The title of the post was “Patience is Perspective.” In my thirty years of investing waiting has rarely cost me money. Trying to catch a falling knife has. Because I tend to buy “fallen-angel” growth stocks, waiting for the dust to settle is imperative. Fallen-angel’s present the greatest difficulty and the greatest potential for the value investor.

Fallen-angel growth stocks are well-managed, fast-growing companies that have unexpectedly hit a road bump (higher raw material costs and consequently shrinking margins: Coca Cola in the 1980’s, slower sales or, worse, obsolescence due to new competition: Eastman Kodak–who?–and the emergence of digital film, or new, ground-breaking technology which impacts the primary product offering: Hewlett Packard in the shadow of the iphone and ipad).  Because growth stock investors tend to focus on price momentum they are rarely patient with earnings misses and often unload the stock at the first sign of weakness.  The fallen-angel stock presents a great opportunity for the value investor but the important thing is not to become too eager to buy a former growth icon.  Value investors must remember that growth stock investors can and will bail out of a stock much quicker than the more price sensitive investor can accumulate holdings.

So, what to do?

As soon as a stock disappoints, add it to your wish list.  Begin tracking the price.  And wait.  The former darling will pass through the three stages of stock market grief:  disappointment, hate and finally, neglect.  Neglect is the point when the stock price flat lines:  the intelligent value investor’s buying opportunity.

Next post we will examine the price performance of an actual fallen-angel growth stock.

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