Don't Jump Too Fast To Get On Long-term Bankers

The Age

Saturday December 10, 2005

MARCUS PADLEY

DISAPPOINTING stocks are often the most rewarding. Some of the best examples over the past five years have been Computershare, Aristocrat Leisure, CSL, Cochlear, Macquarie Airports and QBE. Big, big falls followed by sustained share price rises.

On that basis investment is easy. Just buy any big stock that falls over. As anyone professing a contrarian investment philosophy will tell you: "Buy when there is blood in the streets."

As a stockbroker I can tell you, persuading mums and dads to buy something that's fallen a lot is one of the easiest sales lines a broker can use. It's in everyone's nature. The fact that 130 million Telstra shares traded the day after their Strategic Review (and all the buyers are now underwater) tells you how tempting it is to follow your guts and buy something just because it's 10 per cent cheaper today than it was yesterday.

But, buying a "shock-drop" stock is a high-risk trade, especially on the first fall.

Here's why:

? Stocks fall over for a reason, and it's not often because they have been misunderstood for 24 hours.

? The institutions react a bit slower than you and have a lot more stock than you. It takes them a while to make and execute a decision. If you buy an institutionally held stock on day one of a collapse you will be punished, if only because the British and US institutions only really wake up to it the next day and load up their selling orders the next morning.

? Institutional brokers operate large selling orders by guaranteeing the institutions the volume weighted average price (VWAP) for the day. The only way they can operate a VWAP order and manage the risk is to average their selling over the day. All the mums and dads usually jump on the bid first thing in the morning. By 10.30 they are filled. But the institutional selling orders go all day. Shock-drop stocks almost always close day one on the low of the day as tardy institutional orders complete their selling on the close.

? It is established in financial theory that when a company has a shock price movement (in either direction) the stock tends to trend in the same direction for the next nine days.

? Forget the nine days. After the initial bad news and the shock-drop, all the stocks mentioned above went into downtrend for a year or more. You never buy a shock-drop stock on the drop. It will continue to trend that way for ages. You'll have plenty of time to research a shock-drop stock before the turning point.

? It takes a long time to blow up a balloon, only an instant to burst it. It is the same in the sharemarket. It takes three times as long to build confidence in a share price as it does to lose it. Making money out of a sudden share price fall is always a long haul. There's no rush.

? Shock drops are a sign you should go and have a look at a company. They are not an automatic buy signal. Sometimes they are precursors to a terminal problem. Pasminco, Ion and Sons of Gwalia taught us that. Buying shock-drop stocks is investment, not trading. Investment requires at least some research.

? New management appointments after a shock drop are a great buy signal (unless it's Telstra, of course).

Some of the most rapid returns eventually come on offer in big stock shock drops. But do yourself a favour. If a stock falls over rapidly, think about selling it for a trade, not buying it. Leave your buying for later. What you are really looking for is a short-term opportunity to enter a good long-term stock.

Get in the habit of trawling through the worst performers in the ASX 100. Some of the most recent drops (hardly shock drops) might include Telstra, BlueScope Steel, Macquarie Infrastructure Group, Tabcorp, IAG and Sims Group. None of them are going out the back door. All worth a look.

Marcus Padley is a stockbroker and the author of the daily sharemarket newsletter Marcus Today. For a free five-day trial of the newsletter, go towww.marcustoday.com.au