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Friday, 23 March, 2007

Averaging Down - Yes or No?

Averaging Down was talked about in Gurufocus here.

Here are my comments.


I have a slightly different view.

Averaging down is good. Even I have averaged my stocks down to reduce my holding cost. But there are certain things that one must take care of.

1. The company you have put your money in should be fundamentally a good company and price fall must be irrational (not logical - YES NOT LOGICAL!!!!). In other words if the stock prices of chicken hatcheries is down because of bird flu (irrational reason), makes sense to average the cost down. And if price is down because the industry has been made obsolete (logical reason), don't average down (eg: pagers, CD manufacturers etc.)

I am from India and when Bird Flu struck us last year, all the hatcheries stocks tanked and there was nothing wrong with the business. It made all the sense in the world to get into hatcheries and poultry farm businesses.

2. Once it's made sure that market price is down because of some irrationality, another thing to keep in mind is upside potential. How soon can market realize that it was being irrational? For example bird flu sooner or later has to be cured and people would not stop eating chicken. Return to mean would thus happen in predictable amount of time. If in any case, return to mean takes longer than predictable amount of time, IMHO, averaging might be a bad idea. Personally I would not average down. It would be like putting more weight on a sinking ship (trying my hands at churning out one liners like WEB).

3. Finally averaging down must also consider the biggest cost of all - the opportunity cost. Averaging down is made possible only because market is down or some unrelated thing is affecting investor behavior and confidence (butterfly in New York cooks up a storm in Sahara). In these times, there could be other companies available even cheaper with higher upside potential. Better check out other opportunities before averaging down.

Please point if I am incorrect somewhere.

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