SmartCapitalist.com

Profit when Buying

Tuesday, January 24, 2006
A lot of real estate and stock investors get over zealous and buy at the wrong time for a price that is more than the investment is worth. Then they claim that it will go up over time and that they are not worried. Long term investing is not a bad plan, but that does not mean to buy something at a price above what it is intrinsically worth as an investment.

Lets talk about real estate first. If you buy a property for 100,000 and it is only worth 90,000, even if it does appreciate over the long term you are still playing a catch up game in the short term. This time could have been spent where the property was actually appreciating in value. Then with scenario B you purchased a $110,000 property for only $100,000 because the owner was moving out of town and wanted a quick close. We will compare the future value of the homes in 5 years with 5% appreciation. With the first case when there was a bad purchase, the home was worth $114,870. This is not a bad appreciation however it is nowhere near 140,400 which is $25,000 more money in profit just because of a smart move.

In the stock market the same principal applies with stocks that are going up at a very rapid pace. These companies often become very over valuated and might have a decline in the near future. Not that I am predicting the downturn of Google, but I would be very weary of investing in such a firm for the long term when their market cap is leaps and bounds above their income and assets. I am pretty weary of having multiples less equity in a company than the amount of money I have in the stock. A stock price with a healthy level above the equity is not necessarily a bad sign, but multiples above the equity are usually the sign of a potential catastrophe. In the event of a potential problem, traders and bankers will usually win. The long term holders are the ones that get decimated because their position that was worth $50,000 may now be worth $25,000 and it will take years to regain that $25,000 back before the long term investor starts making money again.

So when you are buying an investment in the future, think about how you are profiting from buying the investment and not from selling. You can think about the profit from selling in the back of your mind, but it is just icing on the cake. If you focus on getting a good deal and ignore the fact that the stock has doubled in the past month, you are one step ahead to be able to avoid getting slaughtered on the stock market.