Know When to Buy Great Companies

James is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

Finding great companies is only part of a successful long term strategy.  Knowing when to buy those companies separates the experts from the beginners.

I must confess that I love earnings misses, one time bad news events, and minor drama that cause price drops.  Those are buying opportunities if the company is still fundamentally sound. Often they also shake out the short term investors and provide a deeper look at who's really in for the long haul and by how much.

Though Warren Buffett is fairly open about his investing philosophy, his timing process is still somewhat cloaked.  I've read hundreds of articles over the years about why he chooses to buy stocks when he does and how the price he's willing to pay is determined.  Many an observant author has noted that he's a famed bottom caller (or creator), but how does this happen?  One could make the argument that he's tracking long term accumulation trend lines in stocks he favors.

These base line accumulation rates are no fluke.  Geometry hardly ever is when numbers are concerned.  As good stocks with solid futures continue to grow they attract long term investors.  If these same stocks pay a good dividend with many investors opting into a DRIP (dividend re-investment plan) then that can also add to long term accumulation rates.

However, you can't simply expect to draw a line and chart support levels if there is no reason for support to exist.  So please understand that technical analysis is simply a compliment to value investing fundamentals.  Using the two together, in my experience, produces better results than simply relying on one or the other exclusively.  Though my analysis always begins with value.

Take Apple (NASDAQ: AAPL) for example, which is indeed a great company.  Lately it has seen a price drop from $700 to just under the $500 mark.  Those investors that bought at $700 may see some handsome returns over the next ten years, but not nearly as much as those who are currently buying at or below the $500 mark as I did on Jan. 15.

But smart money knew a pullback was inevitable and waited.  If you see my article Three Favorite Long Term Investments on Sale, syndicated on Dec. 19, you'll see why I started recommending Apple as a buy for the first time in over a year at $503.  Let's revisit the chart (Figure 1) in the afore mentioned article.

Figure 1:

<img src="/media/images/user_14634/apple-3-year-chart_large.png" />

 

Long term charts don't get much easier to read.  You can see long term accumulation giving support.  Then comes the spike and inevitable collapse.  While Apple was about 60% over-valued, using this simple metric I wouldn't be surprised to see it overshoot to the downside by 10%-15%.  That's the nature of a bubble.  Then right back to long term support levels, where it will continue to climb.

This pattern plays out thousands of times a year in hundreds of different stocks.  Here we will discuss the importance of long term accumulation support for stocks.

Costco (NASDAQ: COST) is another name that is already in my long term portfolio.  I bought this stock after my first visit to their warehouse, where I unwittingly spent $300.  The long term future of this company appears solid, the books look great, and management is obviously watching out for shareholders as evidenced by the $7 special dividend paid out before 2013 as potentially huge tax increases were on the horizon.

Again, using a three year chart (Figure 2) we can see that Costco has enjoyed the same long term accumulation base trend line.

Figure:2

<img src="/media/images/user_14634/cost-3-year_large.png" />

 

Using this as a rough guide we can see that any minor pullbacks in the coming future should put us at this base trend line.  So while the stock is currently trading at $102, I would look for an entry point approximately 8% below the current price.

Google (NASDAQ: GOOG) is a stock that I have been watching for quite a while as good value investors are often forced to do while waiting for an acceptable entry point.  Let's dwell on this for a bit.  A good and patient investor knows that you do not have to purchase a stock the same day you decide it's worth owning for the next five years.  Often it is far better to wait for an acceptable entry point to save yourself the angst of seeing dead or declining money.  Looking again at a three year chart (Figure 3), we can see the making of a base accumulation trend line.

Figure 3:

<img src="/media/images/user_14634/goog-3-year-charty_large.png" />

 

While I want to own Google, I am willing to wait.  I would be happy with an entry point within 5% of this given trend line, meaning currently I'd be looking at a $630 entry point.  Something tells me that with the spectacular earnings they just put up I might be waiting quite a while.

I personally love their mobile OS and believe they are on the verge of monetizing mobile better than anyone else in the field.  Content, advertising, open development, and search are all going to keep them at the head of the class.

Conclusion

Don't be afraid to use a little long term technical analysis once a stock has been determined to be suitable for ownership.  A successful "Buy and Hold" strategy requires two things.  The first of course is the buying part--the second is the hold.  Only the buying requires active participation from the investor.  So use all the tools at your disposal.

Patience is important.  Not just when it comes to holding the stock once you've bought it, but also waiting to buy the stock, sometimes for months at a time.  Warren Buffett famously took two years away from the market when he determined that it was too expensive.  He was right.  Those two years of waiting ensured he wasn't part of the market drop but rather in a position to benefit from that drop with massive purchasing power.

Value is the ultimate goal.  These trend lines mean nothing, absolutely nothing, if there is no underlying value to these companies.  At the core of every good long term strategist lies the heart of a value savvy investor.  Before you can even begin to rely on technical analysis you must be confident in your assessment of the value and growth of a company.  A thorough understanding of value investing fundamentals are required for a successful long term strategy to work for anyone.  Remember: you can't simply expect to draw a line and chart support levels if there is no reason for support to exist.  So please understand that technical analysis is simply a compliment to value investing fundamentals.


Lulupoopsalot has a position in Costco and Apple. The Motley Fool recommends Apple, Costco Wholesale, and Google. The Motley Fool owns shares of Apple, Costco Wholesale, and Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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