![\"Primary](\"https:\/\/businessecon.org\/wp-content\/uploads\/buy-low-sell-high.jpg\")
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\u201cBuy not on optimism, but on arithmetic.\u201d<\/strong> \u2013 Benjamin Graham<\/em><\/span><\/p>\n The one statement that best explains business is ‘Buy Low, Sell High’. It is a universal principle<\/span><\/strong><\/a> referred to as a tenet of business. It is commonly stated in other terms such as control costs<\/span><\/strong><\/a> or focus on the best customer. In effect, it is a simple math equation of revenue minus costs equals profit.<\/span><\/p>\n With the stock market, obviously buying low and selling high is the goal for any investor. But the real problem, and it is depicted well in the illustration above, is knowing when the lows and highs exist. If you purchase the stock at its absolute lowest point in a cycle and then sold it at the highest point in the cycle, well you are either God or lucky. The simple truth is that nobody can predict either extreme. Value investors are not trying to predict either extreme; value investors only wish to identify acceptable lows (good value points) and reasonable highs to dispose of the investment. In effect, value investors merely take advantage of a good portion of this volatility with stock.<\/span><\/p>\n The buy low sell high tenet is not an absolute statement; it does not mean to buy the stock<\/span><\/strong><\/a> at the absolute lowest price and then sell it when it reaches the highest point. It means to buy the stock when its value is appropriate and then sell the stock when it its high price seems unsustainable in the market. Look at this graph for a better depiction of the buy low sell high concept.<\/span><\/p>\n With this particular stock, the value investor determined that during the upcoming year any price discount of 9% from a peak price warrants a buy and once the price fully recovers to its prior peak, it warrants selling the stock and reaping the respective rewards.<\/span><\/p>\n Notice how the value investor doesn’t wait until the stock gets to its lowest point, value investors have no idea when this will happen. A value investor only knows that the stock is under priced once it dips 9% from a prior peak price and thus buys this stock during Week 5 when the price hits 91% of the peak of $57.45. Thus, the buy is at $52.28.<\/span><\/p>\n The sell trigger is set for full recovery with this particular stock; thus, once the stock recovers to its prior peak of $57.45, it is time to sell.<\/span><\/p>\n In Week 12, the stock is fully recovered and via a computer order, the stock is automatically sold at $57.45.<\/span><\/p>\n Altogether, the value investor earns $5.17 per share or 9.89% on the investment of $52.28.<\/span><\/p>\n Immediately, novice investors will proclaim that 9.89% is not a lot. Actually, it is wonderful. Why? Look at the time period the investment was held. Assuming that during Week 5 the stock was purchased early in the week and sold late in Week 12. Thus, the stock was held for eight weeks inclusive. Therefore, the annualized return is equal to 68.5%. The math is that the investment was held for 56 days, thus earnings equals 9.94 cents per day or $36.19 for an entire year. $36.19 divided by the investment of $52.28 equals 68.54%.<\/span><\/p>\n There is more to this than this simple example. There are costs involved, typically transaction fees equate to 7% of gains; therefore, a typical return is closer to $4.80 ($5.17 *93%). In addition, recovery periods are generally longer than eight weeks. More common recovery periods are in the 16 to 30 weeks range. Thus, assuming 30 weeks to recover and earning $4.80 on a $52.28 investment really equates to an annualized return of 15.9%. But still, a 15.9% return is high quality. But there are bonuses.<\/span><\/p>\n Almost all high quality stocks pay dividends. Assume this stock pays 75 cents per quarter. Actual final earnings, assuming two quarters of dividends<\/span><\/strong><\/a> and gain on the sale equals $6.30 ($1.50 dividends plus $4.80 net gain). This equates to an annualized return of 20.9%.<\/span><\/p>\n This is more realistic with what happens with value investing. The buy low and sell high tenet merely provides a good foundation to earn positive gains. Go back to the four principles which will each be examined in Lessons 6 through 9; 1) Risk reduction via quality stocks<\/span><\/strong><\/a> only, thus quality stocks generally pay dividends during the holding period; 2) Intrinsic value provides confidence that the share price will not further decline dramatically as the underlying assets act as insurance of the company’s worth; 3) Financial analysis validates a fair and reasonable market share price thus assuring the value investor the stock price will recover; and finally, 4) Patience is required to simply wait for the stock price to recover; if it takes longer, it is OK; it just means that the annualized return on the investment will not be as high as predicted.<\/span><\/p>\n There are several keys to success with the buy low sell high tenet of business, especially stock transactions. First, note that if a value investor decides to take less risk and buys at a much deeper discount, it is possible that further declines will not materialize thus negating or limiting opportunities to buy stock at a good price. In most cycles of stock values, the typical share price does not even get to the desired buy price. In general, they will fluctuate down and up past the prior peak price; thus value investors never get to exercise their preset buy and sell points for the stock. Therefore, setting the buy price must be reasonable, i.e. not too deep of a discount or not enough of a discount as the return on the investment may not warrant the associated risk of holding the stock.<\/span><\/p>\n Go back to above graph. Suppose the value investor sets the discount at 5% instead of 9%. Now the buy price is $54.58. If the sell point is the prior peak, the gain equals $2.87. Look at other negative contributing factors towards the annualized return on the investment.<\/span><\/p>\n Overall, at a 5% discount and with the other conditions remaining stable, the actual final earnings is $4.17 (including two dividend payments and a 7% transaction fee for the buy and sell activity with the broker). The annualized return equals 12.8%, earning $4.17 over a period of 217 days (one week longer than the prior example) on an investment of $54.58.<\/span><\/p>\n A second key to success is at the other end of this formula. The sell point must also be determined with some accuracy. If, it is too high, it may not materialize with enough frequency to make a good return. In effect, too high of a sell point will and does often take a lot longer to achieve. Too low, and the value investor misses an opportunity to reap real good returns on their respective investment.<\/span><\/p>\n Understanding both the buy and the sell points are essential with value investing. There are some rough figures for most investments; but good research will provide the necessary decision model that will earn outstanding returns on an investment. Some rough rules include:<\/span><\/p>\n In general, value investors create a pool of similar investments and thus have multiple opportunities to buy and sell from within this group. The money is continuously at work and rarely held as cash. This refers to effective utility of the funds. This is also explained and illustrated in Phase Two of the program.<\/span><\/p>\n![\"Primary](\"https:\/\/businessecon.org\/wp-content\/uploads\/Standard-Stock-Price-Graph-with-Buy-Sell-Points.png\")
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