The Motley Fool

Investing Basics: When Should You Buy a Stock?

The best time to buy a stock is when its price trades below its intrinsic value. In this article, I will highlight situations where there could be price-value mismatches to provide great buying opportunities.

The ominous sound of bad press

Warren Buffett once said, “Whether we’re talking about socks or stocks, I like buying quality merchandise when its marked down.”

Stocks can dip below their intrinsic value for numerous reasons. It could come from negative investor sentiment due to a short-term problem that is solvable. Or the company could have received bad press. Take the recent viral video of a rat found in a hot pot soup in China’s Xiabuxiabu Catering Mgt Chn Hldgs Co Ltd. The immediate reaction was a sell-down on the stock, sending it down 12.5%. This decline could represent a buying opportunity for investors who believe in the long-term potential of the company. In my view, consumers tend to have short memories when it comes to bad press. In fact, many major food chains have had food hygiene issues, and most have managed to recover.

As investors are spooked by the headlines, it creates price-value mismatches that long-term investors can exploit.

The bear market roars

Another good time to buy stocks is during a bear market. This scenario often occurs when liquidity is tight or when there is too much pessimism surrounding stocks or the general economies. When this happens, stocks can plummet to prices that are way below their intrinsic value. In such a situation, we can view it as a “store-wide” sale whereby almost any stock is on a discount.

However, investors should still ensure that they only buy stocks that have strong balance sheets and capable management teams that can see them through tough economic cycles.

When the stock is cheap (even at all-time highs)

Buying a stock need not only be when prices have dipped. As mentioned earlier, stock prices can still provide good value even at all-time highs. Take for example. Over the past few years, the company’s share price has hit all-time highs numerous times. However, hitting new highs did not mean the stock was expensive. On the contrary, the company has delivered impressive performances quarter after quarter.

In this case, even at all-time highs, Amazon could be still trading below its intrinsic value. Amazon’s price has increased more than 25 times in the past 10 years.

To decide whether buying at all-time highs make sense, it is important to look at a company’s fundamentals and growth trajectory. By using simple valuation metrics, such as price-to-sales or price-to-free cash flow, investors can decide whether the current share price is cheap.

The Foolish bottom line

There are no hard and fast rules when it comes to when it is a good time to buy a stock.

Much of it depends on what you believe is a good price to pay, and whether the current stock price meets your expectation. That said, situations when there are price-value mismatch such as bear markets and negative press surrounding a good company could be a good time to look out for bargains.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. The Motley Fool Singapore has recommended shares of and Xiabuxiabu Catering Mgt Chn Hldgs Co Ltd. Motley Fool Singapore contributor Jeremy Chia doesn't own shares in any companies mentioned.