The Motley Fool

When Buying Great Companies, Investors Should Look Forward to Falling Share Prices

Many investors have a natural tendency to favour higher share prices and are averse to seeing them fall. Financial and investment media exacerbate these feelings by writing doomsday articles and spreading fear and panic when stocks take a sharp tumble. The message all around seems to be a loud and clear one: Avoid falling share prices like the plague. But is this the correct mindset for long-term investors?

Investors spend time and considerable effort seeking out great companies. They assess the business’s competitive moat as well as the growth catalysts and trends relating to the sector or industry in which the company operates. When faced with an attractive company with good long-term prospects, investors should obviously try to purchase it as cheaply as possible; therefore, they should arguably prefer lower share prices.

Great companies are not always available at great prices

The problem with great companies is that they may not always be trading at cheap valuations. If the consensus among investors is that a business is great, its share price will often be bid up to a point where a lot of optimism is priced in. This reduces the margin of safety for the investor in the event of something going wrong. Therefore, where there is an opportunity to buy such companies cheaply, investors should greedily grab them.

Accumulation amid declining prices

Investors should also be prepared to average down if need be in order to increase their stake at cheaper valuations. This may happen in an overall environment of falling share prices due to macroeconomic or political events. Averaging down involves spacing out your purchases by making a smaller initial purchase, and adding on steadily should the share price decline. This slow accumulation enables investors to take advantage of lower prices to gradually lower their average cost of ownership.

A higher dividend yield

By buying more cheaply, investors would also be rewarded by a higher dividend yield, all things being equal. If we assume that a company is paying out a dividend of $0.05 per share, buying the shares at $1 would give you a 5% yield. If the company can continue to maintain the dividend at $0.05 per share, buying the shares at $0.80 would provide a higher dividend yield of 6.25%.

Think differently from the crowd

The key here is not to be swayed by the majority and to think differently from the crowd. Other investors fear falling prices because they are fixated on the share price rather than on the business. Investors who view holding shares as having part-ownership in a business should welcome declining share prices as a way to accumulate more shares on the cheap. This provides them with both a better margin of safety and a superior dividend yield.

There are 28 surprising and important things we think every Singaporean investor should know—and we’ve laid them all out in The Motley Fool Singapore’s new e-book. Packed with information and insights, we believe this book will help you be a better, smarter investor. You can download the full e-book FREE of charge—simply click here now to claim your copy.

The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.