Is it time to buy American?

A few weeks ago I posted my thoughts on the financial sector as part of an instructional guide on what I look for in buying an ETF. I actually ended up buying 4 shares of VFH(Vanguard Financial Sector ETF) for about $33 a share. It looks like I timed it to well for my own good, because it has gone up to $41 a share and now I don't want to buy it any more. So what next?

Well, I saw an article on Yahoo! Finance called "Will Ford and GM Run These Funds Off the Road?". The gist of it is that US Auto makers have taken a beating on the stock market recently, and funds that own them may also perform poorly. Poor performance! Thats just what I'm looking for!

Down on their luck

Looking for poor perfromance? I'm sure you think I'm crazy, but I'm a contrarian investor. That means I look for stocks or sectors that have been punished for no good reason ( or for temporary reasons) and whose stock value has been driven lower than it probably should be. That is the time to buy. The highs and lows of a stock are unpredictable, and choosing which startup company will be the next Starbucks or Google is pretty darn tough. But seeing that an otherwise good company is down on it's luck is not that difficult right?

Well, there are somethings to watch out for. No company it too big for bankruptcy. If bankruptcy is coming up or being talked about, don't buy! Stock holders have about as much claim in backruptcy court as obese teenagers suing Mcdonalds. But seriously, stock holders are pretty much last priority, and most likely the stock will be entirely reissued.

Also, it's impossible to call the bottom. I learned this with Moneygram International (MGI). I noticed their stock when it had lost about half it's value. I bought 6 shares at $15. Now the stock is about $1.70. I decided to keep buying on the way down. They were hit pretty hard due to the credit crisis, but I think they still have good prospects for the future. Because I buy in increments of $100, I now own over 300 shares with an average price of $2.13. I'm also a long term investor, so I can wait years for the company to recover its finacial footing.

Buying in small increments helps protect you from losing too much at any one time. Sometimes, you lose out on more of the upside like I did with VFH, but I sleep better knowing that I bought 6 really expensive shares of MGI, and a lot of cheaper ones. Of course, if the company is going down, the shares are expensive at any price.

Down, but not out

So back to American auto makers. They've had a bad quarter. Actually, looking at the charts, Ford's stock has been sinking since 2000, so they've had a bad decade, and this past quarter is just the iceing on the cake. So why an I optomistic.

I can see several senarios that work in my favor. First, gasoline prices. They were high, but now are coming down. This will have two effects. The auto companies got a shock when people stopped buying big SUV's and trucks. Therefore, they will work to make better small cars in the future to regain market share. Also, after a while people will forget about how high gas prices and start buying trucks and SUV's again.

Second, the losses this quarter shocked investors. This means people irrationally sold the stock without evaluating long term trends. Therefore, the stock should be undervalued. Value is difficult to determine when profits are negative, but I don't believe profits will be negative forever. Also, the losses this quarter include a number "special charges". I think the auto companies are taking their lumps all at once, and future quarters will not be so bad.

I'm still new to investing in individual stocks, so hoping that auto makers read the signs and shift gears may be in vain. However, I'm an optimist. That's why I'm going long on F and GM.

Comments

[Adam - Natural, Personal Finance]

You gave some very solid advice here and I'm enjoying reading through your other articles. You should definitely give UpDown a try since I think you'll do quite well vs the market.

I especially enjoyed your article "Some random thoughts on stocks." I should mention that inflation is largely influenced by money supply (http://en.wikipedia.org/wiki/Money_supply#Link_with_inflation) and ignoring that bit might lead to some erroneous conclusions.

[Step3]

Thanks for the support! Since I wrote that article I've discovered that the source of stock returns is 3 fold: inflation, company growth, and dividends in about equal amounts.