Goldcorp purchase (G) – The problem with bottom fishing for stocks! 2

Mining companies have been hit really hard this year. If you look across the board, companies that have mining operations have had their stock prices decimated as a result of the commodities rout. With stock prices so low at the moment, it could seduce investors into buying shares of these companies at what they perceive to be a cheap price. It could lead to a situation of a value trap.

This is exactly what happened to me. I bought into Goldcorp (G), a gold mining company listed on the Toronto Stock Exchange (TSE) during the middle of this year. The logic was sound. I thought the gold price which had depreciated by over 40% over the past 3 years had stabilised and would in fact increase due to the Greek bail out problems which were to happen in a few weeks (as it turned out, there were problems as Greece didn’t accept the bailout conditions but the gold price didn’t budge – so much for gold being a hedge against crises!)

Furthermore, the stock price of Goldcorp (G) had reduced by a massive 60% in this period going from $54.91 to $20. The price was below what the stock sold for in the great recession of 2008/2009 which was $22.

I thought to myself, if gold prices have stabilised and Goldcorp is trading at a price below what it did during the depth of the great recession, surely the only way is up from here. I bought into Gold Corp at $20 and boy was I wrong!

After I bought the stock in the company, the stock price kept heading one way – down! The company even cut its dividend in August damaging the stock price even further. The company currently trades at $15.30.

Whilst this venture speculating on a stock rather than investing (what I should be doing!) has turned out to be somewhat costly, it has taught me a valuable lesson: don’t just buy a stock because the market prices has dropped. If you think it can’t go lower: it can!

Bottom Fishing for stocks can turn out to be a very bad move!

One of my investing heroes, Peter Lynch, stated that you should not buy a stock just because it has gone down in price. In that instance, Lynch had been, seduced by Standard Oil of Ohio (now part of BP) after it fell by 33%. He then watched it collapse further until it was down 67%. If you think it can’t go lower: It can.

In an interview Peter Lynch had with Louis Rukeyser, Lynch had the following to say about bottom-fishing for stocks

“There’s a common mistake, people buy stocks because they’ve fallen from price X to two thirds of X or half of X. On that basis alone, they’re buying the stock. That’s called bottom fishing the stock market. It’s very, very difficult. I had a rough go of it. Standard Oil of Ohio shares fell this year from 90 to 60 and I told everybody this stock is not going to go any lower. Then it went to 50. I said this it, no lower. As it went through 40, I said to people, this is it. Finally when it got down under 30, and people said what do you think of Standard Oil of Ohio? I said: “What does Standard Oil of Ohio do? I don’t know that company.” I absolutely backed away from it.”

Bottom Fishing for stocks is a type of market timing which in itself is a very very difficult skill. As Terry Smith says, there are two types of investors, ones that know they can’t time the market and one s that on’t know that they can’t time the market.

Right now there are many mining companies that appear to be like Goldcorp. Don’t make the mistake I made and simply bottom fish for stocks. Instead do your own research and only purchase a stock if the fundamentals of teh company make sense to you.

It is also important to remember that just because a stock price goes down, doesn’t mean that you have made the wrong decision. If you have done your research on a company and buy in at a price below the intrinsic value and the price goes down due to no explainable reason, you should hold your stock in that instance or even buy more, like what I have done with Zambeef. The difference with doing your research and knowing the value of a company and bottom fishing is that the latter is pure speculation whilst the former is investing based on research.

As Peter Lynch said “ when stocks are attractive, you buy them. Sure they can go lower. I’ve bought stocks at $12 that went to $2, but then they later went to $30. You just don’t know when you can find the bottom.”