BT threw investors a curveball this past month by stating that its Italian business is facing an accounting scandal which has caused the company to write off £530million. Whilst the headlines around the company were focusses around the Italian scandal, BT also reported a deterioration in the outlook for UK public sector and international corporate markets. This has sent shares crashing from 380p to 300p; a drop of over 20%.
Readers of this website will know that I first initiated a position in BT in the summer of 2016 for a price of 397p. I subsequently topped up my stake through my monthly stock programme which brought my overall holding to 314 shares and an average purchase price of 390p a share.
Naturally, when BT reported its results, I as investor was deeply interested. And when the stock price was falling I was even more so. At this point I had the choice of buying more shares to average down on my purchase price, sell and take the loss or do something. I didn’t want to act in haste so I did nothing. Instead, over the next few days I digested the results and looked at them in conjunction with my overall thesis I made on BT when I first purchased the stock. I realised that BT is still a financially string company with a great future in front of it and this weakness inn price gives me an opportunity to top up my stake in the company for a cheap price.
I bought 241 shares in the company for 309p each using my monthly stock purchase programme . This brings my total holding in the company to 555 shares and the dividend I expect to receive from the company to £80. To fund this purchase, I have sold my shares in Merchants Trust for a profit – but I will do another post on why I have made my very first outright stock sale.
So the natural question as readers is, how did I decide whether to average down on BT. Or more generally, how do I decide to average down on nay company?
When to average down on a falling stock in a company?
When a company reports bad results that sees its stock price fall, the first thing I will do is go and look at its debt load. For me, the balance sheet is the single most important aspect to look at in the midst of operational uncertainties.
- ‘Is the debt load manageable?’. That is the question I ask myself. A company taking on excessive debt spells trouble. For defensive companies, I don’t like seeing debt over 10 times earnings.
Why is looking at debt so important? As Peter Lynch put it brilliantly, ‘companies that have no debt can not go bankrupt.’
- Does the original investment thesis still hold? Does the reason I first bought the stock still exist? If the answer is yes, I am more likely to average down on the stock.
- Is the problem one off or more cyclical l in nature? If it is one off, it bodes well as an investor. But if the problems are more structural , e.g. the industry is changing and the company is getting left behind. then this is problematic and the chances of the stock falling remain high.
- Are insiders buying? Management buying stocks are a great way to tell if a company is undervalued. Another great indication is of the company buys back stock at the lower prices.
At the end of the day, you need to be comfortable enough on the prospects of a company to average down on the stock. Asking yourself the above questions will certainly help you do that. If you are not happy to see a reduction in the value Mr Market places on your current holdings I’d argue that you need to make changes. It is an indication that (1) the security is expensive or (2) you don’t really understand what you are investing in; either way , it’s time for a change.
When purchasing depressed stocks in troubled companies, seek out the ones with the superior financial positions and avoid the ones with loads of bank debt. Peter Lynch
In the case of BT, it has met my criteria and that is why I have averaged down. Another stock that I averaged down on was Zambeef and it has climbed over 100% from my averaged down price.
Two stocks of mine that have dropped more than 15% recently are Cobham and Pearson. With these two I have so far remained inactive and look to see guidance and full year figures to see what decisions I will be taking. I am in no hurry to make quick decisions that I will regret. I am in it for the long haul. Having a long time frame allows me to see beyond the next few quarters and buy beaten down shares that will compound for years to come. This is the advantage of the individual investor. There is no need to act hastily as I don’t have to have good performance in the short term to attract customers (investors) like professional managers have to do. Instead, I can ignore short term performance and concentrate on the big picture; compounding wealth over the long haul.