As a beginners gambit, and as a value investor, I personally like to gauge any potential long ideas I am considering with what the equity was trading for at the height or low for that matter of the 2008-2009 recent stock market crash.
This article was created for the novice investor in mind. Any novice investors who are considering a dive into the stock markets, but lack the experience may find this reality check contained within this article useful.
Of course as with any measurement or technique in investing, this beginner's gambit does not work with every situation, and further analysis into any potential investment is required. However this technique can be used as a tool for beginner investors to quickly gauge how an equity's current price compares to that of its crash price.
This information will offer up a potential basic safety net that may exist for investors to work with. From there investors could proceed to use other tools like DCF/FCF calculations, MACD, moving averages, P/B & P/E, Oscillators, and so on so forth. All of which are beyond the scope of this article. However, I may build on this article and provide future examples of how to use these tools with the examples shared below.
If you believe in the Efficient Market Hypothesis, then you could consider that at the time of when all hell was breaking loose in the financial markets circa 2008-2009, equities based on this theory were priced at Armageddon levels.
In hindsight, we now know that many equities were severely discounted during this period of time. Using that statement as a guideline, I will coin the term the "Ground Zero Benchmark" or GZB. As a special note; the GZB works best with low beta, mid to mega cap stocks, and many equities should be compared to get a feeling for the use of the GZB. The exception to this rule I found are some junior gold producers. Which are showing no current correlation to the high price of gold.
Example of Kinross Gold (KGC)
KGC is an example of an equity that shows breaching of the GZB. Notice how KGC hit an approximate low of $7.65 around October 2008. Fast forwarding to today, KGC is trading at around the same price. KGC has a Beta of 0.42. Now granted there are other variables to consider such as a recent write down that KGC had, you could also consider that KGC is trading lower in comparison to the current high price of gold. The additional homework to consider in evaluations is beyond the scope of this article. The main point is to ask the question: How much lower will an equity go than its crash price, all else remaining equal?
Example TransAlta (TAC)
TAC is an additional example of a breakout below the GZB. With a Beta of 0.89, TAC was trading at a low of near $18 during the crash, and as of today it is near $16.25. This is a prime example of the GZB. The investor can then start to investigate further, as to why the price of TAC is below that of its crash price. As mentioned in a future article, I will dig further into the analysis of TAC and KGC respectively.
These are by no means meant to be prefect examples. However, as mentioned the GZB can be used as a starting point for new value-orientated investors. If a stock price drops due to negative news, and this particular news is viewed to be rectified within a chosen holding period, then investors can then use judgment and further analysis. The GZB is a good reality check and first benchmark to use in an initial investigation as part of a value screen.
One cautionary note that I will leave the readers with; just because an equity breaches the GZB, doesn't mean it is finished its downward trend. Investors should learn about reversal patterns to try and gauge a bottom, and possibly an upward trend breakout. Otherwise you may end up trying to catch a failing safe. Another strategy to consider when an equity breaches the GZB, is buying Call Options or LEAPS in that equity, instead of outright buying the equity, something I plan to post as well in future articles.
Charts: Courtesy of RBC Direct Investing.