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Dollar Cost Averaging in times of crisis.

Stories about how someone lost all his money during a recession are abundant. This is why many people are scared to invest in the stock market. The catch here is that as there is people that lost money on a recession there is also people that made millions in the recovery after the recession. In fact many professional investors make all their buying at times of crisis, this is because at this time is when you can find a lot of bargains.

It is not necessary to wait until the next big recession to start buying stocks, crisis that affect different equity prices can be found from time to time. Right now is the Geek, European crisis that has affected all market to some extent, but has created great opportunities in European equities. The best play here is to find stable European companies that have a big percentage of income coming from outside Europe.

One problem with buying in crisis is that even if you did your analysis and was correct, it is impossible to know at the exact time to buy a stock.  Usually when times are bad stocks get very volatile, and can drop fast and rise with the same speed, so buying early is just as bad as buying late.  The best way to get rid of the problem of timing is to use a dollar cost averaging strategy.  Dollar cost averaging is a timing strategy, in which equal dollar amounts are invested over a period of time. In this case the period time cannot be to long given that some crises resolve pretty fast.  The purpose of this strategy is to help the investor get a price in average that is closer to the cheapest price, for example if a stock is dropping in price you buy one time at 20, then at 18 then at 16 and then at 18 again, the average price will be 18 which is closer to the cheapest price of 16 than the fist buy at 20.

The Dollar Cost Average strategy is a powerful tool that can make investing more profitable, but is not a tool that has the power to work alone. In order for this strategy to be profitable the investor must have an understanding on the macroeconomic environment that affects the company as well as expectation on how the company is going to perform in that environment. Good fundamental analysis is a must in this strategy.  What we are looking for is a company that is very cheap, and by very cheap I mean that is not lower in price than before, but that is cheap compared to the new expected earnings of the company.

Common size analysis and ratio analysis are tools that will help the investor asses the strength of a company. If the company has the strength to be resilient to the crisis, then the next step must be taken. This step is to establish a price range in which the company is a bargain. To do this, the price of the stock must be divided by the following years expected earning to get a more realistic PE ratio. After this step is taken, and you have the price range on which certain security is a bargain you can proceed with the strategy.

Disclosure: No positions