Should You Buy the Dip
Should You Buy the Dip? There have been several articles recently published about why buy the dip is dead. Here are some article titles as examples: “Buy the dip is a horrible market strategy,” “Analysis: Buying the dip? Not so fast, some Wall St banks say,” “Here’s why a buy the dip investment strategy doesn’t work,” and “Buying the dip is dead.” These articles were all written in the past 30 days. So, is buying the dip really dead? Should you buy the dip?
What is Buy the Dip?
Before we answer those questions, let’s answer what does buy the dip mean? The best site to turn to for this is invariably Investopedia. Their definition of buying the dip is that it.
“…means purchasing an asset after it has dropped in price. The belief here is that the new lower price represents a bargain as the “dip” is only a short-term blip and the asset, with time, is likely to bounce back and increase in value.”
One thing to note is that the definition of the buy dip is not limited to stocks. The strategy can be used for any asset class. Next, the concept of the buy the dip is reportedly based on the theory of price waves. Finally, investors, who engage in a buy the dip strategy hope the downturn is temporary, and an upward trend will resume once investors digest negative news and return to their long-term investment thesis.
The strategy works well for a stock that is in a long-term upward trend. You don’t need to look far for good examples like Apple (AAPL), Amazon (AMZN), and Tesla (TSLA) over the past five years. The chart below from Stock Rover* is for Apple (I’m long Apple), a Dividend Challenger. There are clear points where the stock has dipped, at least in hindsight.
Risks for a Buy the Dip Strategy
Like any investing strategy, there are risks for buy the dip. The significant risk is what happens when you buy the dip, and it keeps dipping. This action is the fear of many investors. For instance, suppose you owned Bear Stearns, Merrill Lynch, or Lehman Brothers during the sub-prime mortgage crisis. In this case, a buy the dip strategy just resulted in more losses and eventually loss of your principal.
The risk is not limited to financial companies. I recall a colleague who kept buying the dip on MCI Worldcom. He lost a few thousand dollars.
Buying the dip in healthy companies can lead to losses if they face operational challenges or are significantly overvalued. For example, buying the dip after the peak in Cisco (CSCO) during dot-com boom was not a good idea. Suppose you purchased Cisco (I’m long Cisco) in early-2001 after the stock price had dropped in half. It took almost two decades to return to that stock price.
Today, a buy the dip strategy in retail is a potential recipe for losses.
Problems with a Buy the Dip Strategy
The main problem with a buy the dip strategy is market timing. How do you know it is a dip? Sure, you can use technical indicators, but most investors don’t know how or find it challenging to implement. Buying during a slight dip is not too helpful for generating excessive returns. In addition, buying on a slight dip is essentially the same as buying on no dip at all.
On the other hand, you could wait for a significant dip, but you may be waiting a long time. The stock market is volatile. However, the stock market only experiences a bear market every six to seven years. Since 1945, the S&P 500 has only declined between (-20%) and (-40%) nine times, and there have only been three declines more significant than (-40%). Declines of this magnitude are hard to predict.
However, there are many more declines ranging from (-5%) to (-20%), 113 to be exact. Suppose a stock declines into correction territory. Is it time to buy the dip? Possibly, but it depends on the reason for the stock price drop. Is the decline due to a short-term drop because of missed earnings? Or is the decline just part of a downward stock market trend? Or is the decline due to a long-term secular decline in an industry?
Can Buy the Dip Work?
In any case, suppose you are long a dividend growth stock, and it hits some short-term headwinds, then maybe it is time to add some shares. For instance, 3M’s dividend yield sometimes goes over 3% and rarely goes above 3.5%, as seen in the chart below from Portfolio Insight*. When the dividend yield does go over these thresholds, it is probably a good time to add shares since the stock price is inversely related to the dividend yield.
Alternative to Buy the Dip
The most straightforward strategy to implement is probably dollar-cost averaging (DCA). Most investors already do this in their retirement plans. This strategy is simple and automatic. Invest the same amount of money at a regular interval irrespective of the stock price. Sometimes, you will buy the dip but sometimes not. Over time, it likely does not matter too much since you are consistently investing. The stock market rewards consistency and the long-term and you should not care too much about the short-term.
A DCA strategy works because it is calendar-based. You can easily control how much you invest and when based on the calendar. An investor will not always buy at the market bottom but will sometimes capture some of the dips.
Final Thoughts on Should You Buy the Dip
Many professional and even retail investors engage in a buy the dip strategy. However, the strategy comes with risks, and it is not for everyone. A buy the dip strategy is not dead, but it takes effort. Most dividend growth investors should probably follow a DCA strategy in their retirement and taxable accounts. Overall, keep it simple and consistent whether you are buying dividend growth stocks or dividend growth ETFs, and in time it pays off and you can live off of dividends.
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Chart or Table of the Week
Today I highlight Amgen (AMGN), which I am long. Since late July, the stock price has been under pressure due to higher costs, margin pressure, and more competition. Some of the expenses are related to new plants and acquisitions and are thus relatively short-term. However, Amgen has a strong pipeline and is expanding organically through R&D and by M&A. The dividend yield is now ~3.4%, and the safety metrics are solid. Amgen is a Dividend Contender with ten years of consecutive annual dividend growth. The Chowder Rule results in a Chowder Number of 15.9% suggesting that Amgen should be a stock to consider for a dividend growth portfolio. The screenshot below is from Stock Rover*.
Dividend Increases and Reinstatements
I have created a searchable list of dividend increases and reinstatements. I update this list weekly. In addition, you can search for your stocks by company name, ticker, and date.
Dividend Cuts and Suspensions List
I updated my dividend cuts and suspensions list at the end of September 2021. The number of companies on the list has risen to 531. We are well over 10% of companies that pay dividends, having cut or suspended them since the start of the COVID-19 pandemic.
There was one new company added to the list this past month. The company was Capstead Mortgage (CMO).
Dow Jones Industrial Averages (DJIA): 35,295 (+1.58%)
NASDAQ: 14,897 (+2.18%)
S&P 500: 4,471 (+1.82%)
The S&P 500 is trading at a price-to-earnings ratio of 28.2X, and the Schiller P/E Ratio is at about 38.1X. These two metrics were down the past three weeks
. Note that the long-term means of these two ratios are 15.9X and 16.8X, respectively.
I continue to believe that the market is overvalued at this point. I view anything over 30X as overvalued based on historical data. The S&P 500’s valuation came down as the index companies reported solid earnings for the second consecutive quarter.
S&P 500 PE Ratio History
Shiller PE Ratio History
Stock Market Volatility – CBOE VIX
The CBOE VIX measuring volatility was down 2.5 points this past week to 16.3. The long-term average is approximately 19 to 20. The CBOE VIX measures the stock market’s expectation of volatility based on S&P 500 index options. It is commonly referred to as the fear index.
Fear & Greed Index
I also track the Fear & Greed Index. The Index is now in Fear at a value of 51. The Index is up 17 points this past week. This Index is a tool to track market sentiment. There are seven indicators in the Index that are measured on a scale of 0 to 100. The Index is calculated by taking the equally-weighted average of each indicator.
These seven indicators in the Index are Put and Call Options, Junk Bond Demand, Market Momentum, Market Volatility, Stock Price Strength, Stock Price Breadth, and Safe Haven Demand.
Junk Bond Demand indicates Extreme Greed.
Safe Haven Demand is in Extreme Greed.
Market Volatility is set at Neutral.
Stock Price Breadth indicates Fear.
Market Momentum indicates Fear.
Put and Call Options are signaling Fear.
Stock Price Strength is signaling Extreme Fear.
The U.S Bureau of Labor Statistics Job Openings and Labor Turnover Survey, or JOLTS, reported 10.4 million job openings as of the last day of August. The drop follows an upwardly revised (and record) 11.1M openings in July. Job openings slid for the first time in 6 months. Industries contributing to the drop include healthcare and social assistance (-224,000), food service (-178,000), and state and local government education (-124,000). The federal government reported an increase in openings (+22,000). The number of people who voluntarily left their jobs rose 242,000 to 4.3M, contributing to a record quits rate of 2.9%. Driving the quits rate were people resigning from accommodation and food services (+157,000).
The U.S. Bureau of Labor Statistics reported the consumer price index rose 0.4% in September; this follows a 0.3% increase in August. The Index’s year-on-year rate is up a seasonally adjusted 5.4% from a year ago. The indexes for food (+0.9%) and shelter (+0.4%) contributed to more than half the seasonally adjusted increase. The indexes for new vehicles (+1.3%), household furnishings and operations (+1.0%), and motor vehicle insurance (+2.1%) also rose in September. The energy index came in at (+1.3%), with the gasoline index reporting (+1.2%).
The Commerce Department reported advance retail sales increased 0.7% to $625.4B in September, following an upwardly revised 0.9% in August. Excluding autos, sales advanced 0.8%. Retail sales are 12.2% higher than in September 2020. Total sales for July 2021 through September 2021 were up 14.9% year over year. Sales increases were reported in sporting goods (+3.7%), general merchandise (+2.0%), miscellaneous retailers (+1.8%), gasoline stations (+1.8%), and food and beverage (+0.7%). Sales by motor vehicle and parts dealers increased 0.5% in September and followed a 3.3% decrease in August.
Thanks for reading Should You Buy the Dip – Week in Review!
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Prakash Kolli is the founder of the Dividend Power site. He is a self-taught investor, analyst, and writer on dividend growth stocks and financial independence. His writings can be found on Seeking Alpha, InvestorPlace, Business Insider, Nasdaq, TalkMarkets, ValueWalk, The Money Show, Forbes, Yahoo Finance, and leading financial sites. In addition, he is part of the Portfolio Insight and Sure Dividend teams. He was recently in the top 1.0% and 100 (73 out of over 13,450) financial bloggers, as tracked by TipRanks (an independent analyst tracking site) for his articles on Seeking Alpha.