Image source: Getty Images
A stock market crash can give investors the chance to buy quality shares at bargain prices. But strategic repositioning in December can also create amazing opportunities.
The end of the calendar year is a popular time for fund managers to make strategic portfolio moves. And this is something long-term retail investors can benefit from — if they know where to look.
December sales
In Warren Buffett’s words, what creates opportunities in the stock market is other people doing dumb things. And December can be an especially good time for that kind of thing.
At the end of the year, fund managers have strong incentives to sell underperforming stocks – regardless of what they think of their long-term prospects. And this can create opportunities.
One reason is tax. Selling something that’s down and realising a loss can reduce the amount of tax an institution has to pay on its winners, which can boost the firm’s overall returns.
Another is marketing. When clients are deciding what to do with their finances in January, nobody wants to show them they’ve been holding something all year that’s down 70%.
Institutions obviously can’t commit fraud or mislead investors. But they can legally sell stocks that are down to reduce their tax liabilities and make themselves more attractive.
Retail investors, however, don’t have to worry about these things. So additional pressure on shares that are already cheap can be a good place to look for buying opportunities.
An example
A good example is Lululemon Athletica (NASDAQ:LULU). The stock is down 52% in the last 12 months (and 48% over the last five years).
A lot of the decline, however, is a result of valuation multiples contracting. The stock was trading at a price-to-earnings (P/E) ratio of 22 at the start of the year (and 86 back in 2020).
There are some signs of weakness in the underlying business – sales growth has just started to turn negative. And this does highlight an important set of risks with the company.
Switching costs for customers are virtually zero, so there’s always a risk of competition. On top of this, there’s a danger of consumers going away entirely when things are tight.
That’s why the stock is down, but there’s a lot to like about the business. It has a strong brand, its financial position looks good, and that makes it well worth considering at the right price.
At a P/E ratio of 12, it looks interesting. But if the stock falls another 10% in December – and there are good reasons to think this is possible – it might become too cheap for me to ignore.
Value investing
I’m not saying investors should buy stocks just because they’re down. That’s a recipe for finding value traps instead of good opportunities.
I do think, though, that the end of the year can create some interesting opportunities. Fund managers aren’t stupid, but they are incentivised in a certain way and this is worth keeping in mind.
Could something like this cause me to buy Lululemon shares before the end of the year? Potentially – but there are a number of other names that are also jumping out at me right now.
