2 ways to fish at the bottom of the market

Bottom fishing can be incredibly profitable. My best investment over the past few years has been Novavax (NVAX 5.44%)and he remains my best performer in Motley Fool CAPS.

In the fall of 2019, I bought shares of Novavax at $7. By the end of the year, the damn thing was down to $4. I added some extra shares. (I had to ignore the voice in my head that said, “That’s really stupid.”). In February 2021, the stock reached $330 per share. It was very fun.

Can I do it again?

Of course, I want to replicate my Novavax success. So I bought stocks that are down in the cheap seats and have the potential for big upside potential.

My family recently bought a $2 microcap stock, Bike3D (VLD 20.00%), because SpaceX is a major customer. And when carvana (CVNA 5.04%) dropped 90%, we doubled the number of shares. When iBuyer’s top space dog, open door (OPEN 3.23%) fell into the numbers, my family opened a post. Shopify (STORE 1.96%)my favorite stock, is down about 80% from its highs (and it’s still expensive!)

In fact, the best stocks in the market are usually expensive on a price/earnings (P/E) and price/sell (P/S) basis. The market as a whole thinks Shopify is an amazing company and has priced it accordingly. Shopify’s P/E ratio is 282, and that’s after the 80% drop in the stock price.

My goal as an investor is to own stocks in the companies that will become monster stocks in the future. The price of a stock only tells you what the market, as a whole, thinks of a stock. Thus, a dramatic drop in a stock’s price indicates that other investors are becoming more negative towards a company. Investing in this negative environment can be scary. What if the market was right?

To use Carvana as an example, the market thought it was worth $375 per share a year ago. Now the market says it’s worth $22 per share. For me, it’s actually exciting as an investor because I see a huge gap in these prices. I don’t feel like the market was an idiot last year, and now it’s brilliant. Instead, my view is that the market does not know how to value this stock.

How to buy shares that have been killed?

You have to be a philosopher. Remember that almost all billionaires have made their money on the stock market. Elon Musk is the richest man in the world thanks to the stock market. Jeff Bezos, Warren Buffett, Bill Gates – these are all people who have made billions of dollars by owning stocks of the best companies in the world.

The first thing to remember is that a stock market crash, as many of us saw in 2022, hits every optimist who gets rich from stock ownership. The world’s richest people lost billions of their net worth in 2022, while multi-millionaires lost millions. And the rest of us have lost thousands.

It’s just on paper. These are just valuations. And a crash in valuations doesn’t count as a loss unless you actually sell your shares for cash.

Last year my car died and I had to buy a new car. Luckily for me, in 2021 Carvana shares were much closer to $375 per share than $22 per share. So I sold some shares to buy a used car on Carvana. (Great customer service, by the way – they fixed my brakes for free.)

It was quite exciting to be able to buy back shares at a much lower price. I am bullish on Carvana. The company had a bad first quarter. But management has a plan, and my investment thesis remains intact. My one-sentence investment thesis: Used car sales are shifting to the internet, and Carvana – as the top dog and first mover – will be the main beneficiary of this trend.

CVNA given by Y-Charts.

It’s a way of bottom fishing. Start with stocks in your own portfolio! These are the stocks you should know best. Your investments are where your money is, so I hope you know something about your investments. Don’t just blindly add money to stocks that have fallen 90%. As a rule of thumb, I assume most stocks that fall 90% are horrible investments. Over time, good stocks go up and bad stocks go down.

In the short term, amazing price swings can occur. This year, the market has turned really negative on the basis of macro criteria (inflation, war in Ukraine and recession). Remember that a falling stock market makes people scared, and a lot of bail, often taking a loss. And hedge funds sell everyone short.

When the sky falls on the market, even the most amazing companies can see massive declines in stock prices. This is, in my opinion, what happened to Carvana and Shopify. For those with a long-term view, this short-term devastation can be an opportunity.

The other way to fish at the bottom of the market

It can be really scary to buy a stock that is at an all-time low, and all the investors are underwater (except maybe the founder and other insiders). My initial Novavax investment was like this. Recently I bought shares of Velo3D and Opendoor. There’s no pretty mountain in these stock charts. It’s downhill the whole way.

OPEN chart.

OPEN given by Y-Charts.

One of the best ways to deal with fears is to limit the size of your first purchase. If you buy a new stock and it is well below its highs, you could be investing less than 1% of your assets in it. So if your net worth is $100,000, following this rule, you will only buy $1,000 worth of high-risk stocks.

Another method is to pretend that you are buying at the all-time high. Say you normally invest $3,000 in a stock when you feel confident. Velo3D, at its highest, was $13 per share. You could get 230 shares for $3,000 at that price. Instead of using the dollar amount ($3,000), use the share amount. Buy 230 shares of Velo3D at $2 a share. It would cost you less than $500.

You can always add more if the company outperforms and the stock goes up. The key is to make lots of different investments, be patient, and let your winners run.

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