Cheap Isn’t Always a Bargain

It’s deal-hunting season

A guilty pleasure of mine this time of year is to scan websites for good deals, sorting by the biggest percentage discounts. Anybody who has gone down this dark path already knows that this is a fruitless exercise. All it leads to is hundreds of listings of absolute garbage. Investors often make the same mistake during bear markets.

But do not equate big price declines to value

Nearly one year into this bear market, some have begun to scour the lists of the largest decliners for big discounts, failing to realize that those lists are dominated by prior market leaders for which the risk of failure was drastically underpriced. As the chart below clearly demonstrates, the biggest decliners in the first year of each of the last two bear markets were dominated by underperformers and failures. In each cycle, eight out of ten of those biggest initial decliners — not including the decliners that didn’t last a year from the peak (e.g. Lehman Brothers) — underperformed the market significantly in the subsequent decade (or however long they continued to trade). See Appendix for further details.