Buy good companies when they’re down

A simple rule for making money in the stock market that I’ve learned over the years is to buy good companies when they’re down.

In his book One Up on Wall Street, Lynch talks about this concept in a couple of different instances. One is the Turnaround stock. A Turnaround is a company that is close to bankrupt or is coming out of it. In his book he describes Chrysler in the 1980’s as a successful Turnaround story.

His other description of this concept comes when he talks about the earnings line. He uses the concept of a company that’s growing earnings, and has a high p/e ratio as consequence. However, at some point the p/e ratio pulls back to 15 or lower. It’s at that point the company presents a buying opportunity.

I’ve done this myself with other companies with great success. One particular example was with Activision (ATVI). In 2012, the clouds had gathered over Activision. They were in a bad business relationship with the conglomerate Vivendi. Also, the hype around mobile games had some industry “experts” claim the days were numbered for companies who made games for consoles – companies like Activision.

Around this time Activision’s p/e ratio dropped below 15. That’s when I started buying Activision.

Below you see a chart of Activision from 2012 – 2018. From 2012 to about 2014, you can see the p/e ratio hangs around the 15 or lower mark. This indicates a buying opportunity. In 2018, the p/e ratio sky rockets to over 200 just before the share price declines.

The funny thing is, is that from 2012 – 2014, Activision’s earnings we fantastic. They never stopped making money selling games for consoles. Quarter after quarter, Activision exceeded analyst estimates. The fear that console gaming would be wiped out by mobile gaming never came to pass. This presented a buying opportunity to those who were willing to ignore the predictions of experts and trust that Activision has a long history of making games and being a profitable company.