Averaging in the Works

Please notice that situations such as these are few and far between. We must say that for every EVCI and EVOL that we have ever owned, we have had just as many stocks tank immediately after purchasing them. We recall once buying a stock in a now defunct company called Net Gravity (NASDAQ: NETG). If we remember the stock was an online advertising company similar to Double Click. While we don't exactly remember all of the specifics about this particular company, we do remember the stock tanking hard just a few days after we bought it. We believe that our wallets were about ten grand lighter when the dust had settled!

So, now that we have explained why we don't put off purchasing a negatively trending stock, permit us to disclose our rationale for averaging down. In the vast majority of cases, the stocks that we purchase in the beginning decline in value. As we are making the purchase during a sustained downward trend, this is not unexpected. We will generally re-review the stock in question and if our confidence in the stock's fundamentals is reaffirmed, we will average down on the stock. The key to averaging down is to do it in undersized increments. A recent article critical of averaging down asked the question of when was the right time to average down, the article presented a negatively trending stock and asked “Do you average down here?" "How about here?" The article made the point that you don't know when a negatively trending stock will take a turn for the better, so there is no good way to time an averaging down purchase. We agree with this assessment and that is why we sponsor averaging down in multiple small increments.

We will give you an example of how averaging down once worked to our advantage. In January of 2004, we found a stock that we considered to have stupendous fundamentals. The stock was J2 Global Communications, Inc. (NASDAQ: JCOM) and, as is natural, it was in a downward trend at the time. Within a few days of purchasing the stock, JCOM took a sharp nose dive. While we did expect the stock to continue downtrending, we certainly did not anticipate such a rapid decline. We reviewed JCOM's fundamentals and reread a few of its SEC filings. We felt assured in the stock so we added a few more shares to our holdings at the lower prices. As JCOM continued its slide we were beginning to second guess ourselves! Fortunately for us, the company soon held its quarterly conference call and our confidence in the stock was bolstered. Everything with JCOM looked great. It had outstanding P/E and PEG ratios, remarkable growth, money in the bank, and little debt. Despite these extraordinary fundamentals, JCOM stock continued to weaken, due in large part to an ever-increasing short position on the stock. Right then and there we made a conscious decision to average down in a major way. The strong fundamentals combined with the large short position led us to believe that JCOM was due to turn around and make a nice run. We felt so strongly about this that we drove down to the local branch of our online broke and deposited additional funds into our account. As JCOM continued to fall we made numerous small purchases to average down our position. Over a one and a half month period our preliminary entry price of just over twenty seven dollars was averaged down to approximately twenty three dollars. We also more than doubled my holdings of JCOM stock in this process. We set tight stops with most of our investments, but we were not doing so with JCOM. Because we were averaging our position down, a tight stop would have defeated our purpose. In lieu of setting a tight stop, we closely monitored the stock. we would not recommend this tactic for those with weak constitutions as watching your averaged down position slowly decline is a tormenting experience. From our initial entry at twenty seven dollars, JCOM slid to a low of just under nineteen dollars. We had lowered our break even point and we had accumulated a large number of shares by averaging down. On the downside, we had nearly doubled our investment in this stock and our risk was substantially increased. We took these actions with JCOM because we were confident in our due diligence. Of course, we could have been wrong and paid the price in the form of a massive loss. It would not be the first time and it certainly would not be the last. Fortunately, JCOM stemmed its slide around nineteen dollars and soon rose past our break even point. Once this happened we loosened our leash on the stock and monitored it less closely. JCOM had turned the comer and we knew that the shorters would soon move quickly to cover their substantial short positions. This situation combined with renewed interest in the rising stock would permit JCOM to achieve a nice rise. JCOM has risen from its low of just under $19 to split adjusted highs eclipsing $60 over the past two years.

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