Averaging Down Is Not a Viable Strategy

Investors should exercise caution prior to averaging down. Not every stock dip is a buying opportunity, such as Cineplex Inc’s (TSX:CGX) current weakness.

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At times, investors become too emotionally invested in their stock picks. Emotion is one of the main reasons why retail investors underperform the market, which is why investors should always pause before averaging down.

What does it mean to average down? Simply put, it means buying a stock you already own at a price below your average cost basis. This has the net effect of reducing your average cost price per share.

However, averaging down in and of itself is not a viable strategy. Why?

Well, the strategy is solely focused on a company’s share price. One single factor. This is never a wise investment decision.

It ignores a company’s fundamentals, macro events or its place among your portfolio. It’s a common trap. Which one?  That of validating your decision to buy the stock in the first place.

Two Canadian Dividend Aristocrats that have seen recent weakness are Cineplex Inc. (TSX:CGX) and Canadian Tire Corporation Limited (TSX:CTC.A). Should you average down? Let’s find out.

Changing market trends

Cineplex has been one of the worst performing stocks over the past year. The company’s struggles have continued well into 2018 as its share price has lost approximately 25% year-to-date (YTD).

Many Cineplex investors are in the red and may be tempted to average down and lower their cost basis. However, there are plenty of warning signs that should cause investors to think twice.

Cineplex’s struggles have been well documented. The key factor is the lower box office numbers. However, the box office is up 8% YTD, so why is the company’s share price still struggling? Total gross may be up, but attendance continues to trend downwards.

This is a worrisome trend that should not be overlooked.

Cineplex is also expensive. Trading at a 25 times earnings, the company has seen two straight years of declining income. These are not trends investors should follow.

Buying opportunity

Canadian Tire Corporation has been a consistent performer over the last few years. Unlike Cineplex, the company’s recent share price weakness is a buying opportunity.

Canadian Tire posted solid first quarter results. It grew revenues by 8.8% and same store sales by 5.2%. Over the next three years, the company expects to achieve double-digit earnings per share growth.

It’s also cheap, trading at 15.5 earnings and only 12.45 times forward earnings at the time of writing. Analysts continue to be bullish on the company, with nine buys and a one-year average price target of $186.92.

The company has plenty of momentum, and you would do well to average down at today’s prices.

Not all price weaknesses warrant action 

The two stocks above are at opposite ends of the spectrum.

Investors would be wise to increase their position in Canadian Tire. I would advise against the same strategy for Cineplex, however. Although it may be tempting to reduce your cost per share, there is little to suggest that the company will rebound any time soon. Stay patient and hold while the company executes its strategy.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium service or advisor. We’re Motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer, so we sometimes publish articles that may not be in line with recommendations, rankings or other content.

Fool Contributor Mat Litalien is long Cineplex and Canadian Tire Corporation.   

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