Pete Wargent blogspot

Co-founder & CEO of AllenWargent property buyer's agents, offices in Brisbane (Riverside) & Sydney (Martin Place), and CEO of WargentAdvisory (providing subscription analysis, reports & services to institutional clients).

4 x finance/investment author - 'Get a Financial Grip: a simple plan for financial freedom’ (2012) rated Top 10 finance books by Money Magazine & Dymocks.

"Unfortunately so much commentary is self-serving or sensationalist. Pete Wargent shines through with his clear, sober & dispassionate analysis of the housing market, which is so valuable. Pete drills into the facts & unlocks the details that others gloss over in their rush to get a headline. On housing Pete is a must read, must follow - he is one of the better property analysts in Australia" - Stephen Koukoulas, MD of Market Economics, former Senior Economics Adviser to Prime Minister Gillard.

"Pete Wargent is one of Australia's brightest financial minds - a must-follow for articulate, accurate & in-depth analysis." - David Scutt, Business Insider, leading Australian market analyst.

"I've been investing for over 40 years & read nearly every investment book ever written yet I still learned new concepts in his books. Pete Wargent is one of Australia's finest young financial commentators." - Michael Yardney, Australia's leading property expert, Amazon #1 best-selling author.

"The most knowledgeable person on Aussie real estate markets - Pete's work is great, loads of good data and charts, the most comprehensive analyst I follow in Australia. If you follow Australia, follow Pete Wargent" - Jonathan Tepper, Variant Perception, Global Macroeconomic Research, and author of the New York Times bestsellers 'End Game' and 'Code Red'.

"Pete's daily analysis is unputdownable" - Dr. Chris Caton, Chief Economist, BT Financial.

Tuesday, 31 January 2012

What happened to Aussie property values in 2011?

Very broadly speaking, affordability improved, which I think most people will agree is a welcome development.
Average household incomes grew by a surprisingly robust 7% in the year to September 2011, while dwelling values fell steadily throughout the year, capital city values dropping by an average 3.5% over the year.
On a city by city basis, values fell by:
Sydney  -0.5%
Melbourne  -5.6%
Perth  -3.9%
Brisbane  -7.0%
Adelaide -5.0%
Darwin -3.7%
Canberra -1.6%
With interest rates being cut twice in November and December 2011 (and fixed mortgage rates now available at a very cheap 5.9%), this has taken the edge off the affordability issue for the time being at least.
RP Data reported that disposable income has outgrown property price growth by 15% since 2003 - and the figure is around double that in Sydney where values hit astronomic levels in the first quarter of 2004.
Dwelling values in the last month of the year were flat, which may indicate that a period of stability is on the way, the interest rate cuts having brought some relief for now.
Went on the restored Strahan-Queenstown railway yesterday, which was excellent, and did a cruise today down the World Heritage Listed Gordon River today.
Apparently, it has the cleanest air (and definitely some of the coldest) in the world down here, for which we should be grateful to the hordes of protesters of 1981 who prevented the giant HEP station being built on what is now a protected site.
Another few days in Tasmania, then will be heading back to warmer climes in Melbourne, if that isn’t some kind of contradiction…

Thursday, 26 January 2012

So what happens on February 7 then?

OK, now the dust has settled from the inflation data, what’s going to happen on February 7?
Economic forecasters are split right down the middle: half think that the interest rates will be cut by 0.25% and half think they will stay on hold.
It’s interesting because a result of a trimmed mean of 0.6% for the quarter if annualised out implies an annual inflation rate of right in the middle of the 2-3% target range.
Even if the result had been just 0.1% lower the odds would be much more in favour of a cut – for 0.5% annualised is only 2% and allows more scope for easing rates.
This is noteworthy to my mind because it is highly questionable that the ABS figures are that accurate that they can be sure to within 0.1%.  How do I know that?  Because they keep revising the historic figures, and not always by one ’tick’ either! 
(it is worth noting that the revisions so far have tended to be upwards in nature, though).
My main argument for a rate cut (apart from the straightforward fact that I’m an inflation dove) would be based on the high value of the Aussie dollar. 
Today the AUD was buying more than $1.065 US dollars again, and that is way, way too high.  Our exporters are in pain (though it’s good for overseas holidays and Olympics attendees, as previously noted).  Heck, commentators were citing the high Aussie dollar as a reason for rate cuts before it even reached parity.
The problem for the Reserve Bank if they do cut is what happens if the next inflation print is back up at 0.8%?  Do they then have to start raising rates and look foolish?  I strongly suspect that ‘not looking foolish’ is one of the prime motivations of such a committee, also know as "the path of least regret".
Anyway, a lot can happen between 26 Jan and Feb 7, and rest assured that all eyes will be carefully focussed on Europe until then.  My eyes will be watching the Aussie dollar, because, frankly, I’m hoping for another rate cut.
After a few days in Hobart, moving on towards the Strahan after a snout up Mt Wellington tomorrow morning.
Australia Day today and it has been a lovely day in Tasmania, but it’s been pretty windy and cold.  
In the absence of any better movies on in Hobart watched  A Few Best Men – one very funny moment being the best man’s speech.  Two stars, ‘nuff said.

Wednesday, 25 January 2012

CPI surprises on the upside at core measure 0.6%

Hmm. Makes an interest rate cut a line ball call now as 0.6% is in the target inflation range.

Q4 inflation figures out later today

Q4 inflation (Consumer Price Index) prints out later today, and I for one am very interested to see how these stats turn out.  Anything less than a trimmed mean of 0.5% for the quarter and the Reserve Bank of Australia will surely be compelled to slash interest rates for a third consecutive meeting.
It comes too late for Toyota, though, redundancies sadly announced a couple of days ago.
Of course, as I always disclose, as an investor I'm permanently touting for low interest rates – but there has been far too much rubbish talked about lifting interest rates due to some mythical outstanding economic outlook by those with ulterior vested interests (intellectual economists who just want to ‘call it’ right, in the main). 
Retail has had a diabolical time, our exporters are making dreadful losses with the dollar still way above parity at above $1.05 and at a 27 year high against the British pound – and not just in their income statements - it is costing Aussies their livelihoods too.
There is one interesting sub-plot here, and that is that genius economic commentator Chris Joye, in scoffing at a prediction made by former advisor to the PM and Chief Economist at Citibank Stephen Koukoulas, announcing that he would run naked around Martin Place naked if interest rates fell to 3.50% by June 2012.
At the time, it didn’t rate much of a mention as interest rates were way up at 4.75% and five interest rate cuts in eight-and-a-bit months would be pretty hot going. 
Let’s see what transpires later today anyway.  Hoping for a low print.

Cameron getting tough on UK benefits. Bravo!

The big news story from the UK is the attempted passing of new laws to limit benefits to £26,000 per annum.  A subject most dear to my heart, of course.

I need to be careful what I say here and limit myself to a few hundred words or so, or else I’ll end up sounding like a curious cross between Mussolini, Mad Max and Maggie Thatcher.  I’ll probably make a few enemies anyway, but I guess ultimately when it comes to benefits, you are on one side of the debate or the other.

Naturally enough, the BBC has featured the obligatory incendiary interviews.  Right on cue, cut to benefit-drawing mother-of-many, bemoaning “how are we supposed to manage on £26,000 per annum? It ain’t right!"

I don’t even know where to start.  No, it certainly ain’t right, I totally accord with your views madam!  May I suggest that one could feasibly seek remedy through commencing to seek some form of gainful employment? Crumbs.

By my calculations with a minimum wage of £6.08 per hour, this means that decent hard-working people are working full time for a full year to earn less than £12,500, while others who have never worked, will never work and have no intention of ever working are carping and whingeing about a cap on benefits at £26,000 (while drawing on two Silk Cuts, naturally).

The very foundation of a stable civilized nation is based upon a respectable working class who actually work and keep the country moving. 

Australia is a bit more like London in one respect - we are very fortunate in that we have a constant supply of immigrants who will thankfully do the McJobs that most of us will not. 

Britain is currently running the risk of developing a totally new class system.  No longer the landed aristocracy, the artisan middle class and the respectable working class.  Instead, it will become those who work and those who simply aren’t interested.

Politics in the UK is changing too.  There used to be a bitter conflict between the Socialist Worker readership and the centre-right.  Whatever one used to think of Arthur Scargill, the cross-industry strikes and the rent-a-mob flying pickets, at least underneath the headline-grabbing protagonists were a couple of hundred thousand mainly decent and hard-working miners – good, family people who were no-one’s enemies, and more pertinently, actually only wanted the right to work for a fair wage.

Now the lines are being re-drawn between the employed and those permanently drawing benefits.  Tony Blair had the right idea on one thing: an unemployment benefit called a Job-Seekers Allowance.  Not a £30,000-and-a-6-bedroom-house-for-anyone-who-churns-out-enough -kids-Allowance.  The system is, quite literally, out of control.

Of course, there are also perfectly decent people who need benefits – we all acknowledge that and I’m certainly not taking a pop at them here.  But, at the risk of sounding Dickensian, I reckon there needs to be some sort of voucher system (an excellent, draconian concept that I quite gladly borrow from one of my esteemed Sydney buddies – brilliantly conceived one sunny afternoon in the Tea Gardens Hotel, Bondi Junction, if memory serves) that disallows people from drawing benefits to spend on cigarettes, trips to Ibiza, satellite television and cans of Carling. 

Oh, but it’s a restriction of liberty?  Tough!  The country can’t afford to continue the way it has been, so that’s life, I’m afraid.

I don’t suppose you can blame people for not wanting to work.  It’s the system we have given them.  You can make more money and get a bigger house by doing nothing at all.  What a crazy concept.

Whenever my Australian friends talk about that UKTV show Secret Millionaire they are utterly amazed by what they have seen.  I’m pretty amazed myself.  Ghetto housing estates of drug-addicted unemployed in towns and cities dotted all around the UK.  It’s not PC to say so, of course, but this is what the existing welfare system in Britain is creating: dependency.  People have to have some incentive to work or else we’re all going to hell in a handcart.

The welfare state was introduced to help those in need of benefits, not those who need help to get off their backsides - and Cameron is spot on in what he is saying.

One thing Australia does right: phone lines to dob in tax evaders and benefit cheats.  Yep, introduce that too. Ooh, it will be all George Orwell and 1984.  So what?  Nothing used to make me madder than working in the factory and seeing the mysterious lack of employee attendance on a Tuesday morning - benefit day.  It’s nigh on time that kind of abuse of the system was stopped once and for all. 

I have to stop typing.  I think I may have to go in to politics as an independent or risk becoming a seriously cantankerous old bloke.  What am I saying?  I am a cantankerous old bloke. Hmmph.

Monday, 23 January 2012

Aussie stocks are comparatively cheap (so are Europe's mind)

Just from tracking the movements of the indices it has been very obvious that the Aussie market has underperformed the US badly of late.
A report today said that European stocks are the cheapest they have been as compared to the US since 2004.
We know Europe has its problems.  Down under, our problems are more related to the strong Aussie dollar which is making investing in stocks here far less attractive for overseas investors.
Q. Just how cheap are Aussie stocks compared to the US?
The Price to Earnings ratio of Dow Jones stocks in the US today averages at 13.73.
How does this compare to our top companies?  Here’s a snapshot as of close of business 23/1/2012:
BHP Billiton – 9.87
Rio Tinto – 8.13
CommBank – 11.20
NAB – 9.53
ANZ – 9.82
Westpac – 10.10
The answer is that Aussie stocks are much cheaper - and Australia is somewhat better positioned than most to avoid recession if Europe does implode.
Would still be nice to see that interest rate cut on Feb 7 though…
Went to Port Arthur historical site today where one of Tasmania’s huge convict prisons is located. 
Absolutely stunning place and well worth a visit.  Entry price includes a whole day of stuff to see and a harbour cruise.  They’ve done a really fantastic restoration job.
Still no closer to tracking down my convict ancestry though.  William Wargent was deported from Herefordshire, UK to Van Diemen's Land (Tasmania) in 1840 on the ship the Asia…but not to this prison it trasnspired.
In Hobart tonight, so will continue my search tomorrow (while taking in a bit of the 4th Test v India, of course).

Saturday, 21 January 2012

Michael Yardney on Sydney population growth

Read property expert Michael Yardney on Sydney population growth versus construction activity here.
This is exactly the point I have been making!
Sydney’s population is increasing by 1.7% per annum – that is 75,000 extra people every single year, now up to 4.58 million people.
It might not sound too much, but to put that in perspective, in 10 years we will have 5,330,000 people squeezed in to the same limited space.
We need to start building now or else we will have a very serious affordability crisis.

Friday, 20 January 2012

Drive a car like James Packer...for $20,000.

Great article in today’s Herald Sun on the best car buys for under $20,000.
It’s well known that cars can lose 20-40% of their value the second you drive them of the forecourt.
Statistically, the best buys can be those of cars that are 7-8 years old and with 100,000kms+ on the clock, as they tend to have fully depreciated by that stage.
Herald Sun’s top picks:
Ø  BMW 735li (2002) for $19,500 – price when new $170,000
Ø  Mercedes Benz S320 (2002) for $19,500 – price when new $180,000
Very nice too!

Been in Tasmania for the last week-and-a bit.  It’s a rather lovely place, very old fashioned and quaint.
It can be a bit confusing with all the place names, as they are mainly those of English towns and cities.  Drove to the Bay of Fires from St. Helens today.
The Aboriginal names never stuck here so much as there were only up to 15,000 Aborigines here until British colonisation in 1803.  By 1830, Tasmania being a small island, almost all Aborigines had died from unfamiliar diseases to which they had no immunity.
When I get to Hobart, I hope to look in to why the Wargents ended up in Australia.  William Wargent was one of 276 convicts deported to Tasmania in 1840 on the ship the Asia.
Wargent is a reasonably common name Down Under - not so much in England - as far as I could ever tell anyway.

Aussie dollar flying high...STILL.

Who remembers when a single British pound bought 3 Aussie dollars?  I do!  Everything in Australia just seemed so cheap back then, as a Pom it was a veritable pleasure to visit a restaurant and indulge!
Not so any longer! This week, the AUD hit a 27 year high against the desperate English pound (which was buying only $1.47).  And that is after the two interest rate cuts in Australia in late 2011.
The Aussie is still flying high against the USD too, buying over 104 US cents this week.
Of course, this is all great if you’re an Aussie going to the London Olypmics this winter (or, like me, just going to spend some time over there) but it’s not really great for the country as a whole.
Australia, roughly speaking, is a country that digs stuff up and sells it to Asia. 
With the Aussie dollar so strong, some companies are now struggling to make a profit.
Companies are valued by estimating their future cash inflows and outflows and discounting these back to today’s value using an appropriate rate of return.
So what happens, when a once-great company stops being able to generate profits. 
Bluescope Steel (BSL) was one of Australia’s greatest companies, but it has had an absolutely desperate time since the global financial crisis, as charted below.  This resulted in the closure of their Port Kembla plant and thousands of jobs lost..
Inflation data is out next week.  Here’s hoping for a benign inflation print for the 4th quarter of 2011 and another 25 basis points interest rate cut on February 7.

Sportingbet mispricing? Australia at $1.75 to whitewash India...

Of course, I don’t advocate gambling irresponsibly as it can bring terrible crises upon families, but I definitely do take an interest in when odds get mispriced.
Today, Sportingbet are here offering a very generous $1.75 on Australia to beat India in the 4th Test.
Given how miserably India has performed in Tests one, two and three that does seem very generous indeed.
The punters have agreed with me, with over 96% of bets so far going on Australia.  The bookies could be in for a hiding on this one.
Potential stumbling blocks: Tendulkar makes his 100th international hundred a double or even a triple, the pitch is exceptionally benign…or it rains a lot (but five days of glorious 35 degree Adelaide sunshine are forecast).

Tuesday, 17 January 2012

Predictonomics 202

Most overused phrase by economists in 2012 so far: “Cautious optimism.”
Even the McDaddy of Australian economists, Shane Oliver of AMP, was heard to say the magic words, that they were “cautiously optimistic”.
It’s a nothing phrase.  Let me translate: “We think the stock market is heading up.  But it might go down too and we want to be able to say we got it right.”
Here are some other great prediction ruses.
2 – Make lots of predictions.  Some of them must be right!
3 – The Wide Spread: “We think the property market will go up by between 2% and 13% this year.  The funny thing about this is that they still manage to get it wrong so often!
4 – Change your predictions retrospectively.  Amazingly, this happens too – just tell people you predicted the economic outcome correctly, they won’t remember what you said, right?
5 – Cover all bases.  Here’s a classic: “I think interest rates are heading up…but I actually hope they go down.”
6 – Write long rambling predictions and then highlight one paragraph after the event…
You’ll see all of these and more in 2012…
Went to the Beaconsfield mine museum today and it was splendid.  Respect to those guys who survived the terrible mine collapse (and the rescuers) in 2006, it must have been truly awful.
Going to check out the Boag’s brewery tour tomorrow in warm Launceston.

Monday, 16 January 2012

Population boom-time returneth

With so much talk of an impending property crash, notably from the Lord Chief of Doomsayers, Professor Steven Keen (who has “predicted 6 of the last 2 crashes”) it is often worth reflecting on Australia’s demographics.
ANZ flagged today that the net arrivals from immigration is tracking at around 267,000 for the year, up from 230,000 in the prior year - as quoted on Christopher Joye’s excellent blog which you can read here.
That equates to a population growth of about 1.75% per annum as compared to 1.4% for last year.
Those are serious numbers for a country with a population as small and concentrated as that of Australia - and provide property investors with comfort that provided they are investing in the cities and suburbs where the immigrants are heading, the long term directon of values is north.
Significant immigration and property value growth are often strongly linked.
Currently staying at Beauty Point near Beaconsfield in Tasmania.
Beaconsfield is famous for the earthquake and mine collapse here in 2006. 
Of the 17 underground miners, 14 escaped immediately, one died and two were trapped underground for 2 weeks before being rescued.  They survived on rainwater that seeped through the rock.
Will check out the museum tomorrow before heading to Launceston.

Friday, 13 January 2012

"Neither a borrower nor a lender be."

It interests me how proverbs written sometimes thousands of years ago still ring true today.
This one was written by Shakespeare over 400 years ago (wise old man Polonius in the play Hamlet!):
“Neither a borrower nor a lender be.”
Very wise words.  I’ve only been involved in lending friends money a few times and it’s created tension and trouble every time.
When is it OK to lend?
There are essentially only two types of investments: ownership investments (commodities, shares, business, property) and lending investments.
Lending investments include assets such as bonds, bills and notes (and their Government equivalents T-bonds, T-bills, T-notes…) and involve you effectively lending a company or Government your funds in return for regular interest payments (‘coupon’) and, hopefully, the return of your capital at a future date.
There is a time and a place for lending investments.  They can be lower risk and so assets such as bonds are ideally suited to those nearing a retirement age (shares can be volatile) and can be used as a hedge against potential deflation.
In a capitalist and inflationary environment, though, ownership investments over time create greater wealth – because they allow the investor to participate in capital growth upside.
When is it OK to borrow?
You might sometimes hear reference to good debt and bad debt.
Bad debt is said to be borrowing for buying consumer goods – cars, plasma screens…anything that depreciates in value.
Good debt is said to be borrowing to buy assets…margin loans to buy shares or mortgages to buy investment properties.  This is sometimes also known as using gearing or leverage.
Gearing in this manner definitely can work.  It is a time-tested method of wealth creation.
Go easy, Tiger
Don’t be misled by the term good debt though.  Debt can be a useful tool to create wealth, no question, but too much of anything can kill you.
There was an old classic theory of finance that said that the more debt a company took on, the more it was worth (because of the tax shield – interest payments being tax deductible – and because the debt could be used to create more wealth).
Yeah, OK, that’s fine in theory but it didn’t work for Enron or Centro, did it?  Some debt is OK; too much debt that can’t easily be serviced is dangerous.
That is why I suggest keeping loan to asset value ratios (LVR) reasonably low.
Personally, I have some interest only loans because they can super-charge wealth creation, but I have some principal and interest loans too to pay down debt.  The LVR on my UK properties is less than 50%, for example.
Arrived in Tasmania last night on the ferry.  It was a reasonable crossing but still felt a bit queasy, though dealt with that by having a curry last night.  Marvellous.
Beautiful sunny day, so going to hop on the ferry across to (West) Devonport, and hopefully catch a bit of the Test Match on TV later. 

Wednesday, 11 January 2012

The 'January effect'?

Is this the start of a stock market revival or just the hallowed January effect?
The January effect (ring any bells? Cf. the Santa Claus Rally?) is a recognised phenomenon whereby securities tend to appreciate in the first month of the new year.
The effect was noted as long ago as 1925, and tends to be at its most prominent smack bang in the middle of January (i.e. now!).
Note, however, that historically the January effect seems to affect the small cap and mid cap stocks far more than the efficiently-priced large caps.
The January effect was said to be caused by income-tax sensitive individuals offloading before Xmas and buying again in January.
Of course, that might be true in the USA, but not in UK or Down Under in Oz where the tax years run to 5 April and 30 June respectively (though what happens in the US can be followed overseas, almost religiously sometimes).
Interestingly for the Aussie market, the ASX seems to have a lot more ‘room’ to move upwards than other global markets.
The Dow Jones Industrial Average in the US is all the way up to 12,463, which isn’t getting a million miles away from its almighty peak of over 14,000 in the heady days of October 2007.
In Australia, on the other hand, stocks are still relatively cheap, with single PE ratios abounding and the XJO a world away from its peak of nearly SEVEN THOUSAND, now only at 4,218 as I write this...
It’s freezing in Melbourne. C’est tout.

Saturday, 7 January 2012

Are Aussie stocks cheap at the moment?

Anyone who has invested in Aussie stocks over the past few years would tell you that it had been a frustrating experience.  The market tends to underperform, or so it seems.
But is that really true? Well, yes it is – the Aussie market has underperformed the global equity markets for some six years now.
Price to earnings ratios (price per share/earnings per share) are still hovering in the high single digits for a lot of the finest companies.  The historical average for Australian stocks has been around 15, so you might say that stocks are selling for a third off at the moment as compared to historical averages. 
There is certainly much more value to be found here than the US, for example, although PE ratios do have inherent limitations - for example, they are based on historic profits and 'old' information, and they don't take in to account non-recurring accounting/book entries.
Why so cheap?
One trend I have definitely noticed is that with Australia being ahead in the time zones, Monday trading is often totally directionless.  The market lacks a spine of its own and without a cue to take from the American markets, it seems to fall or trade very thinly every Monday, which is enormously frustrating.
However, that wouldn’t explain a long-term underperformance.
I think the real reason for the cheap prices is the strength of the Aussie dollar.  A  significant chunk of Australian shares are held by foreign investors and with the AUD riding so high, it just doesn’t seem to be an attractive market right now.
The Australian dollar is still stronger than the US dollar and against the Euro it tipped an all-time high yesterday. The British pund only buys 150 Aussie cents as compared to around double that a decade ago.
Of course, with interest rates still over 4% the fixed interest products are still seeing plenty of action, but not so much the share market.
This may change if rates drop further in February, but most analysts seem to agree that interest rates won’t fall too much further in this cycle so it could be a long slow recovery for Aussie shares.

Friday, 6 January 2012

Dividend stripping

What is dividend stripping?
The practice of buying a stock just before the dividend is paid in order to receive the dividend payment before going on to sell the stock.
The hope is that after the dividend is paid the share price falls by less than the value of the dividend plus the associated tax benefit received by the investor (the franking credit).
The investor gets a dividend income and a capital loss, the tax treatment of which can make the transaction favourable to the investor overall.
The investor has to be wary of brokerage costs eating in to any profit and the risk of holding the shares overnight (there could be price sensitive news in that time, for example).
Companies themselves sometimes use dividend stripping as a tax avoidance scheme – which is not so good!
The date when the share price drops is known as the ex-dividend date, and most times the share price falls in a rational manner by the amount of the dividend.
Does it work?
It can in a bull market...this strategy can work OK when prices are in an upward trend.
In a bear market the price might fall by more than the value of the dividend, so you’ll be left with a stock you didn’t want to hold at a lower price.  So, not so good in that scenario.
The market is generally seen to be 'efficient', so it is hnot straight-forward to make 'easy profits' in this manner.

Wednesday, 4 January 2012

Down down, deeper and down

US stocks started the year with healthy gains, and it’s easily forgotten that the US market was actually UP across 2011, by around 5% or so.  No-one yet knows if this is the first sign of a market recovery.
The smartest investors make money in down markets too – some by short-selling stocks others by averaging down (sometimes also known as stockpiling).
One of Buffett’s favourite questions is: if you are going to be buying stocks for the next five years do you want the market to go up or down? 
The right answer is: DOWN.
The reason: so you can buy more stocks at better prices.  Counter-intuitive perhaps, but correct.
If you know the intrinsic value of a company is $50 and its price falls to $25, buy more.  Easy!
The point is that price and value are not the same thing.  Obviously, this entails knowing how to value a company.
Averaging down
The theory goes like this: you buy a stock at $50.  It falls in price to $40 and you buy more, thus reducing your average cost per share.  It falls again to $30 and you buy more reducing your average cost further.
When it returns to above $50, you have made healthy profits. Simple.
If you bought at $50 and it went up straight away then…happy days…so you win either way.  Right?
3 ways that averaging down MIGHT stuff you up
1)      Picking a dud company
If you had averaged down in to Enron (or General Motors, WorldCom, Ansett, Lehman Brother, washington Mutual, or....) you would have eventually ended up with a stock with $0.  So, you’ve lost all your money there.  Not ideal really.
In the Aussie market a lot of people seem to have been caught out averaging down in to Bluescope Steel (BSL) from above $12.00 all the way down to below 40 cents. 
People thought that the losses the company made in the financial crisis would be reversed in to profits and it just hasn’t happened.  Key lesson: turn-around stories don’t always turn around (so stick to companies making healthy profits).
“But Enron was profitable too?” – yes, true, but nobody understood what the heck they were doing and what derivatives they were using, not even the Directors of Enron.  Key lesson 2: stick to simple businesses that you understand.
2)      Finite capital
Not a problem for Buffett with his $50 billion stash, but it can easily be a problem for individual investors. If you initially invest 30% of your capital and then the price falls and you invest another cash can soon all be used up and you become unable to capitalise on the lowest available prices.  Step forward if this happened to you before…ah, Mr. P. Wargent esq.….
3)      Losing your bottle
While averaging down is great in theory, it can be devilishly difficult to BUY when everyone else is panicking and SELLING. 
“What do they all know that I don’t?” – sometimes the market might be right! 
Again, experienced investors like Buffett have the confidence in their own opinions.  Most average investors (yep, that’s us) look at the plummeting share prices and worry themselves stupid.
Averaging down:  a great tactic but only for investing in great companies!