Don't Buy Low … Buy High

John Wightkin
Director of Equity Research Applications, Schwab Center for Financial Research
November 10, 2009

Key points

Buying low and selling high is useful investment advice. But what is "low?"
We'll explain why one commonly used methodology—buying at the 52-week low—may be less effective than buying at the 52-week high.
Helpful information for stock investors.

You may have heard the investment adage: Buy low and sell high. This is one of the oldest pieces of investment advice. However, putting this advice to work is easier said than done.

One of the biggest challenges is determining what is "low." We did some research and found surprising results.

By buying stocks at their 52-week low, you're more likely to own the wrong stocks most of the time. Buying at the 52-week high, however, showed promising results. Read on and I'll explain why.

Debunking the buy low/sell high advice
Examining stocks at their 52-week lows is a popular screen used by many investors and traders who are looking for buy candidates they can research further. The idea is that the 52-week low represents a level of support for the stock price and, therefore, a point to buy the stock.

The hope is that these stocks have been oversold and are more likely to rebound in price and outperform other stocks going forward. The reality, however, is something different.

Our research
To investigate the merits of "buy low, sell high" advice, we divided a universe of stocks, comprised of the top 1,500 stocks ranked by market capitalization, into three groups:

The 52-week low: Stocks whose current price is at most 10% greater than their 52 week low.
The 52-week high: Stocks whose current price is greater than or equal to 90% of their 52-week highs.
Other: Stocks that weren't included in the first two groups.

At the end of each month, from December 1989 through September 2009, we formed these three groups and examined their subsequent 12-month average relative returns. We thought that our 52-week low group would outperform both the average stock return in our universe and those in our 52-week high group.

Surprisingly, we discovered just the opposite. Our 52-week low group underperformed the average stock return by 3.2% historically on a 12-month return basis. Our 52-week high group, meanwhile, performed better than our universe average by 1.5% annually.

We also examined the performance of these two groups in different market environments. Take a look at the table below, which shows:

The average 12-month return to the 52-week high and low groups in up and down markets.
The percent of positive return periods in up and down markets. An up market occurs when the 12-month return to our universe is positive. A down market is just the opposite.

Based on this breakout, the 52-week-low group struggles significantly in up markets and barely outperforms in down markets. The 52-week-high group, however, performs admirably in both up and down markets. Unexpectedly, it actually performs significantly better in down markets than up markets.

The 52-week high and low groups in up and down markets

	52-week-low group	52-week-high group
Up market excess return	-3.6%	1%
Percent positive excess return in up markets	27%	64%
Down market excess return	0.8%	4.4%
Percent positive excess return in down markets	55%	79%

Source: Schwab Center for Financial Research. Top 1,500 stocks by market capitalization from December 1989 to September 2009.

These results clearly show the weakness in using the 52-week low to identify stocks to "buy low." Even buying stocks that are A- and B-rated by Schwab Equity Ratings from the 52-week low group, as shown in the next table, seem to only help you break even. This table also shows the significant underperformance of stocks trading at their 52-week lows that are F-rated.

You probably should avoid these stocks at all costs. The problem is that the stocks trading at their 52-week low may be low for a reason and could continue to drop in price. In other words, don't wait for a bounce that's unlikely to come anytime soon.

Average 12-month excess returns to Schwab Equity Ratings within the 52-week high and low groups

Schwab Equity Rating	52-week-low group	52-week-high group
A	0.23	3.68
B	0.20	2.53
C	-2.15	1.20
D	-6.74	-0.58
F	-11.44	-5.01

Source: Schwab Center for Financial Research. Top 1,500 stocks by market capitalization from December 1989 to September 2009.

Explaining the performance difference
One of the major reasons for these surprising results relates to fundamentals. A stock often hits a new high because investors believe it's a good investment with improving fundamentals—thus leading to a preponderance of positive earnings surprises.

You can see this most clearly in the relative outperformance of the 52-week high group in down markets where the better-quality stocks are most revealed.

Conversely, stocks making new lows are often perceived by a majority of investors to have poor fundamentals that continue to surprise on the downside. So possibly due to declining fundamentals, the price of these stocks may continue to drop.

This is most visible when Schwab Equity Ratings can't even identify winners among this group, as the second table showed—the declining fundamentals are just too poor.

Investor psychology also plays a major part in explaining these results. When bad news pushes a stock's price down over the past 12 months, investors are often unwilling to sell at a price that is as low as the new information implies. Eventually, the information usually prevails and the price continues to move down.

This is especially true for stocks with the worst fundamentals, as the Schwab Equity Ratings demonstrated in the significant underperformance of the F-rated stocks trading at their 52-week lows.

When good news has pushed a stock's price up over the past 12 months (which is related to being near or establishing a new 52-week high), investors are often reluctant to bid the price of the stock higher even if new information warrants it. Eventually, the information usually prevails and the stock's price often continues to move up, resulting in a continuation. (See Read more on the right.)

Finding winners at the 52-week high
As shown in the first table, the 52-week high group clearly dominates the last two decades, outperforming the 52-week low group overall, in up markets and in down markets. It's noticeably a better "buy low" point.

Your next step, then, is to screen for stocks making new highs and buy them. Well, almost. There's one caveat: You need to know which stocks in this group are more likely to outperform. Some new highs may be near the end of a trend.

To identify the better-performing stocks making new highs, we turn to Schwab Equity Ratings for help. In the second table, you can see that A-rated stocks significantly outperformed F-rated stocks among the 52-week high stocks. Focusing on A-rated stocks among those making new highs can probably improve your selection success and help you avoid those nearing the end of their run.

Putting this advice into action
As surprising as it may seem, we've shown that just substituting "buy high, sell higher" for "buy low, sell high" can possibly improve your investment success. Overlaying Schwab Equity Ratings on this strategy might only improve it.

An efficient way to execute this advice and create a candidate list is to use our Stock Screener. Here are a few simple steps to get you started.

Choose the following criteria in the screener:

Under Basic Criteria, check Index and click the S&P 500, 400 and 600 indexes. (Note: Continue following the steps below, you don't need to save the screen yet.)
Under Analyst Ratings, check Schwab Equity Rating and click the A-Rated stocks.
Under Price Performance, check Percentage Below 52 Week High. To the right, in the Percentage Below 52 Week High selection box, click on the Range link to the right of the 52 Week High header. In the drop-down box, choose "Less than or equal to" and type in 10 in the box to the right. This filters for stocks whose current price is greater than or equal to 90% of the 52-week high.
Click View Matches to see the stocks that made it through the screen.
You should perform other research on these stocks. See Read more on the right.

Bottom line
Buying low and selling high is the goal of any investment strategy. Picking the right "low" could spell the difference between being successful or not.

Important Disclosures

Schwab Equity Ratings use a scale of A, B, C, D and F, and are assigned to approximately 3,000 stocks headquartered in the United States and certain foreign nations where companies typically locate or incorporate for operational or tax reasons. Schwab's outlook is that A-rated stocks, on average, will strongly outperform, and F-rated stocks, on average, will strongly underperform the equities market during the next 12 months.

The information provided is for general informational purposes only and should not be considered as an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Past performance is no guarantee of future results.

(1109-11092)

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