MARKET COMMENT
Be Prepared To Average Up

By David Kuo (TMFDragon)
December 1, 2003

In recent years, a lot of column inches have been devoted to the practice of averaging down. This is what investors do when they buy additional shares in a company at a price lower than they bought originally. This effectively reduces the average 'buy price' for the shares.

Averaging up is exactly the opposite of averaging down. It occurs when investors decide to buy more shares at a higher price, and this will effectively raise the average buy price of the shares.

Curiously though, investors can be quite reluctant to average up. Their reasons for not doing so stem from a belief that they are now being forced to pay more for a share in a company than they did before. For example, investors who bought shares some eight months ago, when the stock market was wallowing at multi-year lows, are now faced with an interesting problem of whether to buy more shares at today's higher prices.

Paradoxically, investors who choose to average up may be paying more in terms of the price per share but. perhaps, not in terms of the quality of earnings that these companies are now expected to deliver.

Take, for example, Tesco (LSE: TSCO), which stood on a valuation of 10 times prospective profits in March. At that time, there was some uncertainty over whether Tesco would be able to meet its 2003 profit target. Furthermore, even at that prospective valuation of 10 times earnings, the shares, which cost 163p each, were considered by some to be expensive!

Today, Tesco is valued at 14 times earnings, 40% more expensive than in March. However, with profits expected to grow by 17% to £1.6b, and a further 11% to £1.8b in 2005, the shares, which currently stand at 249p, still do not look that expensive. The prospective dividend yield of 3% is not that bad either.

When we invest, we should be looking around for a home for our money based on prevailing market conditions. This may mean buying shares at a higher or, in some cases, lower price than before. However, it is best not to get too bogged down with the semantics about averaging up or down. Instead, the focus of any stock market investor should be whether the shares look cheap, and if that means having to average up, then so be it.