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Here’s why you should never buy at stock market peaks!

This has been a volatile year, with the FTSE 100 slipping from its peak of 7,778 in mid January, even dipping below 7,000 before recovering. That’s bad, isn’t it?

The upside of down

Yes, that’s bad, if you are planning to withdraw money from your pension or ISa funds, as you will get less today than three months ago. However, if you are paying money in, a stock market dip is actually a good thing, because you pick up more company stock or fund units for the same money.

Even experienced investors struggle to get their head around the concept that buying when markets (and sentiment) are down is the right thing to do. People prefer pumping money in when share prices are riding high, but history shows this is a dangerous thing to do.

Top to bottom

Stock markets famously peaked on 31 December 1999, during the dotcom mania. If you had bought the world’s 25 biggest companies at that point, just nine would have delivered a capital gain, according to research from AJ Bell. The winners are: Home Depot (152.3%), Exxon Mobil (91.4%), Oracle (63.5%), Microsoft (59.1%), IBM (44%), Toyota Motor (38.1%), Walmart (25.1%), Intel (24.6%) and Pfizer (10.8%). Here are two UK stocks that have done far, far better than that this millennium.

The likes of General Electric, Cisco Systems, Nokia, Deutsche Telekom, BP, Citigroup, AIG, Time Warner, AT&T, BT, Merck, Vodafone and WorldCom have all lost money, and a lot of it – losses range from 70% to 100%. If you had bought all 25, you would be down 17.2% overall. If that’s enough losers, you might prefer to check out these winners instead.

Similarly, those who bought the world’s largest 25 stocks at the pre-financial crisis peak in 2007 have also lost heavily, despite the long recovery, down on average 6.2%.

Russ Mould, investment director at AJ Bell, reckons investors can learn four things from this.

1. Don’t assume that what works today will always work

New rivals, new technologies and management incompetence, such as a change in strategy or bad acquisition, can unseat the most successful company.

2. Never ignore balance sheet and cash flow

The tech firms that did survive the dotcom crash had strong balance sheets laden with cash. Microsoft reinvented itself while Intel has maintained its technological and scale edge in microprocessor production. In contrast, acquisitive and debt-laden WorldCom collapsed amid an accounting scandal, while Alcatel’s defensive merger with American rival Lucent made a bad situation even more complex.

3. Valuation matters

No matter how good the story looks, you must only pay a reasonable valuation as this leaves room for upside and limits the downside if something goes wrong.

4. Shun the crowd

Here’s a simple rule: it is hard to buy what is popular and do well for any sustained period.

This has direct application to today’s market. Just look at today’s five biggest companies in the world: Apple ($845bn), Alphabet ($699bn), Amazon ($693bn), Microsoft ($688bn) and Tencent ($500bn). All five are in the technology sector, last year’s hottest. This makes them vulnerable.

I would not rule them out out together, for example, most pass test number two with flying colours, but approach with caution. It’s a long way down.

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Teresa Kersten is an employee of LinkedIn and is a member of The Motley Fool’s board of directors. LinkedIn is owned by Microsoft. John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Harvey Jones has no position in any of the shares mentioned. The Motley Fool UK owns shares of and has recommended Apple and Amazon. The Motley Fool UK is short shares of IBM and has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool UK has recommended BP, Cisco Systems, Intel, and Time Warner. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.