Upside versus Downside

Stocks that appear to be on sale may not be worth it. I usually won't buy a stock unless I believe I can make around 100% or more for my money. The downside risk needs to be negligible also. The fundamentals of the stock and the macro view of the world need to be examined before buying a stock regardless of whether the chart looks good or not. It is not worth it to gamble on buying a stock with a possible 20-30% upside versus a downside risk of that same amount.

A recent example of this is GMCR, Green Mountain Coffee Roasters. They sell the Keurig single cup coffee makers, and I love the one that I own. I also enjoy the single cup serving K-cups of coffee that GMCR sells. I believe the company has great products, and they will continue to grow.

However, when it comes to investing, GMCR may not be the best choice. In November of 2011, the stock price had dropped to the mid 60s from a high of over $100 per share. The chart made it appear that GMCR had formed a bottom in the mid 60s, but "the devil was in the details." It still had considerable short interest against it, and when it missed its earnings for the quarter narrowly, the stock sold off in an avalanche and dropped 38% to $42 per share. This was a costly loss of capital for anyone who had just bought the stock in hoping that it would go back to $100 per share. At $42 per share, the stock's PE was still high at 32, and it was a lot higher at $67. At its high around $108, GMCR had a PE of around 80.

So, GMCR had about as much downside risk in the mid 60s as it had upside potential. No one can deny the company's growth, but investing must be done carefully to avoid large losses. Bad things can happen as much or more than good events. Unless the downside risk of a stock of almost nothing, and the upside is fairly certain to be around 100%, it is not worth investing your money.