My favourite stock is down 30%. Here's why I'm buying more

The market has been in a rough patch. The Sensex is down 15 per cent from its peak in September 2024, and investors are feeling the heat. Stocks that were once soaring are now sinking.

One of my favourite stocks—a mid-cap FMCG company—has plunged 30 per cent in just a few weeks as most investors continue to bolt. But not me. I am staying put and even buying more.

"Same company, same fundamentals, 30 per cent discount. What's not to love?" I thought to myself as I placed a fresh buy order, doubling my position.

At the risk of sounding too confident, I would say I have pretty good reasons for buying more instead of dashing out. Hear me out:

Why I am buying more

What I am doing is buying more shares of a falling stock to lower my average purchase price—averaging down, as it is known. On paper, it sounds seductively logical. If I liked the stock at, say, Rs 100, shouldn't I love it at Rs 70?

But what does averaging down do? It magnifies the potential for profits when the battered investment rebounds.

In simple words, when my FMCG stock eventually recovers to its previous level or higher, I would potentially make higher profits as I bought more of it at a lower price.

Here's an example. HCL Tech traded at Rs 62 in January 2008, but by year-end, it plunged to Rs 29. The stock crash brought the average price per share to Rs 46. If you had bought 1,000 shares at this average, you would have made an extra 3 per cent on your investment today. That may not seem like much, but over a larger investment, the impact can be significant.

However, one important caveat is that you believe in the long-term fundamentals and the recovery potential of the company you are buying more of.

Averaging down works only if the stock is fundamentally sound. Not all stocks in free fall are bargains. Sometimes, they are just rightfully crashing.

Not every dip is a buying opportunity

Averaging down is risky because it assumes the stock is undervalued, not fundamentally broken. But just because it is cheaper than before may not necessarily mean it's worth the lower valuation.

If a stock trades at 200 P/E and falls to 100 P/E, it might look like a steal. However, 100 P/E is still expensive if the underlying fundamentals are weak.

Many investors make this mistake. Take Jaiprakash Associates, for instance. Once a celebrated stock, it traded at a lofty P/E of 100 in 2007. But the stock kept sinking year after year. Anyone who saw these dips as buying opportunities would be sitting on a 99 per cent loss today.

The lesson? Cheap can always get cheaper. Before you buy more, compare the historical valuations of the stock and, more importantly, assess the business's underlying strength.

Three critical checks before you buy more

So, how do you know whether averaging down is a smart move or a costly mistake? Ask the below three questions to evaluate if buying more of a falling stock makes sense:

1. Has anything changed fundamentally?

When my FMCG stock dropped 30 per cent, I had to ask myself why this was happening.

Sometimes, stocks fall because of temporary factors that don't affect the underlying business, like market-wide fear. These scenarios often present genuine opportunities.

But other times, stocks drop for concerning reasons, such as:

• Deteriorating financials
  
• Management problems
  
• Competitive threats
  
• Regulatory changes

The test: If you see any of the above warning signs, it might be better to wait and watch before buying more.

2. Is the entire sector struggling?

Sometimes, companies don't fall in isolation. The entire sector may be under pressure.

For instance, coal stocks have been declining for years as renewable energy gains ground. Investors who kept averaging down on struggling coal companies failed to see the structural decline of the industry.

A cyclical stock will eventually bounce back, but a company in a dying or slowing industry might never recover.

The test: Research whether the company's struggles are company-specific or industry-wide. If it's the latter, you might want to rethink buying more.

3. Are you diversifying or overloading?

One of the biggest risks of averaging down is unintentionally overloading on a single stock.

I once started with 5 per cent of my portfolio in a pharma company. After averaging down multiple times, it ballooned to 20 per cent of my total holdings. The problem? If the stock kept falling, my entire portfolio would take a hit—even if my other stocks were doing well.

The test: Check what percentage of your portfolio this stock would represent after averaging down. If it exceeds 10-15 per cent, consider whether that concentration aligns with your risk tolerance.

Back to my decision

So, was averaging down a smart move or a costly mistake? It's too early to say for sure. But I believe I made the right call. My FMCG stock has started to recover, and I'm confident that with the strong fundamentals in place, it has the potential to make a full recovery.

What gives me this conviction? I dug deep. I read all recent investor calls from the company and confirmed they hadn't experienced any operational setbacks. The drop seemed to be because of a sector-wide selloff rather than company-specific issues.

Most importantly, I used the three-question framework to guide my decision. Had the stock failed any of those tests, I would've cut my losses and walked away.

Also read: 8 smart money talks every newlywed should have, before it's too late

This article was originally published on March 06, 2025.