When markets tumble, investors often hear a familiar refrain: “Buy the dip.” But in his latest blog post, valuation expert and NYU finance professor Aswath Damodaran says that advice can be dangerous—akin to “the art of catching a falling knife.”
The core of contrarian investing is simple: buy when others are selling. In an analysis blog published Sunday, Damodaran dissected the allure—and the dangers—of this strategy, warning that blindly snapping up beaten-down stocks or markets can lead to costly mistakes.
Damodaran cautioned that while buying stocks after a sharp fall can seem like a tempting opportunity, it’s not always a winning strategy. He warned that a stock’s decline may be a signal of deeper issues, and without careful evaluation, it’s easy to be swept up in the optimism of a potential rebound.
The risk of "catching a falling knife"
While it’s tempting to pick up undervalued stocks after a sharp drop, Damodaran warned that not all market declines are the same. He explained that buying during a downturn assumes that stocks will eventually rebound, but this optimism can be misplaced. “The danger is that buying the dip in the market is akin to catching a falling knife,” he stated. “That initial market drop can be a prelude to a much larger sell-off.”
Damodaran’s caution stems from his belief that market declines often signal deeper issues. As such, the idea of blindly investing in declining assets may lead to significant losses if those issues are not properly understood.
Why contrarian investing requires patience and discipline
Investing against the crowd is no easy task. Damodaran acknowledged that “buying stocks in the face of market selling will not come easily,” especially when fear and panic dominate the market sentiment. The temptation to follow others or act impulsively can override the disciplined approach needed for successful contrarian investing.
Despite the psychological challenges, Damodaran practices contrarian investing himself—but with caution. He revealed that during the current market downturn, he placed limit orders on three companies he’s long admired: BYD, the Chinese electric car maker; Mercado Libre, the Latin American online retail and fintech firm; and Palantir, which he believes is “closest to delivering on the promise of AI products and services.”
A case study in patience: BYD, Mercado Libre, and Palantir
Damodaran’s decision to place a limit order for BYD, a Chinese electric vehicle maker, was triggered on April 7 when the stock briefly dipped below his target price of $80. However, his orders for Mercado Libre and Palantir remain unfilled, as their prices are yet to reach his desired levels. “The crisis is young, and the order is good until canceled,” Damodaran stated, showing confidence in his approach despite market volatility.
For Damodaran, these limit buys are not about seizing a quick opportunity but about waiting for the right moment when the stock aligns with his valuation. While he believes in the potential of BYD, Mercado Libre, and Palantir, he isn’t rushing to buy at any price. Instead, he’s showing discipline by waiting for market prices to meet his expectations.
The bottom line: Not every dip is a bargain
Damodaran’s insight offers a timely reminder: buying the dip isn’t always a smart move. While the strategy has its place, it requires careful analysis, patience, and an understanding of the underlying reasons behind a stock’s decline. By setting price limits and exercising restraint, investors can avoid the pitfalls of blind optimism and instead make thoughtful, well-timed investments.
Ultimately, Damodaran's approach underscores the importance of careful valuation over following market sentiment. "Buying stocks after a market sell-off is tempting, but it must be based on more than just market movement," he concluded.
Also read | Aswath Damodaran outlines 4-step playbook amid tariff turmoil, begins revaluing magnificent five stocks
(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of The Economic Times)
The core of contrarian investing is simple: buy when others are selling. In an analysis blog published Sunday, Damodaran dissected the allure—and the dangers—of this strategy, warning that blindly snapping up beaten-down stocks or markets can lead to costly mistakes.
Damodaran cautioned that while buying stocks after a sharp fall can seem like a tempting opportunity, it’s not always a winning strategy. He warned that a stock’s decline may be a signal of deeper issues, and without careful evaluation, it’s easy to be swept up in the optimism of a potential rebound.
The risk of "catching a falling knife"
While it’s tempting to pick up undervalued stocks after a sharp drop, Damodaran warned that not all market declines are the same. He explained that buying during a downturn assumes that stocks will eventually rebound, but this optimism can be misplaced. “The danger is that buying the dip in the market is akin to catching a falling knife,” he stated. “That initial market drop can be a prelude to a much larger sell-off.”
Damodaran’s caution stems from his belief that market declines often signal deeper issues. As such, the idea of blindly investing in declining assets may lead to significant losses if those issues are not properly understood.
Why contrarian investing requires patience and discipline
Investing against the crowd is no easy task. Damodaran acknowledged that “buying stocks in the face of market selling will not come easily,” especially when fear and panic dominate the market sentiment. The temptation to follow others or act impulsively can override the disciplined approach needed for successful contrarian investing.
Despite the psychological challenges, Damodaran practices contrarian investing himself—but with caution. He revealed that during the current market downturn, he placed limit orders on three companies he’s long admired: BYD, the Chinese electric car maker; Mercado Libre, the Latin American online retail and fintech firm; and Palantir, which he believes is “closest to delivering on the promise of AI products and services.”
A case study in patience: BYD, Mercado Libre, and Palantir
Damodaran’s decision to place a limit order for BYD, a Chinese electric vehicle maker, was triggered on April 7 when the stock briefly dipped below his target price of $80. However, his orders for Mercado Libre and Palantir remain unfilled, as their prices are yet to reach his desired levels. “The crisis is young, and the order is good until canceled,” Damodaran stated, showing confidence in his approach despite market volatility.
For Damodaran, these limit buys are not about seizing a quick opportunity but about waiting for the right moment when the stock aligns with his valuation. While he believes in the potential of BYD, Mercado Libre, and Palantir, he isn’t rushing to buy at any price. Instead, he’s showing discipline by waiting for market prices to meet his expectations.
The bottom line: Not every dip is a bargain
Damodaran’s insight offers a timely reminder: buying the dip isn’t always a smart move. While the strategy has its place, it requires careful analysis, patience, and an understanding of the underlying reasons behind a stock’s decline. By setting price limits and exercising restraint, investors can avoid the pitfalls of blind optimism and instead make thoughtful, well-timed investments.
Ultimately, Damodaran's approach underscores the importance of careful valuation over following market sentiment. "Buying stocks after a market sell-off is tempting, but it must be based on more than just market movement," he concluded.
Also read | Aswath Damodaran outlines 4-step playbook amid tariff turmoil, begins revaluing magnificent five stocks
(Disclaimer: Recommendations, suggestions, views and opinions given by the experts are their own. These do not represent the views of The Economic Times)
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