When to catch a falling dagger share?

The share market can be a very odd and fickle beast to deal with. Some businesses can report increasing profits but see their share prices fall.

A ‘falling dagger’ is basically describing a share that just keeps falling and falling.

Falling daggers can be very dangerous because if you base your investment decision purely on share price movements then you might be missing that the underlying business has deteriorated as well.

Vocus Group Limited (ASX: VOC) and Select Harvests Limited (ASX: SHV) are two good examples of where both the business performance and the share price has been poor over the last couple of years.

However, if you’re able to pick up some shares of a business whose share price has temporarily dropped but the underlying business is continuing to grow, then that could be a perfect time to buy.

If you look back over the past year, there have been opportunities to buy quality shares like REA Group Limited (ASX: REA), Ramsay Health Care Limited (ASX: RHC) and Greencross Limited (ASX: GXL) where the share prices have fallen by 20% or more.

REA Group and Ramsay are both very high-quality businesses with clear growth plans and increasing profit margins. I think any opportunity to buy growing businesses at a discounted price should be welcomed by investors, not feared.

It can be a much riskier game trying to decide when a deteriorating business is good value compared to a growing business.

If you go for the deteriorating business then you may be heading towards the investing style of a young Warren Buffett. He compared this type of investing to a mostly smoked and discarded cigar by saying “Though the stub might be ugly and soggy, the puff would be free”. You will only get one last puff on that business if it’s not a turnaround story.

Foolish takeaway

Although Ramsay and REA Group are nowhere near as cheap as they have been in recent times, they both should be market-beaters over the coming years thanks to their ability to grow revenue and earnings at a good rate.

For even more exciting ideas you should read about these small caps.

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Motley Fool contributor Tristan Harrison owns shares of Greencross Limited, Ramsay Health Care Limited, and Select Harvests Limited. The Motley Fool Australia owns shares of Greencross Limited and Vocus Communications Limited. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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