Investing chief advises against buying a cheap stock solely based on its price decrease.

If a pair of sneakers from your favorite brand was marked down by 20%, you would likely add them to your cart. However, what about a 20% discount on the stock of that same company?

What have potential investors in Nike stock been pondering recently?

The athletic apparel manufacturer announced declining quarterly sales, resulting in a rough fiscal year, and the market reacted swiftly. Nike shares plummeted by nearly 20% in the day following the earnings results, marking the worst trading day in the company's history.

Over 31% of the stock's value has been lost year to date.

If the S&P 500 experienced a similar decline, financial advisors would advise sticking to the plan and investing in a diversified portfolio, as stocks have historically risen. Downturns are often viewed as buying opportunities when the market is on sale.

The decision becomes more complex when considering individual companies, as a stock's performance can fluctuate greatly, like Apple's rise from significant losses to new heights, or the decline of Blockbuster.

According to Clark Bellin, president and chief investment officer at Bellwether Wealth, buying stocks when the price has decreased without comprehending the underlying problems or activities could lead to problems.

"Something can be on sale for a reason."

How to approach a beaten-down stock

If you have a diversified portfolio with individual equities, a stock that has fallen significantly may be an attractive addition, but you should carefully evaluate the investment before making a decision, advises Sam Stovall, chief investment strategist at CFRA.

"Whenever a significant drop in a stock occurs, the concern arises whether there will be further declines in the near future or if it is an overreaction that presents a highly appealing buying opportunity."

Investment pros recommend these three steps to help sort things out.

1. Have a process in place

Investing in stocks that make financial headlines is not a reliable way to narrow down choices, according to Bellin. He explains that people often see a dip and then try to research whether they want to add it to their portfolio, which is the wrong approach. This can lead to problems.

Instead of rushing to research, maintain a list of stocks you're interested in purchasing at the right price. This way, you'll have already completed your research when the price drops. All you need to do is confirm your investment thesis before making a purchase. Bellin advises, "If something on your watchlist goes on sale, feel free to add more to your position. Just be mindful not to overweight your portfolio. Diversification is key."

2. Check the numbers

A stock can experience a decline due to various reasons such as the company's CEO being fired, the failure of a new product line, or investors losing confidence in the entire sector.

It's crucial to examine a company's core values before investing in it for the long term, according to Charles Rotblut, vice president of the American Association of Individual Investors.

"He suggests examining gross margins and operating cash flows over a period of time to determine the direction of the situation. He questions whether the current trend is a one-time blip or a gradual worsening that is now accelerating."

If a company faces major earnings problems, it may be prudent to adopt a wait-and-see approach, according to Stovall. "The problem tends to persist and requires a sustained effort to address," he explains. "Companies often fail to act quickly enough, necessitating multiple attempts to resolve the issue."

3. Reassess your outlook

Whether the short-term issues affecting a stock are a significant long-term risk to the company's business remains to be seen.

Is it possible that investors are overreacting to a problem that can be resolved? This scenario is not unusual, according to Raife Giovinazzo, a portfolio manager at Fuller & Thaler Asset Management, a mutual fund company that specializes in financial psychology.

"He remarks that people tend to exaggerate their responses to intense, emotional narratives, particularly when it comes to losing money."

If higher-ups at the company are buying a stock, it may indicate that the public is overreacting negatively on it. This information is publicly disclosed and can be found on free sites such as Nasdaq and Yahoo Finance.

"Insider buying or share buybacks is the initial step, according to Giovinazzo. This action indicates that management is not only expressing their belief in an overreaction but is also taking action to back it up. They are putting their money where their words are."

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