Tuesday, July 05, 2011

Did We Screw Up With Our Stock Selection?

Digging and reading thru some old stuff, I found the following set of writings. No, they are not mine they are from an investing forum based in Singapore but unfortunately that forum, wallstaits, has since closed down. (iinm the writings were from 2005)


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Investment lessons learnt this year and advice for newbies

When I just started investing late last year, this was the first investment website I stumbed upon. I was greatly influenced by its FA bent and the eloquent arguments from fellow forummers.

I have some advice for newbies from personal experiences as a newbie.

There are certain practices advocated by FA proponents that newbies need to be careful of.

The first one is with regards to averaging down. FA proponents like to say when the share price of one of your holdings goes down, you should buy more because it has become cheaper. So, when prices are depressed, you should be happier because you can buy more of the same good thing more cheaply.

You could try that if you have sufficient grounds to be so confident of your investment. But if you are just starting out as a newbie like me, please cut your losses and don't compound your mistake. You make a purchase, the share price goes down -> probably you made a mistake. Who are you, little junior, to argue against the market? If you are a newbie, assume you are an idiot waiting to pay school fees and don't average down. Cut your losses!!

Perhaps the most valuable advice that I have received from FA proponents is to know your investments very well and avoid those which you only vaguely understand. If you know your investments with the depth that Warren Buffett has with his, then you can average down with less worry.

One of my mistakes was to make investments based on superficial understanding. True, I read prospectus, annual reports and even taught myself accounting so that I could understand financial reports better. Most of my investments were made based on favourable financial ratios without a deep understanding of the business nature. I did not try out the company's goods and services. I don't know if the company's customers, employees, suppliers are satisfied with it.

My main fault as a newbie was to be over-confident. I thought after reading and learning so much, I was ready. I thought I could be as good as the masters and followed one of their strategy -- concentrate your eggs in one basket and watch that basket carefully. Once again, I reiterate that such a strategy is meant for the masters. If you are an amatuer, it is safer to assume that you are an idiot and to protect yourself from stupidity, please diversify. By putting all your eggs in one basket, you may have fatally injured yourself by catching all the falling knives with one hand.

Some FA practitioners do not have a stop-loss policy. They use a similar argument - if a good thing becomes cheaper, I should buy more instead of selling it away.

The TA approach "Cut your losses and let your profits run" is worth considering. It is a safe way to protect your capital. Sell after your losses reach 10% of the intial capital outlay no matter what. After all, he who fights and runs away may live to fight another day. In fact, by adopting such an approach, you could protect yourself against CAO, Informatics and Auston.

Unfortunately, I did not follow the advice above. I waited until fundamentals have clearly decayed before thinking of selling. In the meantime, I continued to average down as the price slided down. When the financial report was out, fundamentals did look bad but ALAS!!, it is too painful to sell now.

This is one of the problems with FA. You can only make decisions an a quarterly or half-yearly basis which by then, the price may have slid to a psychological unacceptable level to sell.

FA proponents like to say making decisions based on price movement is nonsense. Say, the management has been trying to hide important fundamental data from the financial reports for as long as they can. The silent accomplices - auditors and independent directors - who are on their payroll prefer to close one eye or both eyes as long as they have ready excuses to plead ignorance and other disclaimers when the situation implodes.

The poor FA practioner will continue to average down, thinking that he is profiting at the expense of the foolish irrational market. Meanwhile, the insiders are selling the stock down to the sucker - that foolish guy averaging down.

In such a situation, the TA practioners will be safe. Having observed that the price has been in a downtrend caused by insiders selling down, they would have already sold out before the bombshell explodes. In the cases of CAO, Informatics and Auston, the price chart has shown an obvious downtrend before the explosive truth was out.

Are there any other advice and warnings fellow forummers can share with future newbies?

PS: I do not want to get into a TA vs FA debate. If any FA proponent thinks I am wrong, please point it out objectively without making personal remarks. I am still learning and am considering using a mixture of both FA and TA at the moment.



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I agree that averaging down is a scary thing. When you buy a stock like you buy a business (which means price is only one small component of your overall analysis) and the price falls-- what I do is ask myself "if the business is failing"? A falling stock price may be a sign of danger as other savvy investors see flaws with the business model, increasing competition (usually seen as narrowing profit margins), etc. Or, sometimes it is an over-reaction to what you believe is a temporary setback, like rising commodity prices.


If, after raising your skeptical antenna, you continue to believe your business is on track to continue its long term growth and build shareholder value... than the proper (if corageous) thing to do is buy more shares at the now more attractive price. After all, it is the same business you previously liked at a higher price.

If, on the other hand, your heightened skepticism results in some important questions needing answered-- maybe about intensifying competition or rising raw material costs-- you might want to sit back and wait and study further. But, cut loss on rumors and whims isn't likely to make you wealth. Often, you will be selling into weakness with the irrational crowd without confirming any business weaknesses. A cut-loss system, or any other system that doesn't require careful analysis and thought, is not very wise and not very FA-ish.

An example... Warren Buffett accumulated shares of the Washington Post during the 1970s recession, and bought more during a newspaper union employee strike. He saw these as temporary troubles, while others were cutting losses. He is now up more than 10-fold. He bought American Express during troubled times, he bought Geico Insurance when it was in trouble too. He looked at the falling share prices in each case, and decided to buy more, because he believed the businesses were sound and their troubles temporary. He was usually right.

Most important aspect of FA... be careful you only buy good businesses at fair prices. If you get this right, you eliminate most worries about cutting losses. Step 2... remember Ben Graham's advice... "Never buy a stock simply because it has risen sharply in price or sell one because it has fallen sharply in price. The opposite advice would be wiser."



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My comments:

Excellent advice!!!


And more so I believe in that one Mr.Soros quote "I am rich because I know when I am wrong"

So when the stock you purchased, tanks after your purchase, don't just blame it on bad luck but ask oourself this simple question:  Did we screw up with our stock selection?

And if you did, averaging down means u are buying more shares in a wrong investment!

Doesn't make sense, does it? Remember CUT YOUR LOSSES!!!!

And Warren Buffett use to say "The most important thing to do when you find yourself in a hole is to stop digging!"

Doesn't it make sense?
Think about it. What does one do when one make a mistake? Don't we want to rectify it? And isn't the best way to rectify it is by stop being wrong?

Do think about it.

So the next time you see losses for a stock in your portfolio, instead of buying more, ask yourself a simple question, 'did you screw up'?

Or perhaps the stock selection might be good, but if you overpay for your investment then the chances of success in this investment would be very slim, yes?

But then... I know .... some would not agree.

They will just HOLD long la. Be patient la. The stock market bull will come and if if you hold it long enough, you can sell your mistake without a loss.

This is their version of buy and hold.

Yes that's so possible and since in a bullish market, most stocks do stand a chance of making a comeback.

But... isn't such a strategy a game of chance then?

Aren't we hoping that the bull market will be kind and help correct the stock selection mistake?

And to make it a bit more complicating.....  in a bull market .... have you consider that it's possible to have individual stock crash(es) ?

How?

I dunno ... me just mumbling ya.

17 comments:

Heineken Pilsener said...

Moola,

Do you still follow Fima Corporation? What is your opinion on the recent drop in revenue?

Moolah said...

The drop was due to extreme low contribution from the palm oil biz.

You can follow some comments made here

Mr ICICI said...

this article makes so much sense.
ive been averaging down on my portfolio all my life!

Moolah said...

Mr ICICI: I agree. I found it so interesting when I first read it because I do recall that many are simply taught that from an investing perspective, one should just HOLD a stock investment for the longer term. Disregard the ups and downs. Hold on for the longer term and you should be rewarded.

And the assumption made is... one's stock selection is always correct.

But what if one is wrong?





Anywayyyyyyy........ the other more interesting issue is .... how do we know if we screw up or not?

Simply cutting loss every single time the stock turns lower is not advisable.... and neither is holding on stubbornly to a stock purchased based on a flawed set of reasoning.

yauwenchin said...

Averaging down only on the Top 30 stocks (avoid companies run by Bumiputra). Avoid averaging on second or third liners (unless you know some kind of catalyst is going to happen). Learn from your mistakes (normally it is an emotional one). TA or FA is fine, is better if you know more like cycles or even Elliottewave (because good timing enhance your return). Average your portfolio around 10% each stock. There more than one way to make money, just have to explore what is suitable for you. If you are the super patient type, wait for world crisis (tend to happen every 10-15 yrs). Or you can focus on dividend yield stock (for recurring income). The beauty about investment is DIY, don't past it to mutual fund, run it yourself, if you know (if not, learn or educate yourself, it is worthawhile). I know people who have the luck (don't even bother about FA or TA) and still makes more money than those who is more knowledgeable. Perhaps some common sense involved.

Moolah said...

Err.. averaging down just because it's a Top 30 stocks?

Ok.. so you are suggesting that it's ok just to keep average down just because it's a top 30 stock?

But what about the reasoning if the investment made sense or not?

Let's see... Hai-O used to be a top ... err... top 10 recommended investment grade stock some 2 years ago.

Would you call that a top 30 stock?

Look at it then and now. Would the average down strategy work?

How about KNM? Was it not a so-called top 30 stock?

Or how about Gamuda?

Moolah said...

yauwenchin: Thanks for sharing anyway.

Yeah, I am not a fan of average down.

snowball said...

@moolah,

This is unrelated to the topic. Wallstraits has a replacement forum called value buddies. The website i think is valuebuddies.com. But, the discussion may not be as good as Wallstrits :-)

Moolah said...

WOW! Many thanks snowball. I see many old names there! :)

Moolah said...

snowball: Btw... what do you think of this issue?

Are we, the normal averge Joe/Jane, be susceptible to mistakes?

And if we do make a mistake.... what do we want to do about it?

Correct our mistake(s)?

Or use the plain old 'average down' and HOPE that the market will one day correct our mistake?

snowball said...

Hi Moolah,

I think my answer is the good old "it depends".

It depends whether your averaging down is an educated one or just a mere hope one.

If you think you have more information at hand than the one that are selling i.e. market data shows product price is increasing, cost is decreasing and etc. It may be valid. But, most of the time, we do not have that unless it is small cap stock. I knew a few small cap that have no analyst coverage but I know whose their major customer are. It happened that some of this got sold down, their customer (from US which report financials earlier) are doing very well, so, I average down.

But, if stock are going down like crazy and if you have no information. It may really be the market knows more than you do. Like the fraud I bought into, Chaoda Modern, it went down straight after I bought it. I got uneasy and just sell it. Now, it is a proven fraud. Probably the short seller from US will finish it up.

Sometimes, we need to give credit to the market. They generally know more than we do. Unless you have some sort of information edge that you think people do not have, it is wrong to average down. And, for small fish like us, it is hard to have that information edge.

I think the questions to asked whether to average down, average up is that, "Assume you don't own the stock, whether you will buy it now or you will short it?" If you will short it, why are you still holding the stock?

This need some discipline, I, myself also find that very hard.

Moolah said...

Thanks for sharing. :)

Me? I always like to ask myself "Am I wrong?"

:)

Moolah said...

snowball: Are you aware of this stock called Uchi?

It 'used' to be an investment darlling.

Everything about it was ... simply too good. Numbers were good, growth was there and it paid great dividends too.

And early investors were more than happy. Some were enjoying a 4 bagger from this stock!

What a dream... :D

Then... 2006... got some ESOS concern... and then... some slowdown in earnings appeared in 2007.

It was around 3 bucks then.

Now... if one purchased at 3 bucks then... ignoring the ESOS and the possible slowdown in earnings.. and argued that the stock pays great dividend.....

well.....the stock... fell.

Now.. if one had used the average down theory... how?

The market today.. record highs.. but look at Uchi.

Less than 1.40 today....

limko said...

I would say 'It depends..' although it is 'cut loss at the pre-determined level' still the best policy, because it cut all pains that you will have to endure subsequently if you hold.

In my past experience, if a stock were to be over the cut loss level into the painful category, I will let it drop until it reaches its bottom,start turning up and I will buy at that time. It is likely I will be able to recover he cost. I called it second chance strategy.

However, having saying all that, I am moving towards 'cut first, buy back later' approach now, as waiting for a second chance can be long and elusive!

Moolah said...

limko: Did you follow Hai-O?

Say one ... was attracted to Hao cos of the high growth story... and more so ... it was darling stock in 2009....

Now... consider this one... was prudent... this one did not kejar sama ni kuda... and imagine one was very patient... waited and waited.... and then in June 2010, Hai-O warns about the challenging year... but then ... one looked at the stock price... and ... err... starts counting...

you see... err... April... about 4.60+.... now... July... 3.50 only woh....

3.50 and 4.60... lot's of pullback already mah... lot's of discount...

so... one buys... at 3.50.

one reasoning?... err... the warning already priced in....
surely... cannot be too wrong mah.

was that a valid reasoning? Maybe? Maybe not?

And then... Hai-O continues to drop.

And drop.

Now... imagine... if one... uses what he reads in the book....dun worry... long term investing ma .. dun be scared ...just do it.... drop more buy more!

Ahem...

look at Hai-O today.

Would average down strategy work?

Or how about cut first, reconsider later?

How?

snowball said...

@Moolah,

Haha...at that time, I am still too young to be in the market lol..that's why I say that I am a beginner investor in my profile.

But I get your point though, historical prices means nothing. When price goes down, need to ask whether you have make a mistake. Whether there are things that you do not know. Don't anyhow average down. :-)

limko said...

Yes, Moo, you are right! that's why I say 'I am moving towards 'cut first, buy back later' approach now, as waiting for a second chance can be long and elusive!'

I learned my lessons, and this is a good reminder. Thanks!