Old School Value

One of the hardest aspects I find in investing is not searching for value stock ideas, analyzing businesses or even calculating intrinsic value. I find selling to be one of the hardest and something I am terrible at, which explains why this post is only the second I’ve ever written on the subject.

Mostly because I’ve only ever been long in any investment position and partly because I’m a greedy human being.

Basics of When to Sell Stock

You would have already heard the basics to selling stocks (including this blog). The basics to selling is:

• selling once it reaches fair intrinsic value
• acknowledging a mistake in the original thesis
• change in company fundamentals
• better stock idea or any other investment opportunity comes along
• in an emergency

It is Difficult Selling Stocks

The problem is that on far too many occasions, I haven’t sold. My greed caused me to try and pick up pennies in front of a bulldozer. Sometimes, I get away with it but once in a while I’m run over and it hurts. This is precisely what happened with my EMAG arbitrage.

Although I was confident that the deal would go through, other completely out of control external factors caused the merger to blow up and my position with it. Just one day before the deadline, I was risking my 50% return (big position at the time) for a few pennies.

But I look back at the situation, recall how I felt after seeing my portfolio drop by 30%, re-read what I wrote and it is enlightening. It helps in reminding me of the lack of discipline and objectiveness.

Learning from Mistakes

With good mid to long term companies that I own, although it reached fair value, I did not sell because I was content with the business operations. This has now become an outdated reason for my continuing to hold.

No matter how good the company, I now prefer to sell once it reaches fair value.

Back when I first purchased KTII and ATW, I was fortunate enough to see the price reach my fair value target within a few months. I held on hoping for it to continue its upward trend. Then the market turned and rather than being cashed out and having a cash balance for new opportunities, these positions dropped like everything else.

This is an example of how holding cash for the next opportunity isn’t so bad.

Selling for Better Opportunities

For someone that goes through quite a number of stocks, I never fully understood how I could go about selling a position each time a better one came along.

If I bought a company one week and next week I come across another equally if not better opportunity, I would have to sell according to the basic rule. But what happens if this occurs every week?

Just like how there will always be someone smarter than you, there is a stock that will always be better than yours.

Selling Losing Positions

When selling losing positions, there are 2 groups of people.

1. A group that waits for the stock to recover so that they do not incur a loss, even if it takes several years to recover
2. Sell even though the return is down 50% because of a new 100+% potential idea

Which would you choose? Most people would say they are number 2 but the majority is in group 1.

I’ve now moved from group 1 to group 2. e.g. Although I like KSWS with its strong balance sheet and experienced management, I sold it and invested in two other positions that have both yielded 20% and 50%.

Mechanical Selling and Trailing Stops

One idea I have been pondering is entering a sell order after my purchase at my fair value. That way if the stock was to run up, it would sell automatically without my intervention.

Other people also swear by the use of trailing stops in protecting gains.

When Should I Sell?

Still asking this question? It may be a hint that you should sell now. Without conviction, there is no reason to be holding.

Disclosure

I hold KTII and ATW at the time of writing

This is part 2 of the How to Invest in the Stock Market series.

How to Invest in the Stock Market: Part 1 | Part 2 | Part 3 | Part 4

How to Get Started

I found that getting started was the hardest part simply because I just didn’t know where to begin. But I soon found out that learning how to invest is the same as learning anything else. i.e. you have to crawl before you walk and run. There was no shortcut if I wanted to do it properly.

After reading many news and stock tip articles off the internet, everything still made no sense and I remained clueless after spending so much time reading. So I did what we all do when we start learning about a new topic. Identify the basics work up towards the intermediate level followed by advanced techniques.

Basic Level Investing

The following sites will guide you in why you should invest, what should you invest in, how to invest, the different types of stocks, what causes price changes etc etc.

• The Fool.com Investing basics
• Investopedia Basic Investing Tutorial

These two sites alone will provide you with more than enough information on the basics. I spent a considerable amount of time trying to read everything. I still consult Investopedia to this day.

Once the basics were down, I had a strong desire to understand the financial statements and what each line and term meant. I knew by this point that a thorough understanding of the accounting terms and financial ratios was required. With no prior education in accounting or finance, it went over my head at first, but as I kept referring back to it over and over again, it slowly started to make sense.

• Introduction to financial statements
• Beginners guide to financial statements
• Understanding financial ratios

However, you can get a all this information in a clear and concise format in the book Financial Statements: A Step-By-Step Guide to Understanding and Creating Financial Reports. I also wrote a review of the book.

Intermediate Level Investing

After coming to grips with the basics and finally understanding what stocks and investing was all about, it was natural to try and figure out what companies I should buy.

It was at this point I stumbled upon a forum post by Joe Ponzio of F Wall Street and was introduced to the concept of owning a business. Although I had read about a stock being a business in The Intelligent Investor, Joe has to ability to explain it in a clear manner that helps us to visualize the whole process.

It was mind blowing and it completely flipped everything else I was reading on its head. I truly believed that I had to know the technicals and tricks like selling in December and buying in January would produce greater returns.

I came to understand that;

1. buying a stock was owning a tiny piece of the business
2. I had to think like a business owner
   • If you owned your own corner grocery what would you consider important? Is it your EPS is for the quarter or how much cash you have generated for each day? Would you splurge on jets, cruises or pay your cashier $100 an hour? Or would you rather cut useless costs and seek to grow the company?
   • Since we own parts of the business, it is important to identify whether the company you own follows your own ideas of business. e.g. I don’t invest in biotech because I have no knowledge about the industry or business and therefore would be a clueless owner. I also have yet to put my money in financials because I do not understand how one operates.
   • A business owner is also passionate about their business. Are you passionate about your companies?
3. I wanted to be an owner of high quality cash generating businesses
4. there is a price for everything and came to understand fair value or intrinsic value

F Wall Street has an outstanding series of valuing the business which really puts everything in perspective. I have read every single article ever written on F Wall Street which is over 100 and it has been better than any book. (Note that I pre-ordered Joe’s book from Amazon). Visit his How to Value a Business series.

The book I most highly recommend at this stage: Pat Dorsey’s The Five Rules for Successful Stock Investing.

Both F Wall Street and The Fives Rules book introduce the concept of Discounted Cash Flow which was also the starting point of the ongoing investing spreadsheet project available for purchase or free download on this site. I spent hours going through calculations, ratios and formulas and this hands on experience is what I believed to have helped the most.

Then came this blog. I had to force myself to write clear and organized content since it would be scrutinized by all. If I was going to write about something, I had better know what I was writing about. The best thing is, I received constructive criticism which I took to heart and the discussions with fellow like minded readers have helped immensely.

The point is to get involved wherever you can, except Google and Yahoo Finance since it is so abused. Comment and ask questions on high quality content blogs. Discuss with other readers. Start your own blog. The best students were always the ones actively involved.

Coming Up

We’ll be looking at what is involved in advanced investing topics in the next post. Don’t worry it isn’t really advanced.

With the term “cheap” and “value” so often around, especially in a bear market, what are the characteristics of a value trap?

If my wife had to define value, it would be buying a Chanel handbag on sale. From firsthand experience,a 10% sale for Chanel is truly good value. On the other hand, a value trap would be where I bought the Chanel handbag on sale, only to realize it was a fake.

The following  characteristics as described by Investopedia, are some common traps.

Low Multiple Value Trap

Multiples certainly do help in providing a picture of the company, however, if the company has been trading at its low multiples for an extended period of time, there is a reason.

Some reasons for why the company may be so cheap:

1. The company has difficulty generating meaningful and consistent profits and is unlikely to generate institutional or substantial retail interest.
2. Management is reluctant to get out on the road and tell the company’s story to retail and institutional investors.
3. Competition is extremely stiff, and the company is unable to differentiate itself.

No Catalysts

There are some investors that state the deep discount itself is a catalyst. I agree to some degree. A majority of net nets are value traps because they fail in their ongoing operations, yet they have extremely cheap multiples. But if we bought purely for its cheapness and think that management will turn it around sooner or later, we are in for a bad ride. Without a catalyst to unlock its value, the company is a value trap.

In the value investing realm, Sears is a big value stock. By looking at its balance sheet we see that Sears has a huge property value that is being mispriced. However, I believe this fact is well known. Many small investors are aware of it and I’m sure the institutions know it as well. The problem is, the property value has be to unlocked. Unless Lampert unlocks its true value, I wouldn’t be surprised if SHLD doesn’t travel upwards for a while.

High Insider Ownership

Although high insider ownership is a sign of faith by managers, it may also be a deterrent to institutions as it prevents change being enacted if the managers are not performing in the best way. If I am unfamiliar or don’t have enough information on the managers, I am hesitant in purchasing a company where insiders own more than 15%.

This includes companies that have a dual class share structure as it gives the owners an overwhelming authority over the direction of the company.

Investor Rear View Tendencies

One of the problems I faced is placing too much emphasis on the history of the company. If a company has performed admirably for the past 5-10 years, I placed a heavy emphasis that it can continue. This tendency is much like falling for the low multiple trap. Just because the company did well in the past, it doesn’t mean it will continue in the future unless it has a moat and strong market share.

Disclosure

No positions in any stocks mentioned at the time of writing.

I was searching for an article at the request of a reader but I came across this words of wisdom compilation covering different topics from Value Investor Insight.

With my portfolio crying bloody murder and Sherlock Holmes investigating, I think it’s time I sit back, relax, read this, and just… chilled~

Below is a neat Feb 23 article published in Value Investor Insight written by Seth Klarman.

The document is a bit hard to read but valuable lessons in value investing. Maybe it’s called “value” investing because we are always trying to learn valuable lessons that traders and speculators never consider.

Also consider reading this article by Vitaliy Katsenelson on The Pain of Mean Reversion.

For non-techie people, open source is where the internals of a software (such as Firefox) is open to anyone to modify. It helps strengthen the overall project and drives creativity. Rather than being stuck with the same bland thinking that is only generated by one person, hundreds of people suggesting ideas and theories create a countless number of perspective, insight, knowledge and wisdom. I believe the community at Old School Value is the same.

The failure with EMAG hurt, but a positive consequence of the failure dawned on me. One which overwhelms the negativity of the loss.

Encouragement

After posting about the aftermath of EMAG, I received emails from readers who encouraged and gave me a virtual pat on the back for being able to admit my mistakes and to learn from it.

I’m always humbled and embarrassed to hear that people admire and respect me for what I do on this blog (though I’m not sure what I do..). I’m very grateful for that. Readers could have just as easily blamed me for their losses or leave abusive comments but there has been none of the sort.

Advice and Food for Thought

Along with encouragement, I’ve been able to receive advice from others. No two people think identically, and the correspondence I am able to have with readers through email and comments is always challenging and mind expanding.

This whole EMAG drama produced a flurry of ideas and communication as well a chance to reflect on my investment habits and processes.

(The next post will be a discussion I had with a reader on Risk-Reward compared to Reward-Risk)

Open Source

This is where I bring up the term Open Source Investing. I lay out my thoughts, ideas and everything else and leave it for people to pick it apart and reveal weaknesses.

All I have to do is accept the genuine contributions and reject the spam. Always be willing to replace an idea with a better one.

Handling Difficult Situations

I just want to share something from a multi-disciplinary approach that helps me with how I handle losses and difficult situations.

Response + Ability = Liberty

With the ability to respond in a positive and correct way, we are free from the stress and disappointment that comes with a big loss. The liberty to think through it objectively rather than to shut it out completely and be consumed by the responsability.

Big Thank You!

Thank you to all who send me emails. Your encouragement and exchange of ideas make it a joy to keep writing.

Thank you to all who comment and contribute, and also helping me to make money

Thank you to all that read.

Thank you to all that visit.

Thank you for making this an active, open source community.