Post by oldman on Oct 19, 2013 13:45:45 GMT 7
Your First Million, 2nd Edition
Chapter 3: The Battle Plan
I don’t think we should be like Warren Buffett and hold forever. If we held SGX (Singapore Exchange) blue chips forever, history will show that in a bear market, these shares can lose up to 90% of their value. I also believe Warren Buffett has no choice, as he has such large positions that in a falling market he would find it very hard to sell out, without putting even more pressure on the stock prices.
For me, I will execute my exit strategy when I feel that the risks of a market crash far outweigh the potential upside. A feeling of uneasiness in the market is one that you will learn to recognise as you spend more time in the stock market.
Essentially, the markets move in trends. There are big trends – called megatrends – that every investor must learn to recognise. If I think that the megatrend has changed to become bearish, I would sell all my fundamental stocks. A change in the megatrend is a very important change. I don’t mind riding through corrections, but I hate to be caught in a major directional change in the market. Hence, I am always in the market because I want to have a feel for it, as this is the only way I sniff out danger signs that usually precedes a megatrend change.
However, a megatrend change is not common – maybe once in three to five years. Hence, chances of a megatrend change are low, but when it changes to a bearish trend, you do not want to be part of the market. One megatrend change was in March 2003 when the bull took over from the bear. Prior to this, it was in January 2000 when the bull became a bear. Given that it is not so common, you would not see me calling a bear every now and then.
By the way, I believe that bulls usually last longer than bears because the feeling of fear is stronger than the feeling of hope. In a bear market, there is a lot of fear and everyone will sell. Hence, in a bear market, stock prices will not simply fall – they crash. When the market is bullish, there will be a lot of hope, but there will still be fear lurking around, as investors dread corrections. Hence, any upward movement is usually slower. While the previous bear market lasted three years, the ensuing bull market, which started in March 2003, lasted a lot longer than that.
When I was trading stocks in the UK, I religiously followed the belief that one should sell 50% when it doubles and then keep doing the same as it triples, and so on. But one day I stepped back and asked myself why am I doing this so mechanically. When you sell 50% on doubling, it is still traumatic seeing it double again or going up even more.
There is some truth in the conventional wisdom that once you get your capital back, you can be more detached about that stock. But my experience is that when your stock doubles, you are already quite detached from it anyway, as your cost is half the existing price. As the stock multiplies further in value, you naturally become even more detached.
Today, I practise a totally different approach after my experience in holding on to all my stocks that multiply. I actually add to my holdings as the share price rises. The key consideration is actually not on the share price but on the prospects of the company. If the prospects of the company continues to be good or is improving, why should I sell when the stock price doubles?
This is against the principle of fundamental investing. When a company is doing better and the share price is increasing, the risk to fundamental investing should be decreasing. Instead of selling, I would still be a buyer under such circumstances. If however, the fundamentals of the business deteriorate, regardless of the share price, I would still be a seller. Take for example formerly listed entertainment firm Eng Wah. I was very bullish about this company when it announced that it was going to run the Crazy Horses cabaret show in Singapore. But when the outlet opened and I saw the dwindling crowds, I did not hesitate to sell, even though at that time, this was one of my fundamental stocks.
Eng Wah needed a boost from a new business and if this business fails to take off, its growth will be curtailed. All my fundamental stocks are either growth stocks or recovery stocks underpinned by a good margin of safety. Without growth or recovery in sight, I would not hesitate to remove that stock from my fundamental list.
I always keep a close eye on the businesses of my five fundamental stocks. If you do this the way I do, it is very time consuming. I have to keep in touch with all the industries of the five fundamental stocks, as well as do regular research on the companies themselves. If any of the fundamentals change, I may have to change my positions on these stocks.
If fundamentals remain intact, you are more likely to see me holding on to the stock, unless of course, Mr Market grossly overprices it. I don’t have a definition for gross overpricing but when it happens, I think most of us can recognise it. Gross overpricing is different from mild overpricing. Gross overpricing stares you right in the face!
Do remember that it is always much easier to buy a stock than to sell one. To buy, you just need to assure yourself that you have paid a fair price for the stock. The main fear is that you have overpaid. If you are like me and go for bargains, you would have paid a very low price and would then have a very high margin of safety. Hence, this fear is minimised if you stick to sound fundamental investing principles.
To sell is a different matter. You will always have a fear that you have sold too early and the share price rises significantly after you have sold. I am sure all of us have experienced this at one time in our investing career. This fear will always be there after your first experience of watching the stock you have just sold, shoot up to the stratosphere.
To overcome this fear, I have an exit price in mind for every stock that I buy. This exit price is usually the fair market value of the stock that I have purchased. Recall that I usually buy a stock at below market value and I will wait patiently for the stock to be revalued. When it is revalued sufficiently, I can be a seller.
Contrast this to what the average investor will do. They will buy a stock at fair value as recommended by a broker. Then, they will have to wait for the profits of the company to improve and the market revaluation of their stock before they can take a profit. There is a lot of unknowns with this strategy and to decide on the exit price will not be easy as the exit price has to be calculated based on projected profits, and frankly, it is hard to predict the future as company profits may not go up all the time.
This is why I would rather buy undervalued companies as I will immediately know its fair value based on its existing business. I do not need to look into the crystal ball to try to figure out a fair value and hence, my exit price for that stock. When the stock has reached my exit price, I do not sell it immediately. Instead, I will ask myself whether the rise of the stock price is justified based on what is happening in the industry or in the company.
If the company did not make any announcements or is not releasing any results soon, then, it is really a gut call whether the rise in the share price is sustainable. This is when I will go to the charts to take a closer look. I will draw the support and resistance lines on the charts and from there, decide whether to sell or to hold. Yes, I do use basic technical analysis to help me with my sell decisions but this is not the only tool that I use to decide whether to sell or to hold. One still needs the instinct and the experience to decide whether this rise is sustainable or not.
On the other hand, if the industry is growing and the company results are around the corner, I will be more inclined to hold on to the stock as I am likely to revise my exit price upwards in line with the better results. If this company continues to do well, then I may have another multi-bagger in hand and the last thing I want to do is to release my shares too early. Hence, at the end of the day, the decision to sell or hold is really a decision based on experience and gut feel.
From the article above, you will realise that serious investing is a full-time career. You need to be available when the opportunity to buy or sell appears. This opportunity may only last a few minutes. No, this does not mean that I am on the screen all the time. Rather, I am usually somewhere else in the house or outside as I have stock alerts that will keep me in touch with the market. Whether I act on any of these stock alerts is really up to me.
Hence, an investor is still in control of his life. The stock market just adds a little bit of spice to his life.
----------------
Question: u said u will sell a fundamental stock when it reaches its fair value. How do u derive this fair value?
Chapter 3: The Battle Plan
I don’t think we should be like Warren Buffett and hold forever. If we held SGX (Singapore Exchange) blue chips forever, history will show that in a bear market, these shares can lose up to 90% of their value. I also believe Warren Buffett has no choice, as he has such large positions that in a falling market he would find it very hard to sell out, without putting even more pressure on the stock prices.
For me, I will execute my exit strategy when I feel that the risks of a market crash far outweigh the potential upside. A feeling of uneasiness in the market is one that you will learn to recognise as you spend more time in the stock market.
Essentially, the markets move in trends. There are big trends – called megatrends – that every investor must learn to recognise. If I think that the megatrend has changed to become bearish, I would sell all my fundamental stocks. A change in the megatrend is a very important change. I don’t mind riding through corrections, but I hate to be caught in a major directional change in the market. Hence, I am always in the market because I want to have a feel for it, as this is the only way I sniff out danger signs that usually precedes a megatrend change.
However, a megatrend change is not common – maybe once in three to five years. Hence, chances of a megatrend change are low, but when it changes to a bearish trend, you do not want to be part of the market. One megatrend change was in March 2003 when the bull took over from the bear. Prior to this, it was in January 2000 when the bull became a bear. Given that it is not so common, you would not see me calling a bear every now and then.
By the way, I believe that bulls usually last longer than bears because the feeling of fear is stronger than the feeling of hope. In a bear market, there is a lot of fear and everyone will sell. Hence, in a bear market, stock prices will not simply fall – they crash. When the market is bullish, there will be a lot of hope, but there will still be fear lurking around, as investors dread corrections. Hence, any upward movement is usually slower. While the previous bear market lasted three years, the ensuing bull market, which started in March 2003, lasted a lot longer than that.
When I was trading stocks in the UK, I religiously followed the belief that one should sell 50% when it doubles and then keep doing the same as it triples, and so on. But one day I stepped back and asked myself why am I doing this so mechanically. When you sell 50% on doubling, it is still traumatic seeing it double again or going up even more.
There is some truth in the conventional wisdom that once you get your capital back, you can be more detached about that stock. But my experience is that when your stock doubles, you are already quite detached from it anyway, as your cost is half the existing price. As the stock multiplies further in value, you naturally become even more detached.
Today, I practise a totally different approach after my experience in holding on to all my stocks that multiply. I actually add to my holdings as the share price rises. The key consideration is actually not on the share price but on the prospects of the company. If the prospects of the company continues to be good or is improving, why should I sell when the stock price doubles?
This is against the principle of fundamental investing. When a company is doing better and the share price is increasing, the risk to fundamental investing should be decreasing. Instead of selling, I would still be a buyer under such circumstances. If however, the fundamentals of the business deteriorate, regardless of the share price, I would still be a seller. Take for example formerly listed entertainment firm Eng Wah. I was very bullish about this company when it announced that it was going to run the Crazy Horses cabaret show in Singapore. But when the outlet opened and I saw the dwindling crowds, I did not hesitate to sell, even though at that time, this was one of my fundamental stocks.
Eng Wah needed a boost from a new business and if this business fails to take off, its growth will be curtailed. All my fundamental stocks are either growth stocks or recovery stocks underpinned by a good margin of safety. Without growth or recovery in sight, I would not hesitate to remove that stock from my fundamental list.
I always keep a close eye on the businesses of my five fundamental stocks. If you do this the way I do, it is very time consuming. I have to keep in touch with all the industries of the five fundamental stocks, as well as do regular research on the companies themselves. If any of the fundamentals change, I may have to change my positions on these stocks.
If fundamentals remain intact, you are more likely to see me holding on to the stock, unless of course, Mr Market grossly overprices it. I don’t have a definition for gross overpricing but when it happens, I think most of us can recognise it. Gross overpricing is different from mild overpricing. Gross overpricing stares you right in the face!
Do remember that it is always much easier to buy a stock than to sell one. To buy, you just need to assure yourself that you have paid a fair price for the stock. The main fear is that you have overpaid. If you are like me and go for bargains, you would have paid a very low price and would then have a very high margin of safety. Hence, this fear is minimised if you stick to sound fundamental investing principles.
To sell is a different matter. You will always have a fear that you have sold too early and the share price rises significantly after you have sold. I am sure all of us have experienced this at one time in our investing career. This fear will always be there after your first experience of watching the stock you have just sold, shoot up to the stratosphere.
To overcome this fear, I have an exit price in mind for every stock that I buy. This exit price is usually the fair market value of the stock that I have purchased. Recall that I usually buy a stock at below market value and I will wait patiently for the stock to be revalued. When it is revalued sufficiently, I can be a seller.
Contrast this to what the average investor will do. They will buy a stock at fair value as recommended by a broker. Then, they will have to wait for the profits of the company to improve and the market revaluation of their stock before they can take a profit. There is a lot of unknowns with this strategy and to decide on the exit price will not be easy as the exit price has to be calculated based on projected profits, and frankly, it is hard to predict the future as company profits may not go up all the time.
This is why I would rather buy undervalued companies as I will immediately know its fair value based on its existing business. I do not need to look into the crystal ball to try to figure out a fair value and hence, my exit price for that stock. When the stock has reached my exit price, I do not sell it immediately. Instead, I will ask myself whether the rise of the stock price is justified based on what is happening in the industry or in the company.
If the company did not make any announcements or is not releasing any results soon, then, it is really a gut call whether the rise in the share price is sustainable. This is when I will go to the charts to take a closer look. I will draw the support and resistance lines on the charts and from there, decide whether to sell or to hold. Yes, I do use basic technical analysis to help me with my sell decisions but this is not the only tool that I use to decide whether to sell or to hold. One still needs the instinct and the experience to decide whether this rise is sustainable or not.
On the other hand, if the industry is growing and the company results are around the corner, I will be more inclined to hold on to the stock as I am likely to revise my exit price upwards in line with the better results. If this company continues to do well, then I may have another multi-bagger in hand and the last thing I want to do is to release my shares too early. Hence, at the end of the day, the decision to sell or hold is really a decision based on experience and gut feel.
From the article above, you will realise that serious investing is a full-time career. You need to be available when the opportunity to buy or sell appears. This opportunity may only last a few minutes. No, this does not mean that I am on the screen all the time. Rather, I am usually somewhere else in the house or outside as I have stock alerts that will keep me in touch with the market. Whether I act on any of these stock alerts is really up to me.
Hence, an investor is still in control of his life. The stock market just adds a little bit of spice to his life.
----------------
Question: u said u will sell a fundamental stock when it reaches its fair value. How do u derive this fair value?