Becoming a not terrible investor

[aws]

I’ve come to the realization that the way I pick many of my stocks may be deeply flawed.  This post will have a lot of generalizations and may not be that useful, but I was hoping some people may be able to relate and offer some help for improving.

 

I usually scan 52 week lows to look for opportunities.  Stocks like this are obviously facing some type of immediate problem, and normally trade at something like a 50% discount to their 52 week high.  I am working under the assumption that markets often overshoot on both good and bad news, so 52 week lows are likely to contain some bargains.

 

I will then narrow down the list and start looking for information to confirm whether the overshoot hypothesis may be correct.  Often I use book value the most important metric as it’s so easy to calculate and assuming they aren’t burning up too much cash it should provide a level of support.  Let’s say it trades down to 90% of book value when it had previously traded at 2x book.  I might buy it because it looks cheap and just hope for a small rebound.  I’ll put more analysis into it than that, but I’m usually shooting for just a quick 10% rebound more than I am a 3 year doubling for example.

 

I think this approach does cause me some significant problems as I’m cutting winners very short, and getting stubborn with losers.  I’m constantly buying companies with lots of bad news, and the most likely near-term outcome for a stock like that is it continues down.  Over a long time horizon the returns on a 52 week low stock may be equal to or better than the market averages, but I do think it’s much more likely to continue down than immediately rebound.  So I get into this bad habit where I’m always looking at bad news and more often than not am in the red.  Let’s say for example I bought at 0.9 times book and it went down a further 20% before starting to rebound.  Now, if it got back up say to 100% of book I may sell it because:

 

1. That’s a decent gain for a small amount of time – 10% in probably a few months

2. It doesn’t objectively look as cheap as new stocks on the 52 week low list

3. I’m relieved to be able to exit with a small profit after months of being in the red

 

But what this means is I never get the big rebounds, like tripling over three years or whatever, because by the time it gets anywhere near that point it no longer looks cheap to me on the same metrics I bought it.  If I’m wrong I may get stubborn and ride it all the way to a zero, but if I’m right I settle for a small gain.  Averaged out I’m not coming close to beating the averages – in fact – due to a couple of absolutely horrible investments I’m actually down money since I started dabbling in stocks in 2011.  I got absolutely destroyed in TWGP last year for example.

 

Clearly I need significant adjustments.  I need better discipline to avoid ever putting significant amount of capital at risk of permanent loss.  That could come from a combination of position sizing and checklist routines to make it less likely that I’ll overlook some important factors when making an investment.  I also just need to stop looking at investments where the best thing I can say about it is that it looks like it might be 10-20% undervalued on a conservative basis.  That may be true, but I should have at least enough conviction to think the stock could double in three years to make it worthy of an investment.  If I don't understand it well enough to see the path to doubling then I can't buy it.

 

Sorry if I rambled on a bit – it’s just something I’ve been thinking about and wanted to put into writing.  I hope to be able to share actual good ideas in the future and not just records of my failures.

 

[innerscorecard]

The first question is identifying why you are actively investing your money instead of indexing (because with indexing, you have the guarantee of being a not-terrible investor, because you will achieve market returns minus the very small fees you pay). Maybe it's not an economic reason. For instance, you might think it's fun or you like the feeling of getting dividends each year from companies you know and like. If it's economic, what's your specific advantage? Maybe it's just patience, or the fact that you're an individual investor. Or is it something else, too?

[oddballstocks]

Let's try to treat the cause and not the symptoms.  Sounds like you're biggest battle is your emotional self.  You are battling bad news, then happy and relieved to get out with a small profit.  Then you're disappointed that you didn't let things run.  You're fighting a battle against yourself!

 

The problem with 52 week low lists is you're hunting for problems.  There's a reason these stocks are hitting new lows, there is a lot of bad news and the market is scared.  Now good money can be made if you have a supernatural ability to parse headlines and see what isn't there.  Given your results and how you feel about this it sounds like this isn't your ability.

 

I prefer to search for stocks that are neglected.  I recommend this over the lows list, and since you mention BV a neglected style might suit you.  You'll find little dowdy companies that people have forgotten exist for low multiples, and often they're earning alright returns on equity.  The only battle you'll fight with this style is patience.  You have to buy into an average or better company at a low price and wait.  I'm not a fan of turnaround speculations (although I've been known to do a few).

 

 

[ERICOPOLY]

I prefer to search for stocks that are neglected.  I recommend this over the lows list, and since you mention BV a neglected style might suit you.  You'll find little dowdy companies that people have forgotten exist for low multiples, and often they're earning alright returns on equity.  The only battle you'll fight with this style is patience.  You have to buy into an average or better company at a low price and wait.  I'm not a fan of turnaround speculations (although I've been known to do a few).

 

I think that's the best approach, only for me it's too damn boring so I chose to have guys like Sanjeev do it for me (for a fee).

 

[ASTA]

I find it strange that you mention 52-week lows and don't have a guru scale incorporated. As my self I am not very smart and kind of lazy. So to combat that :D I crate all kind of rule's and checklists.

 

How much does a guru own of a company, how many greats own the stock and so on and all mashed together and the best choice according to my limited brain capacity wins.

What oddballstocks and Kraven and other do I think is actually better. But I work with what god gave me in brain capacity :D     

[Kraven]

It's good that you understand that you are having issues.  The first step in finding a cure is realizing that you need help.  The thing that struck me about your post, and I will be blunt here, is that you don't know how to invest.  I don't see this as a problem of which pool you're fishing in because 52 week lows can certainly be a good one. 

 

You said that you're using book value as your valuation.  Well, that's fine in theory.  But remember it's not what a number is, but what it means.  Here is how you are investing.  You have a nice meal at a restaurant so you figure out what the ingredients are.  You then decide that anytime those ingredients are in a dish you will eat it without determining how they were cooked, prepared, etc.

 

In my most humble of opinions, you need to take a step back and figure out what you're doing.  Figure out who you are (know thyself).  Some thoughts.  Have you taken the time to read some of the investing classics?  If you haven't, you should.  Cover the gamut.  Read Graham, Lynch, Fisher, Buffett, Klarman, etc.  Think about what style resonates with you.  This isn't a process where you read a book and you go from baby to adult in a day.  You need to let these ideas bounce around in your head.  Start doing some small investments with amounts of money that won't hurt you if you go astray.  Develop a style.  Figure out what is comfortable for you.

[aws]

I have read a lot of Graham and Buffett, and I'll read more everyday.  It's not necessarily lack of knowledge about investing that trips me up, but rather a lack of discipline.  As I said in the post I get too emotionally invested in short-term results, and that can either lead to averaging down on losses to the point where I have too much in one stock, and on the flipside not lettings winners run enough to ever have really big gains.  I also haven't really made use of a too hard pile to screen out stocks that look cheap but are impossible to really understand.

 

I am taking steps to work on discipline.  I'm keeping a journal now for each trade to record my thesis.  I want to put more of my thoughts into writing to force myself to think before I act, and to be able to have hard evidence to look back at.  And I'm looking to develop a checklist but have not done so yet.

[augustabound]

To what Kraven recommends, that helped me a few years ago. I read up on the different guru investors and kind of had the "aha" moment when reading up on Mohnish Pabrai.

It made sense to me to fish for the bargains and look for severe mis-pricing. Finding 25% undervaluation can lead to a small margin of safety but look for doubles and triples (which Mohnish says if he finds 2-3 a year he's happy).

 

For too long I fell into the Buffett trap of "great businesses at good prices" but realized (as most here already knew and I think Nate posted on his blog), that wasn't the way for a small investor to make money rather a billionaire's way of protecting it unless you buy them when the world is ending like 2009. 

Geoff Gannon also posted that most investors aren't smart enough to find these great businesses like Buffett is and to look for the small undiscovered and overlooked at bargain prices like Nate suggests.

 

This all happened around the same time and was my aha moment, you need to find your own.  ;D

 

In time you'll figure out your style, maybe innerscorecard is correct that indexing is your best option.

 

 

[jay21]

I have read a lot of Graham and Buffett, and I'll read more everyday.  It's not necessarily lack of knowledge about investing that trips me up, but rather a lack of discipline.  As I said in the post I get too emotionally invested in short-term results, and that can either lead to averaging down on losses to the point where I have too much in one stock, and on the flipside not lettings winners run enough to ever have really big gains.  I also haven't really made use of a too hard pile to screen out stocks that look cheap but are impossible to really understand.

 

I am taking steps to work on discipline.  I'm keeping a journal now for each trade to record my thesis.  I want to put more of my thoughts into writing to force myself to think before I act, and to be able to have hard evidence to look back at.  And I'm looking to develop a checklist but have not done so yet.

 

If the emotional side is your biggest problem, would I be off base to recommend finding good mutual funds and index funds? Develop a plan to dollar cost average into those and stick to it.  Hopefully that will help you with your discipline.

 

Also, I would recommend books on statistics, gambling, etc.  These go a long way into helping you understand variance, sample size, and results orientation.  Once you realize how much randomness is inherent in short term fluctuations maybe you will take it less of a sign as being immediately right or wrong.

 

Third, diversify (if you are concentrated). Your winners and losers may seem to be less significant if you have more positions.

 

Lastly, read everything on investing you can find plus psychology books like Thinking Fast and Slow and Influence.  I think Kraven's advice was on point.  Most investing books would tell you to look for significant margins of safety (greater than 10%-20% undervalued) and stress using different valuation methodologies for each business/industry.

[merkhet]

oddball has it right -- you have to decide sooner rather than later whether you have the emotional temperament required of value investing -- some people do and some people don't.

 

And if you don't, then either index or give your money to Berkowitz or someone like him to manage.

[mvalue]

The psychological aspect others addressed is most important. From a practical standpoint it may help to modify your approach immediately to know that from a short-term "pop" perspective the 52-week low list is the worst place you could be looking. Statistically stocks hitting lows provide much worse short-term performance than other stocks and even and especially stocks hitting new highs.

 

It goes against our view of how things should work as value investors but it's true. You should buy a stock hitting lows if you really have a solid variant long-term view and want to stick with it, and if that's the case by all means do. When you buy from the low list and sell winners fast you are almost certain to suffer, though.

 

Also you probably should do a remedial crash course in value investing to move beyond just price/book. It CAN be a valuable metric but beyond small cap stocks heavy in tangible assets you need a lot more in your tool belt to think about whether a stock is mispriced.

[Guest 50centdollars]

 

For too long I fell into the Buffett trap of "great businesses at good prices" but realized (as most here already knew and I think Nate posted on his blog), that wasn't the way for a small investor to make money rather a billionaire's way of protecting it unless you buy them when the world is ending like 2009. 

Geoff Gannon also posted that most investors aren't smart enough to find these great businesses like Buffett is and to look for the small undiscovered and overlooked at bargain prices like Nate suggests.

 

 

I think Buffett mentioned this once. Someone asked him if he only had $10 million to invest, what would he do? He said he would buy net nets and not big companies like Kraft etc...

[Kraven]

Eventually in the career of an investor I believe that the emotional and psychological aspects of investing subsume the technical aspect.  So I agree with what everyone is saying on those points.  However, it struck me that the OP is lacking some basic skills right now.  He said it's about discipline, not knowledge, but from what he said I am not sure I agree at this point.  Buying something because it appears on the 52 week low list in an of itself isn't a recipe for success.  The list is just one of many places to fish for ideas.  It's not that because something is on the list it's a good idea or will work out. 

[Hielko]

I think the technical aspect and the emotional and psychological aspects are also closely related. Hard to have confidence in a certain strategy or stock if you don't understand it fully and you don't know what risk profile you are exactly facing.

 

About the specific strategy that the OP is using: I'm wondering what is the basis for choosing it? Are there many investors that use it and are successful? I don't know any. Is there scientific evidence that suggest it might be profitable, especially with the strategy of selling it for a small pop? I'm not familiar with any, and I doubt there is. The existence of momentum as a 'risk' factor is actually a pretty strong hint that it might not be a winning strategy.

[aws]

I did over simplify my techniques and level of analysis, but that was the gist of the problem I was trying to get across.  I've picked a strategy that is bad to begin with, and especially bad for me emotionally.  I do still have a lot to learn, but I think my biggest improvements will come from discipline rather than just more reading. 

 

Sitting out entirely and just indexing is certainly an option, but I don't think that's entirely necessary as I can overcome the problems that I have.  In the grand scheme of things my losses aren't that significant and won't impact my life or my family's.  I'm still in my 20s, I make good money, and around 80% of my money is invested in a combination of index funds, rental properties, and Berkshire stock (which I consider a permanent holding). 

 

What I'm thinking about is moving my speculative money into a brand new account so there is a clear break from the past.  I'll put a fixed amount of money in on October 1st and there will be no additional deposits or withdrawals to distort results on way or the other.  Every trade made in the account will follow a more disciplined approach and I'll be able to benchmark how things are doing more easily.  At the end of each quarter I can decide whether to add my excess funds to my speculative portfolio or not, depending on how things are going.

[merkhet]

I apologize in advance if this sounds like nitpicking or we're having some sort of a semantic difference.

 

I did over simplify my techniques and level of analysis, but that was the gist of the problem I was trying to get across.  I've picked a strategy that is bad to begin with, and especially bad for me emotionally.  I do still have a lot to learn, but I think my biggest improvements will come from discipline rather than just more reading. 

 

Firstly, moving over to another strategy won't eliminate the need to have emotional resilience. Any investment has the chance of short-term dipping below (and maybe significantly below) your purchase price -- even if you're buying nowhere near the 52-week low or 52-week high. If you're looking for a strategy that won't do that, I can save you the time -- it does not exist.

 

Sitting out entirely and just indexing is certainly an option, but I don't think that's entirely necessary as I can overcome the problems that I have.  In the grand scheme of things my losses aren't that significant and won't impact my life or my family's.  I'm still in my 20s, I make good money, and around 80% of my money is invested in a combination of index funds, rental properties, and Berkshire stock (which I consider a permanent holding). 

 

What I'm thinking about is moving my speculative money into a brand new account so there is a clear break from the past.  I'll put a fixed amount of money in on October 1st and there will be no additional deposits or withdrawals to distort results on way or the other.  Every trade made in the account will follow a more disciplined approach and I'll be able to benchmark how things are doing more easily.  At the end of each quarter I can decide whether to add my excess funds to my speculative portfolio or not, depending on how things are going.

 

Secondly, and this is where the disclaimer on semantics kicks in -- you call it your speculative portfolio and you call them trades. I don't know if this was just a misuse of the word or if it represents a deeper-rooted issue, but either way, you probably shouldn't think of it as speculative money and/or think of investments as trades. That mentality alone will be self-defeating.

[merkhet]

Also, as an addendum, you seem to have a serious amount of loss aversion. The problem is that you are equating loss with stock price and not with changes in fundamental value -- I'm not entirely sure how to fix that... again, I think it comes down to temperament.

[aws]

I don't have a superstition that changing strategies, or accounts, or anything of the sort will be a magic bullet that fixes everything, but I do think I need to play to my strengths and not to my weaknesses.

[merkhet]

Totally understand that -- what I'm saying is that one of the weaknesses (loss aversion) is going to kick in anyway -- trying to lessen the likelihood of having an investment fall below your purchase price is a laudable goal but an unlikely outcome with any strategy.

 

You have a bit of an emotional loop happening:

 

(1) Buy company

(2) Company falls below a certain price

(3) Loss aversion kicks in

(4) Start just wanting to break even or make a small gain and get out

 

What you have to do is find a way to short-circuit this cycle because, regardless of what strategy you choose, it will still lead you into this cycle. In the short-term, negative market moves will almost always happen. I'm not sure I've ever had a single investment that hasn't dipped below my purchase price, and I don't make a habit of buying companies that have hit 52-week lows.

[oddballstocks]

It can be an emotional rollercoaster for sure.  I have invested in a number of stocks that fell 30-40-50% before eventually rising for a gain (sometimes very significant, down 50% to up 100% or more).  That's how this works, I don't panic or look at those stocks any different IF the business is unchanged.

 

You're in your 20s and will be fine.  I'm guessing you graduated in 2011 or so, which is when you started to invest.  When I was in my early 20s I was spending money as fast (and faster) than it came in, so the idea that you're even interested in this is good.  And unless you have a giant inheritance, or sold a dot-com your portfolio is probably smaller as well.  At this point just saving is going to outweigh any investment gains.  If you have $10k in your account saving an extra $2k is the same as a 20% gain.  It's much easier to save $2k rather than make 20%.

 

There's a tipping point maybe around $100-150k where investment gains start to make a difference verses saving. 

 

I'm still blown away by what consistent saving can do.  I put money into index funds in my 401k and have been for years.  It started at $0 in 2008, and now six years later it's a significant amount of money.  I never put in a large chunk, it was just consistent savings from each paycheck.  And the amount from each check was manageable, each bi-monthly amount doesn't seem like much.  But over the years it adds up.  I also picked up gains from the market, but I'm very limited on what I can invest in, so I've just received the market's return.

[yadayada]

When you are mediocre at something, it is often hard to really see how mediocre you are untill you are good at it. And then you can look back and know how bad or good you were exactly. And even then your not sure as you might still be mediocre without knowing.

 

For example people with low intelligence think higher of themselves then people with high intelligence. So if you invest part time your brain is constantly trying to fool you that you are at least pretty decent when in fact you might not be. Reading this book might be a good start:

http://www.amazon.com/Thinking-Fast-Slow-Daniel-Kahneman-ebook/dp/B00555X8OA/ref=sr_1_1?ie=UTF8&qid=1411483092&sr=8-1&keywords=thinking+fast+and+slow

 

So before you do anything with investing, you should remind yourself constantly to tell yourself that your not nearly good enough. Most people never get good at it because they stop pushing themsleves to become better at some point. Not because they lack some innate skill. That point usually comes way too soon. And when their results are then bad over a longer period they will just throw in the towel and say it is too hard, or complain about bad luck.

 

With most skills if you plateau at some point and stop learning, you will get killed fast. With sports or sales or any skill with immediate feedback and low variance you will fail right away if your learning curve flattens out too soon. The dangerous part with investing is that it can take quite a while before you could blow up with a bad strategy. So this fear should always be in the back of your head. You cannot rely on stock prices going up or down for negative feedback. It should come from within.

[Uccmal]

I concur with virtually everyone here.  If I define successful investing as beating an S&P tracking fund then it becomes an emotional and psychological game.  That is my only advantage over the index, and thousands of mutual finds run by hundreds of thousands of people who all know accounting. If it means buying Berkshire and nothing else then so be it. 

 

Anyone with a modicum of intellect and grade 8 math can read a balance sheet, and run a computer screen.  Successfully applying it is a different matter.  No matter what style one works with the emotional and psychological is what determines the level of success. 

 

One of the books that really helped me solidify my strategy was David Dreman's Contrarian Investment Strategies. 

 

My style would likely make oddballstocks and Kraven sick to their stomachs but it works for me. 

 

aws, it seems you have the right idea.  Partition part of your holdings for experimentation, and work out if you can beat Berkshire or Fairx.  If your experiments fail after a few years than invest in the index or whatever. 

 

I had 20,000 in student debt at 31, and am "retireable" at 50.  So, you have lots of time to work it out.

[west]

In addition to everyone's excellent advise, should you continue to choose to go down the route of picking your own stocks, I highly recommend taking some accounting courses (at least an intro to accounting course) to make sure you know the nuances of what's going on between the financial statements.  In addition, take a valuation class to understand how professional appraisers value companies.  This will give you a framework to hang your potential stock picks on (even if you move beyond DCF to just multiples, which I think everyone does).  Damodaran, the guy when it comes to valuation, gives his courses away for free online (no book required!)

 

http://pages.stern.nyu.edu/~adamodar/New_Home_Page/webcasteqspr14.htm

 

The valuation course taught at one of the top MBA schools ($90k+ per year).  For free.. You can't beat that!

 

Best of luck.

[flixil]

You are showing spring 2014

 

fall 2014:

 

http://pages.stern.nyu.edu/~adamodar/New_Home_Page/webcasteqfall14.htm

[west]

I showed the Spring session because all of the lectures are posted.  The Fall session is still in progress.

 

Speaking of which, anyone can join in in the Fall session if they like!