# First year of "value" investing in review



## Anglers Rest (15 December 2014)

I tend to read a lot of posts here, but never post myself...mainly because I'm still learning and don't have much to say. I've decided that perhaps the occasional post and especially any feedback might speed that learning up.

I made my first direct stock purchases on Dec 16 2013 so tomorrow is the one year anniversary! 

Approach:
I started out with fairly simple approach. I generally used Martin Roth's Top Stocks book and examined selected companies in detail (A GoogleFinance filter will provide a similar list of stocks).
ROE: > 15%
Debt levels: no more than 50-70% Debt/Equity depending on structure of debt
Market Cap > $100m
5 Year ASX history
Good management and prospects given risk
MOS > 15% preference for > 20%

I modified this a little since Dec 16 2013.
ROE: > 12% for consideration with a preference for > 15% and increasing or stable ROE, especially if ROE is <20%
Little or no debt - unchanged.
Market Cap > $100m unchanged
5 year ASX history or 5 years of available fundamental data if off market
Good management and prospects given risk (follow more tightly)
MOS unchanged
Positive Cashflow
Preference for rising ROE or EPS growth
Investing only in areas I can value/understand reasonably well (retail, consumer discretionary, financials etc I can understand fairly easily).
Hard stop loss of 8% (varies in bull/bear markets).
Don't buy a falling stock.

I'm currently holding 100% cash - not because of conditions but because at the moment, I don't have the required time/stress reserves (I'm doing a PhD and it's crunch time).

All commentary is out of date 6 months as are estimated valuations. I haven't updated these since exiting positions in June (October for CDM). Of course none of it is advice.

CCP for -4.43% return I think CCP is a great company with a bright outlook, and I sold at a small loss only because I was exiting the market. Nothing too fundamentally concerning here. 

CCV another I really like, although I'm not sure how their branch out into Carboodle will pan out, so far it looks worthwhile. Bad press in the UK with consumer loans, but that is on it's way to sorted. I bought at $0.78 with an estimated value of $1.15 in two years and sold at $1.13. Return was 44.95%

MMS I remember MMS diving due to the short lived regulation changes in mid 2013, I was on the train to work. If I had the cash I would have bought then and there, but bought instead when I had funds, with only a limited MOS to future estimated value. This was a mistake. I got off the train to work and on the train of "I'm going to miss out on the MMS story" in my head and bought when I should have kept evaluating. I estimated its value at ~$11 so don't ask me why I bought at $11.49. I averaged down at $9.68 and sold at $9.18 for a -13.3% return. Lessons in my own psychology, need for patience and more thorough evaluations before buying. At least the education was for a fairly small $ cost. Overall I think it's a very decent company in potentially a bad regulatory environment particularly given a lot of their customers are NGO's and there are risks they will not retain them.

RKN - Another lesson. I bought at $2.13 after valuing it at an estimate of $2.20-2.30 based on guidance and factoring in royalty payments to Intuit ending. I placed too little weight on Xero taking market share, products being slow to launch. It's still a company I keep an eye on, but they are struggling to grow earnings and there is no obvious competitive advantage over MYOB/Xero. They have the opportunity to be a niche operator but I'm not sure that will happen either. Too many unknowns and I shouldn't have invested I also payed too much attention to one commentators rather ambiguous view. In hindsight, following this kind of 'advice' is very dangerous. Sold at $2.14 for 1.49% gain inc dividends. Lucky to get my money back.

SEK - More lessons. I bought at $12.38 with an estimated present value of ~$10-13 and a estimate on future value of $13.50-16. So I bought this without a good MOS to current value. Although the price rose and I sold at $16.49 for a 32.54% gain, I strayed from my plan. SEK is also a company I see growing but I don't understand it well. Online companies I'm keen to learn more about as many in Aus have done well.

TRS - Here I  had probably the best lesson I could get in regard to averaging down. I bought at $10.84 and again at $9.11 before selling at $8.11. I valued it at the time at around $10 with future values of ~$16. I based this off stores maintaining profits of around $70,000. If ~350? stores returned to higher levels (in the last 5 years stores returned up to $120,000 NPAT each) I thought it was worth $16-18. I ignored problems like diminishing margins, falling AUD (although TRS hedges against this to an extent) and the impact of K-mart/Target. (Unseasonably cold summers I think had little to do with poor results). Given that they're slowing expansion (they expense store opening costs in the year the store is opened rather than over it's life which reduces reported NPAT) they may have higher NPAT in the next few years, but I'm not sureif there is long term value. I just don't know so it's one turn around story I might miss out on. From this experience though I realised that for me, averaging down isn't sound. Had I cut my losses I would have preserved a lot more capital than I did and the chance to reinvest later if the company shows real signs of being on track might have been wiser. I read somewhere that the second half of the phrase (I'm paraphrasing as I can't recall it exactly) "buy when blood is in the streets...but wait until the clean up has taken place" is the most important and most often committed. It was true in this case and in many others. Loss of 19.87%

FGE - Both my best performer and smallest investment $-wise was FGE. I bought at $0.52 and sold at $1.45 (+164%) based on fast moving fundamental changes and future estimated value and risk. At its initial 'bad news' I valued FGE at $0.70-$0.77 and thought the probability of total wipe out was ~30%. I put a lot of faith in the that Rineheart would find $7bln in backers for Roy Hill which would justify that kind of value based on $700-800mln for FGE in revenue from that project alone and considering other losses - estimated the probability Rineheart could do this at 70%. Longer term if they got things together I thought it might be worth $1.10-1.40 and so sold at $1.45 given I thought it already reached it's estimated future value 2 years down the road and had significant risk still. There was some luck in that as information released changed the outlook quite quickly and therefore the value and risk proposition. It was a very small $ investment but at the time made up 25% of my portfolio, and grew to much more.

Finally after exiting all positions I bought into an LIC - CDM at $1.49 and $1.40 - this was essentially a low work required option and I held it through one dividend payment and sold at $1.48. I bought it for more than it's NTA which some would consider a mistake or at least a missed opportunity. Gain on this was 4.24%. I like Cadence and management's approach, even learning from their own methodology. I won't any more buy a falling stock which many value investors would say is daft. (maybe it is). The idea of buying at a lower price because it represents better value only holds true if estimated future value remains the same or higher and the probability of this occurring is high and unchanged. The problem with this is that a) I could be wrong and b) if people disagree with you the price may drop significantly - while some value investors would happily buy more I'd rather sit that out and re-evaluate. I'm not good enough to be so certain in my estimations of a falling stock (there's usually a fundamental reason for it, digested or not). 

Overall the portfolio returned 14.9% inc dividends and minus expenses. Including large cash holdings (for some months) the return was 11.81%.


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## Anglers Rest (16 December 2014)

Any feedback on my approach/analysis would greatly appreciated. I understand this is retrospective but any discussion would be valuable. 

I started out reading Graham, books on Buffett and Munger but also learnt a lot from Peter Lynch's books. I tried to get my head around Technical entry and exit points (John? O'Niel) but suffice to say as far as I've got is, "don't buy a falling stock". I also read a lot of Roger Montgomery's writings, and founds aspects of that quite useful.

Anyway, thanks for reading that long post...any feedback is welcomed, critical or not as I'd like to learn as much as I can.


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## systematic (16 December 2014)

One quick comment from me.  Not a criticism, nor a question - just an observation and personal opinion:

Given the sort of criteria you are looking at, you're probably looking at reasonable length holding periods.

Therefore, it strikes me as bizarrely tight to implement an 8% stop.

Could you also elaborate on "MOS" - I don't know what that stands for?


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## Anglers Rest (16 December 2014)

systematic said:


> One quick comment from me.  Not a criticism, nor a question - just an observation and personal opinion:
> 
> Given the sort of criteria you are looking at, you're probably looking at reasonable length holding periods.
> 
> ...




That's a fair point. I would prefer to hold for longer periods 2-5+ years and I've not used stops before so that's an area I can learn on - from what I've read I wouldn't have thought an 8% stop very tight, but perhaps I've been reading about that in a technical context? 

MOS = margin of safety of current price to estimated value. 

Thanks for the observation.


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## McLovin (16 December 2014)

The problem with having that stop in place is that you seem to be investing based on business fundamentals but you're using a price based stop to get out. You're exit cue should be based on business fundamentals or your entry should be based on price. The two don't really marry up together.


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## pixel (16 December 2014)

McLovin said:


> The problem with having that stop in place is that you seem to be investing based on business fundamentals but you're using a price based stop to get out. You're exit cue should be based on business fundamentals or your entry should be based on price. The two don't really marry up together.




Fair point McL;
but I can also see merit in the OP's approach. Here is why:

Starting an investment on grounds of business fundamentals is as good and reasonable a Plan as any - provided one has a proven and reliable method of measuring "value".
However, there is always Market Perception. While that continues to sink, my yardstick of fundamental value for this particular company can be as good and solid as they come, yet I'm still worse off holding on to my opinion against the rest of the world. We may debate whether 8% is a reasonable stop-loss; I can think of cases where that's too tight, but in others it may even be too generous.

Independent of the method that suggests I buy a stock, my stop-loss depends on a combination of personal risk acceptance/ aversion and a stock's price volatility over my chosen investment horizon.
For a short-term trade, I may be happy to accept the risk of being "wrong" over, say, 3 days of price moving against me. For a long-term investment, I'd tend to apply the filter that doesn't mind 3 average weeks, or maybe even a couple of months, pulling back. Which filter I choose depends also pretty much on the way a particular stock has been trending in the past. If it's prone to 20% dips, I'd much rather sell out closely after the resistance and buy back more for less when market support appears to resume the rise.


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## Anglers Rest (16 December 2014)

Pixel says it much better than I could have.

I'm comfortable with combining the two but understand many don't. I agree the "8%" probably needs to vary and I haven't actually used/tested this approach yet - but it's one that might mitigate being 'wrong' or simply 'unlucky'. It needs some thought.

If you're very confident in your fundamental analysis then perhaps you don't need this as a price reduction is a chance to buy more for less. But it's incurring a loss (opportunity loss or capital loss) that it tries to avoid. There is no way of knowing how far a price will fall and I know some (e.g. Siegling) will only buy on an uptrend to avoid this. (I won't pretend to know much about Technical A).

Agree McLovin that if Fundamentals change there needs to be a more clear exit structure. Exiting on price changes alone could limit gains significantly. The things I currently look for are falling ROE (not small falls, but large, or consistent small falls), falling margins, increases in debt, performance of competitors and acquisitions that don't make sense or may lose competitive advantages, the price has reached or exceeded forecast IV two years out or a much better opportunity comes along. I agree if you think that's vague! Perhaps any stop applied there needs to factor in volatility and if the market is generally bear/bull.



> For a short-term trade, I may be happy to accept the risk of being "wrong" over, say, 3 days of price moving against me. For a long-term investment, I'd tend to apply the filter that doesn't mind 3 average weeks, or maybe even a couple of months, pulling back. Which filter I choose depends also pretty much on the way a particular stock has been trending in the past. If it's prone to 20% dips, I'd much rather sell out closely after the resistance and buy back more for less when market support appears to resume the rise.




What do you mean pixel by "wrong" over 3 days? The price falls for three days and you might sell? Or average price over the three preceding days/ weeks/ months?


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## systematic (16 December 2014)

Anglers Rest said:


> I agree the "8%" probably needs to vary and I haven't actually used/tested this approach yet - but it's one that might mitigate being 'wrong' or simply 'unlucky'. It needs some thought.




Based on your fundamental criteria for buying, it just needs widening (if you're going to have one).  Such a tight stop doesn't equate with your buy criteria, that's all.  Practically, it will most likely cost you more than it's worth to have.


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## systematic (16 December 2014)

Anglers Rest said:


> MOS = margin of safety of current price to estimated value.




Thanks for that.

So - this criteria pertains to some estimation of value?  Are you doing some type of 'intrinsic' valuation here, or are you referring to analysts estimates etc?


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## robusta (16 December 2014)

Looks like you invested in a good group of businesses there with the possible exception of FGE and TRS in my opinion. Can't really have a go at you having held both of them myself however.

The way you are learning lessons from every holding and result should stand you in good stead for even better future returns.

Have you had a look at this thread?

https://www.aussiestockforums.com/forums/showthread.php?t=23385&highlight=present+value


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## luutzu (16 December 2014)

I think that if you have a sense of approximate value of the stock/business... chances are you will buy it too early and will sell it too early. So McLovin and others are right that maybe you ought to not have stop loss at 8% price decline but align exit with fundamental measures.


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## pixel (16 December 2014)

Anglers Rest said:


> What do you mean pixel by "wrong" over 3 days? The price falls for three days and you might sell? Or average price over the three preceding days/ weeks/ months?




Let me use a simple picture, AR;

Since you said you're not very familiar with T/A, I'll try to keep it basic. Apologies if it's too basic.
PS: Double apology - I had missed that bit about your PhD. 

Leaving off all the other alerts that "Trinity" (= my T/A system) gives me, let's first look at the arrows: 
blue Up suggests go Long, red Down means start Short. The respective price levels for either are always the upper rim of those square symbols.




You also see 3 lines: the middle one represents vwap (an average price), surrounded by Volatility Envelopes drawn at a distance of a selected multiple of a short-term ATR (average true range).
In this chart, I have selected a short-fused trading horizon that lets me stay in a trade while the trend is consistent, but gets me out if the trend turns against my direction (which I laxly call "now I'm wrong") by the equivalent of 1.5 days average ranges. Put differently, I don't wait until I lose a set percentage of my net worth, nor do I wait a set number of days, but rather get out when my position has lost 1.5 average daily trading ranges off the mean top dollar I could have reasonably sold for, had I known a turn was coming.
Nobody knows the future, so I can only use hindsight as the yardstick. At the current time and market condition, I find values between 1 and 2 days reasonably successful, especially in combination with related stock picking methods.


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## Anglers Rest (17 December 2014)

I get that time is limited and beginners can be frustaiting, so thank you for these replies.



systematic said:


> Based on your fundamental criteria for buying, it just needs widening (if you're going to have one).  Such a tight stop doesn't equate with your buy criteria, that's all.  Practically, it will most likely cost you more than it's worth to have.




I see. I've heard of people using stops from 3-25% but that's a lot of variation so I'm a bit confused as to how select appropriate stops. How do fundamental buy criteria change them? (A lower risk company e.g. higher ROE, more stable increases in EPS, little debt = more lenient stop?)



systematic said:


> Thanks for that.
> 
> So - this criteria pertains to some estimation of value?  Are you doing some type of 'intrinsic' valuation here, or are you referring to analysts estimates etc?




Correct yes. I try and value using a formula which looks at Required Return, ROE and and retained earnings. Admittedly it doesn't always work well.



robusta said:


> Looks like you invested in a good group of businesses there with the possible exception of FGE and TRS in my opinion. Can't really have a go at you having held both of them myself however.
> 
> The way you are learning lessons from every holding and result should stand you in good stead for even better future returns.
> 
> ...




Thanks for this link. I got bogged down it once before - a lot to take in. I'll revisit! (I need to).

Agree re: FGE, I think it ended up being a financial dogs breakfast. What do you see as the key elements of TRS that make it poor? Going in to it I thought they were fairly sound, then I realised the margins and competition were a real problem, and management makes a lot of noises about doing smart things but these are slow to happen. It would be good to get a different view on it, as it was one I was fairly confident in, and still sort of feel a bit baffled with what the problems are.



luutzu said:


> I think that if you have a sense of approximate value of the stock/business... chances are you will buy it too early and will sell it too early. So McLovin and others are right that maybe you ought to not have stop loss at 8% price decline but align exit with fundamental measures.




Fair call. I can see the validity here, but what happens when the fundamental evaluation is off or market sentiment doesn't agree before the fundamentals change for the worse? Wouldn't that incur a loss? e.g. you think XYZ is worth $1 and it is selling at 60c, so you buy, it falls to 50c so you buy more, then to 35c and you buy again. It then releases it's Half Year report and you revalue it at say 30c, for a loss at exit. The stop would avoid this or am I missing something? (Sorry, maybe i'm confused but just trying to get my head around it).



pixel said:


> Let me use a simple picture, AR;
> 
> Since you said you're not very familiar with T/A, I'll try to keep it basic. Apologies if it's too basic.
> PS: Double apology - I had missed that bit about your PhD.
> ...




Thanks for this pixel. It's not too basic. Are these average prices similar to simple/exponential moving averages?
How did you select the length of the range of days?

It makes some sense you're not basing it on % net worth or days, but a loss from the max possible price you could have had. (Maybe I'm viewing that wrong, but kind of like a consistently trailing stop loss that's pegged to the max value).


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## McLovin (17 December 2014)

pixel said:


> Fair point McL;
> but I can also see merit in the OP's approach. Here is why:
> 
> Starting an investment on grounds of business fundamentals is as good and reasonable a Plan as any - provided one has a proven and reliable method of measuring "value".
> However, there is always Market Perception. While that continues to sink, my yardstick of fundamental value for this particular company can be as good and solid as they come, yet I'm still worse off holding on to my opinion against the rest of the world. We may debate whether 8% is a reasonable stop-loss; I can think of cases where that's too tight, but in others it may even be too generous.




The problem is you end up cutting your position for reasons that are completely unrelated to why you entered in the first place. I'd argue that someone pursuing an investment, as opposed to trading, strategy cannot know within their first year if they have an edge or if they're just seeing noise in their returns, the feedback loop is just too long to know in such a short space of time. So setting an arbitrary stop that has no basis other than been picked out of the air creates very little benefit and may be detrimental. Volatility of returns are part and parcel of being a longer term investor as opposed to a trader. If you want a smooth equity curve then short term trading is far more likely to deliver that. When I look at AR's stocks, and having held a few of them, they can move +/-8% on no news at all in a day or two. craft has often talked about the strong hand weak hand, which is something that really resonated with me. Setting yourself up with a stop loss at 8% is the weak hand and carries little conviction behind it.

*"You" as in one, not you specifically.



pixel said:


> Independent of the method that suggests I buy a stock, my stop-loss depends on a combination of personal risk acceptance/ aversion and a stock's price volatility over my chosen investment horizon.
> For a short-term trade, I may be happy to accept the risk of being "wrong" over, say, 3 days of price moving against me. For a long-term investment, I'd tend to apply the filter that doesn't mind 3 average weeks, or maybe even a couple of months, pulling back. Which filter I choose depends also pretty much on the way a particular stock has been trending in the past. If it's prone to 20% dips, I'd much rather sell out closely after the resistance and buy back more for less when market support appears to resume the rise.




This makes more sense, to me at least, than an arbitrary stop of 8% come what may. I have no idea if it juices extra returns but at least there's some method in it.


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## pixel (17 December 2014)

Anglers Rest said:


> Thanks for this pixel. It's not too basic. Are these average prices similar to simple/exponential moving averages?



yes, they're *similar* to an EMA.


> How did you select the length of the range of days?



It's what I feel comfortable with; euphemistically, one may call it "discretionary trading". Maybe "gut feeling" is a more honest description. 



> It makes some sense you're not basing it on % net worth or days, but a loss from the max possible price you could have had. (Maybe I'm viewing that wrong, but kind of like a consistently trailing stop loss that's pegged to the max value).



That is something I learned (the hard way) from Phil Carret’s _The Art of Speculation_:


> If you have 1000 shares of a stock worth currently, say, $9, disregard entirely the price you paid for it. Rather ask yourself this question: “If I had $9,000 cash today and wished to buy some security, would I choose this stock in preference to every one of the thousands of other securities available to me?”
> If the answer is strongly negative, sell the stock! It should not make the slightest difference whether the stock cost you $5 or $13.
> Your entry price is totally irrelevant, but the average punter gives it considerable weight.


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## Anglers Rest (17 December 2014)

McLovin said:


> The problem is you end up cutting your position for reasons that are completely unrelated to why you entered in the first place. I'd argue that someone pursuing an investment, as opposed to trading, strategy cannot know within their first year if they have an edge or if they're just seeing noise in their returns, the feedback loop is just too long to know in such a short space of time. So setting an arbitrary stop that has no basis other than been picked out of the air creates very little benefit and may be detrimental. Volatility of returns are part and parcel of being a longer term investor as opposed to a trader. If you want a smooth equity curve then short term trading is far more likely to deliver that. When I look at AR's stocks, and having held a few of them, they can move +/-8% on no news at all in a day or two. craft has often talked about the strong hand weak hand, which is something that really resonated with me. Setting yourself up with a stop loss at 8% is the weak hand and carries little conviction behind it.




Agree a lumpy 20% is better than a smooth 10%. Of course, just starting out investing I don't know if I have an edge or have high conviction in absolute terms. I can only have high conviction that the stocks I'm choosing are better than the other 50-60 I've screened and the 15-20 I've looked at in more detail. 

I should clarify my reason for cutting the position is to prevent capital loss and achieve an adequate return which is why I'm entering in the first place. I think one can have fundamental and technical reasons to buy and sell. I can see your point though that to have high conviction letting go of stop might be necessary. The 8% (which wasn't actually used) was chosen from one of William O'Neils books: "How to make money in stocks" p76. Not quite out of thin air, but also maybe not appropriate. I do appreciate the feedback McLovin. I am re-assessing the approach after all.



pixel said:


> yes, they're *similar* to an EMA.
> 
> It's what I feel comfortable with; euphemistically, one may call it "discretionary trading". Maybe "gut feeling" is a more honest description.
> 
> ...




In my line of work "gut feeling" is sometimes called "clinical judgement" if your experienced. My gut feeling about stocks is probably just emotion but I imagine yours is quite a bit more reliable.


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