How can an overvalued stock be rated a 'buy'?

CanOz said:

How can one realize optimal returns if one does not have the intestinal fortitude to stomach the draw-down?...

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Well, to that all I can do is quote Peter Lynch: "The organ that determines success in the equity market is not the head. It's the stomach".

CanOz said:

... What do your returns Rainman, look like and have you held through a major draw-down, maybe share that with us?

I will say that we bailed after a draw-down greater than 30% on a systematic portfolio of trading systems a couple of years ago. I was ok with the Draw-down, just, but the wife was not.

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I have been down 30% on an individual stock many a time. But if the business continues to perform or is not deteriorating I hold. The only risk that I am concerned with is the risk of total capital loss. Beta risk doesn't worry me in the slightest.

Rainman said:

Well, to that all I can do is quote Peter Lynch: "The organ that determines success in the equity market is not the head. It's the stomach".

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Totally agree with this and it doesn't matter what it is, equities, futures, real estate. Everyone has thier vomit point. At least with quantitative strategies you have some idea of historical draw downs. You would think, that investing in good companies, they'll become more attractive to many investors as your portfolio draws down, giving you some faith that common sense and logic will prevail over senseless irrational behavior...but the question is always when? Another quote and perhaps one of the more famous, "the markets can stay irrational longer than you may stay solvent"

CanOz said:

Totally agree with this and it doesn't matter what it is, equities, futures, real estate. Everyone has thier vomit point. At least with quantitative strategies you have some idea of historical draw downs. You would think, that investing in good companies, they'll become more attractive to many investors as your portfolio draws down, giving you some faith that common sense and logic will prevail over senseless irrational behavior...but the question is always when? Another quote and perhaps one of the more famous, "the markets can stay irrational longer than you may stay solvent"

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Yes, but the risk of insolvency only arises if you use leverage.

Interesting debate guys.

CanOz said:

Totally agree with this and it doesn't matter what it is, equities, futures, real estate. Everyone has thier vomit point. At least with quantitative strategies you have some idea of historical draw downs. You would think, that investing in good companies, they'll become more attractive to many investors as your portfolio draws down, giving you some faith that common sense and logic will prevail over senseless irrational behavior...but the question is always when? Another quote and perhaps one of the more famous, "the markets can stay irrational longer than you may stay solvent"

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good points.

Rainman said:

I have been down 30% on an individual stock many a time. But if the business continues to perform or is not deteriorating I hold. The only risk that I am concerned with is the risk of total capital loss. Beta risk doesn't worry me in the slightest.

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Rainman. you and I probably come from similar camps where our perceptions of the business value are more important than the price..... BUT have you really mastered indifference to price? I reckon I have a bit of experience under my belt but there are still days(bad days) when the mark to market value that I'm theoretically indifferent too uncontrollably crystallises in my conscious into how many wages or house or toys or whatever I have just seen wiped from my account and things get tough for a while (not worried in the slightest is not how I would describe these testing times) and I don't think I have seen the last time I sit there at the ultimate buying discount thinking what in the FCUK does everybody else know that I don't - The market price can't possibly be that far out - only to find out later it was. If you have truly mastered your emotions to the level you say I am in awe - But if you are talking theory better get ready for some real life schooling at some stage.

craft said:

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Rainman. you and I probably come from similar camps where our perceptions of the business value are more important than the price..... BUT have you really mastered indifference to price? I reckon I have a bit of experience under my belt but there are still days(bad days) when the mark to market value that I'm theoretically indifferent too uncontrollably crystallises in my conscious into how many wages or house or toys or whatever I have just seen wiped from my account and things get tough for a while (not worried in the slightest is not how I would describe these testing times) and I don't think I have seen the last time I sit there at the ultimate buying discount thinking what in the FCUK does everybody else know that I don't - The market price can't possibly be that far out - only to find out later it was. If you have truly mastered your emotions to the level you say I am in awe - But if you are talking theory better get ready for some real life schooling at some stage.

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True that.

There's a lot of red on my account at the moment and while the dividend meant I have actually made a reasonable return last couple years, it's not pretty and some day I wonder what the heck.

But nothing a couple beers or a few bad jokes can't help, for now

Lucky I don't borrow money to invest and have a reasonable margin for expenses.

Rainman said:

Well, to that all I can do is quote Peter Lynch: "The organ that determines success in the equity market is not the head. It's the stomach".

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True.

I find investing the method and theory to be quite simple. It's the commitment to it on some purchases that's hard. I mean, to see value when many others do not; to buy and see it halved...

Just have to have a big ego and do a lot of homework and hope you aren't the sucker being screwed.

craft said:

If you have truly mastered your emotions to the level you say I am in awe...

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I hope I don't give that impression.

When my portfolios are down, it depresses me. No doubt. But if a stock's business and its prospects are unimpaired, I usually buy more.

I run two portfolios. One contains stocks trading below net current asset value. I call this the NCAV portfolio. I am not really concerned about the quality of the businesses that I buy for this portfolio. The selection process is almost purely quantitative. As long as the stock is growing net current asset value (or, if not growing it, it is not rapidly eroding it), the stock is a possible candidate. Also, the bigger the discount from NCAV, the better, in my view. Last year, for example, ONC (which now trades as TFL) traded for months around 20% below net cash. It ended up distributing a lot of the cash to shareholders. The beauty of it was that even when ONC told the market that it was going to distribute this ton of cash to its shareholders the stock barely moved. I bought a chunk of it.

The NCAV portfolio did well towards the end of last financial year up to the beginning of this financial year. It ended up over 50%. The big winners were ONC, RIS and BAU. UOS which is not a NCAV stock but which is very cheap on an asset basis also made a decent contribution. The losers in that portfolio were TGZ, CHN, MGX and MPO. With an NCAV you always have losers. That is why you must diversify: it is the portfolio as a whole which gives you your outperformance. I have since sold down most of my positions in the NCAV portfolio after huge rises by ONC/TFL and RIS in particular. ONC/TFL almost tripled at one point in a matter of months but I was out of it by then. RIS is no longer trading below net current asset value and I am out of it as well.

My other portfolio contains stocks which I consider have a decent business but which are fairly to cheaply priced. This portfolio is quite concentrated and is currently down around 4% for the half year. The biggest loser has been IMF. It has had a setback with the bank fees case(although it's been granted leave to appeal that case to the High Court). Still, it has kept going down on sentiment alone, it seems. It dropped another 7% yesterday for no apparent reason. I am now down over 22% on it. But I will keep buying. The fundamental story has not changed. But its performance has left me scratching my head, to put it mildly.

By the way, for anyone interested in the sort of outperformance that you can get from adopting a NCAV strategy, I recommend reading:

1. Deep Value by Toby Carlisle (an Aussie);
   
   
2. The Rediscovered Benjamin Graham: Selected Writings of the Wall Street Legend;
   
   
3. How the Small Investor Can Beat the Market: By Buying Stocks That Are Selling Below Their Liquidation Value, an early article by Joel Greenblatt (the article is summarised here:http://www.valuewalk.com/2015/04/original-magic-formula/).

The first and third of these publications contain studies on just how effective Ben Graham's original net-net strategy has proven to be over time and in spite of (or perhaps precisely because of) the emergence of ever more sophisticated quantitative computer programs.