My Investment Journey

[KnowThePast]

This is what i have learnt, and found to be "mostly" true.



This i have also found to be true although a rare event.



I think i have found a way around that, using a methodology involving the use of a very small position size, low cost brokerage, no leverage and the acceptance of the rare total loss of a position or 3 over time. This would allow the investor to be "wrong" and only suffer a small $ loss, so that any one investment cannot hurt you financially or psychologically.

While leaving the investor open to the potential SP recovery and opportunities that may arise from holding the (loser) stock...im going to try this with my new IB account, recycling capital from the winners as per usual and avoiding the more speculative prospectors and bio techs etc.

Hi So_Cynical and galumay,

I think we are mostly in agreement here.

Buying on the downturn (or not selling) may result in large losses sometimes, but by picking good companies with enough margin of safety, it is a very rare event. The potential of the upside, however, is much greater. With minimum diversification, this is the right thing to be doing.

 

[cynic]

Hi So_Cynical and galumay,

I think we are mostly in agreement here.

Buying on the downturn (or not selling) may result in large losses sometimes, but by picking good companies with enough margin of safety, it is a very rare event. The potential of the upside, however, is much greater. With minimum diversification, this is the right thing to be doing.

So good companies and minimum diversification are the ticket to investment success, eh!

When considering "event rarity" and "safety margin" one might benefit from reflection on the outcomes achieved by former, minimally diversified, investors in "good companies" like HIH, Davnet, ABC Learning, Babcock Brown etc.

 

[keithj]

Selling a company just because the price has dropped is just plain lazy (IMHO).

This made me smile.... my philosophy the exact opposite .

If you really believe that you're smarter than the market and that the cpy really is worth more than it thinks it is today, it's likely you can take advantage of an even better price tomorrow. The market frequently has a different time frame from me which stop losses help take advantage of. Of course, you can hedge your bets by selling half at the stop loss, just in case you're the unluckiest guy in Australia who happens to sell at the exact bottom.

 

[robusta]

So good companies and minimum diversification are the ticket to investment success, eh!

When considering "event rarity" and "safety margin" one might benefit from reflection on the outcomes achieved by former, minimally diversified, investors in "good companies" like HIH, Davnet, ABC Learning, Babcock Brown etc.

Hmmmm they were not good.businesses, too much debt, low ROE and poor cash flow.

 

[KnowThePast]

So good companies and minimum diversification are the ticket to investment success, eh!

When considering "event rarity" and "safety margin" one might benefit from reflection on the outcomes achieved by former, minimally diversified, investors in "good companies" like HIH, Davnet, ABC Learning, Babcock Brown etc.

But do note some of my criteria for "good" companies:
- low or no debt.
- management with large ownership of the business.
- good ROC
- few acquisitions.
- simple to understand (for me, and yes, this is subjective).

How many of the listed companies above met all of these? None, I think.

How about coming up with a list of companies that match my criteria that have gone under? I am not saying that there are none, just that the chance of it happening it is so low, that diversification already takes care of that risk, there is no need for further risk mitigation (for this) with stop losses.

You are also putting words into my mouth that I never said. I never advised for minimum diversification, I stated that to take away the risk of losing all/most of your money, only minimum diversification is required. 5+ to be precise.

But I never said you should aim for as few as possible, in fact, I think there are some good arguments that potential returns may be higher with greater than minimum diversification, but that's another topic.

- - - Updated - - -

This made me smile.... my philosophy the exact opposite .

If you really believe that you're smarter than the market and that the cpy really is worth more than it thinks it is today, it's likely you can take advantage of an even better price tomorrow. The market frequently has a different time frame from me which stop losses help take advantage of. Of course, you can hedge your bets by selling half at the stop loss, just in case you're the unluckiest guy in Australia who happens to sell at the exact bottom.

I think the market is correct most of the time, but sometimes there are opportunities. Usually in places no one wants to look.

But by this logic, once the price has gone down, why sell? The market has already priced it correctly

 

[KnowThePast]

Hmmmm they were not good.businesses, too much debt, low ROE and poor cash flow.

Thanks Robusta, glad someone else spotted this.

My dad lost heaps of money in HIH. The only reason he had for buying the company was that his "broker!" friend told him it is a good company that is guaranteed to go up.

He's never read a single annual report of theirs or did any research. But he knew, without a shadow of a doubt, that it was a good company. Up until it wasn't.

I spend just as much time reading annual reports of "bad" companies as I do of "good" companies. They are a lot more interesting. With good companies, things just keep ticking and major news or change of directions are rare.

But with some other companies, it is a constant soap opera, new 3 year plans, excuses, extra focus on unlocking shareholder value. Really fascinating.

 

[keithj]

I think the market is correct most of the time, .....

But by this logic, once the price has gone down, why sell? The market has already priced it correctly

Because the price will to continue to go down, unless you are the unluckiest guy in Oz & sell at the exact bottom. I disagree that the market always prices correctly. The market only tends towards pricing correctly in the long term, it is only sometimes correct in the short term. If the price has gone down (& presumably is trending down) the market is giving you an opportunity to sell today & buy cheaper tomorrow... that's why I consider it lazy to not accept that you were wrong & grasp the opportunity the market is giving you.

Back in the old days it would have been easier to have agreed with you, but with todays good data feeds and v. low txn costs it's more profitable to acknowledge poor timing/bad analysis/change of circumstances/bad luck/etc even for a fundamentals based investor.

 

[galumay]

Because the price will to continue to go down,

Unless it goes up again, or stays the same!

If the price has gone down (& presumably is trending down) the market is giving you an opportunity to sell today & buy cheaper tomorrow... that's why I consider it lazy to not accept that you were wrong & grasp the opportunity the market its giving you.

There is no certainty though, as above, it may go down more, it may go up, it may stay the same. Personally I believe that as a fundamental investor I have to assess the reason for the drop in price and make an informed decision about the best action consistent with the facts I have at hand. On that basis I may sell, I may buy more or I may do nothing - exactly the same process as I would take with a rising share price!

Back in the old days it would have been easier to have agreed with you, but with todays good data feeds and v. low txn costs it's more profitable to acknowledge poor timing/bad analysis/change of circumstances/bad luck/etc even for a fundamentals based investor.

Thats fine, but a hard trigger like a stop loss is counter intuitive because it will prevent me from carrying out any analysis about the reasons for the fall in price - "poor timing/bad analysis/change of circumstances/bad luck" - or an irrational market mis-pricing the share.

I totally get stop losses and other hard triggers for technical investors, the issues and interests are entirely different.

 

[skc]

This is just going around in circles, isn't it?

If you buy "great" companies of course you are going to be fine in the long run. That's the definition of "great'.

By not planning to sell your investment, you are backing your ability to pick great companies. By having a plan to sell your investment, you are preparing for the probability that you will pick some duds. It's up to the investor to decide which one is more realistic for themselves.

If the odd position becoming a total loss is acceptable within your risk appetite, who's to say you can't do it this way? What gets some investors however is when they average down until a large chunk of their net worth is locked in a company that is deteriorating in fundamentals, yet they bury their head in the sand ignoring such changes, or talk themselves into believing that things will improve next quarter / half / decade...

The trick in that isn't just diversification, it's position sizing for risk.

 

[keithj]

There is no certainty though, as above, it may go down more, it may go up, it may stay the same.

Of course there are no certainties regarding tomorrow, only balance of probabilities. One certainty is that the timing of the entry could have been better.

Personally I believe that as a fundamental investor I have to assess the reason for the drop in price and make an informed decision about the best action consistent with the facts I have at hand.

Absolutely. Combining a falling SP, bearing in mind that round trip txn costs are ~0.2% (far less than the daily range of most stocks), and that FA is more likely to be objective with no existing position, my contention is that it's close to a 'free lunch' to be able to take advantage of irrational market mis-pricing and sell today with the likelihood of being able to buy back at a better entry price tomorrow, while still maintaining FA principles.

 

[craft]

This is just going around in circles, isn't it?

If you buy "great" companies of course you are going to be fine in the long run. That's the definition of "great'.

By not planning to sell your investment, you are backing your ability to pick great companies. By having a plan to sell your investment, you are preparing for the probability that you will pick some duds. It's up to the investor to decide which one is more realistic for themselves.

If the odd position becoming a total loss is acceptable within your risk appetite, who's to say you can't do it this way? What gets some investors however is when they average down until a large chunk of their net worth is locked in a company that is deteriorating in fundamentals, yet they bury their head in the sand ignoring such changes, or talk themselves into believing that things will improve next quarter / half / decade...

The trick in that isn't just diversification, it's position sizing for risk.

Nice post – especially the bolded bit.

I Just want to expand on this a bit.

By not planning to sell your investment, you are backing your ability to pick great companies. By having a plan to sell your investment, you are preparing for the probability that you will pick some duds. It's up to the investor to decide which one is more realistic for themselves.

It’s very easy to label longer term fundamental strategies as buy and hold and make the wrong assumptions about the “hold”

To me not having a plan to sell does not mean that an investment won’t be sold – It just means the information to trigger a sale does not yet exist. Not having a price based stop means you are backing yourself to interpret future developments correctly. After a decade or so of no adverse information flow negating your early assumptions about the potential quality of a company and you might just have found yourself riding a life changing “great” company trend.

We are just trend followers - But the trend is defined by the business performance. The last thing you want if you have an analysis edge is to allow yourself to be continuously called offside on a great business by the price action noise - hence no price based stop.

 

[skc]

We are just trend followers - But the trend is defined by the business performance. The last thing you want if you have an analysis edge is to allow yourself to be continuously called offside on a great business by the price action noise - hence no price based stop.

Agree and I certainly don't adovate a price-based stop on fundamental positions.

To me not having a plan to sell does not mean that an investment won’t be sold – It just means the information to trigger a sale does not yet exist.

Also agree and a nice way to describe perhaps what KTP is saying.

Again, it's a trade-off between having a pre-defined trigger that's probably less than perfect and bound to create false negatives, vs the chance of inaction (due to emotions, denial etc) when the "trigger event" does present itself.

 

[galumay]

The trick in that isn't just diversification, it's position sizing for risk.

Agreed, and that was the case with my earlier example of a share that dropped 20% after i bought it, I did revisit my research and consider averaging down, and while the fundamentals were unchanged for me, I was very reluctant to increase the position sizing.

I was happy with the original investment but considered the risk of doubling my position was unnecessary and chose to wait for other opportunity to invest elsewhere.

For me part of the risk assessment is its impact on my ability to sleep well at night - that may not sound very logical or objective but its part of my psychology of investment.

 

[cynic]

Hmmmm they were not good.businesses, too much debt, low ROE and poor cash flow.

Yes everybody knows that now that they've gone under!
I've no doubt that some of the more astute investors here at ASF (several of whom are contributors to this thread, including yourself) would have recognised the dangers and mitigated any perceived risks. It is important to note, however, that many analysts and investors failed to recognise the early warning signs!

But do note some of my criteria for "good" companies:
- low or no debt.
- management with large ownership of the business.
- good ROC
- few acquisitions.
- simple to understand (for me, and yes, this is subjective).

How many of the listed companies above met all of these? None, I think.

How about coming up with a list of companies that match my criteria that have gone under? I am not saying that there are none, just that the chance of it happening it is so low, that diversification already takes care of that risk, there is no need for further risk mitigation (for this) with stop losses.

That's an excellent suggestion! By examining the historical performance of a larger sample of companies meeting your criteria, you'll be better equipped to quantify the risks rather than simply declaring "that the chance of it happening it is so low, that..."

So what's stopping you? This is your strategy remember! Hop to it!

You are also putting words into my mouth that I never said. I never advised for minimum diversification, I stated that to take away the risk of losing all/most of your money, only minimum diversification is required. 5+ to be precise.

So exactly which part of "With minimum diversification this is the right thing to be doing." didn't you say in the post to which I was responding?

For me part of the risk assessment is its impact on my ability to sleep well at night - that may not sound very logical or objective but its part of my psychology of investment.

Although I do not share your overall investment philosophy, on this point I am largely in agreement. The ability to recognise and accommodate the needs of one's comfort zones is an important (possibly essential) consideration.

 

[So_Cynical]

By examining the historical performance of a larger sample of companies meeting your criteria, you'll be better equipped to quantify the risks rather than simply declaring "that the chance of it happening it is so low, that...

Using my own experience.

• All Data: June 2007 to July 2013
• Total Stocks held = 50 (often multiple positions)
• Total stocks to go under = 4

Of those 4 i was holding 1 at the time it went under (100% loss), the other 3 were exited at 66% loss, 5.8% Gain and 0.9% gain.

And i buy stocks that are falling thus pre disposing myself to disastrous stocks and potential wipe outs and yet just 2% of my stock selections have proven 100% disastrous (to Me) over the last 6 years, a period of time covering the GFC.

 

[KnowThePast]

Thanks everyone for the informative discussion.

Because the price will to continue to go down, unless you are the unluckiest guy in Oz & sell at the exact bottom. I disagree that the market always prices correctly. The market only tends towards pricing correctly in the long term, it is only sometimes correct in the short term. If the price has gone down (& presumably is trending down) the market is giving you an opportunity to sell today & buy cheaper tomorrow... that's why I consider it lazy to not accept that you were wrong & grasp the opportunity the market is giving you.

What I am yet to see anywhere is any conclusive evidence that this can be relied on with any high degree of certainty. I am sure some may be able to do it, but I certainly can't. Market timing is something I generally don't get into. I either think the company is cheap, or it is not.

This is just going around in circles, isn't it?

If you buy "great" companies of course you are going to be fine in the long run. That's the definition of "great'.

By not planning to sell your investment, you are backing your ability to pick great companies. By having a plan to sell your investment, you are preparing for the probability that you will pick some duds. It's up to the investor to decide which one is more realistic for themselves.

If the odd position becoming a total loss is acceptable within your risk appetite, who's to say you can't do it this way? What gets some investors however is when they average down until a large chunk of their net worth is locked in a company that is deteriorating in fundamentals, yet they bury their head in the sand ignoring such changes, or talk themselves into believing that things will improve next quarter / half / decade...

The trick in that isn't just diversification, it's position sizing for risk.

Agreed.

As an aside, I never argued that one should buy more and more as the share price is falling. I was simply against automatic selling with no analysis.

Nice post – especially the bolded bit.

I Just want to expand on this a bit. It’s very easy to label longer term fundamental strategies as buy and hold and make the wrong assumptions about the “hold”

To me not having a plan to sell does not mean that an investment won’t be sold – It just means the information to trigger a sale does not yet exist. Not having a price based stop means you are backing yourself to interpret future developments correctly. After a decade or so of no adverse information flow negating your early assumptions about the potential quality of a company and you might just have found yourself riding a life changing “great” company trend.

We are just trend followers - But the trend is defined by the business performance. The last thing you want if you have an analysis edge is to allow yourself to be continuously called offside on a great business by the price action noise - hence no price based stop.

Fully agreed. Hold does not mean no sell.

I see myself making many sell decisions for many different reasons, I just object to an automatic trigger.

Agree and I certainly don't adovate a price-based stop on fundamental positions.

To me not having a plan to sell does not mean that an investment won’t be sold

Also agree and a nice way to describe perhaps what KTP is saying.

Yes, summed up nicely in one sentence. I do tend to rant on too much sometimes. Probably should work more on writing things short and to the point.

Yes everybody knows that now that they've gone under!
I've no doubt that some of the more astute investors here at ASF (several of whom are contributors to this thread, including yourself) would have recognised the dangers and mitigated any perceived risks. It is important to note, however, that many analysts and investors failed to recognise the early warning signs!

But you are replying to my investment strategy. Most of the rules I have provided are generally not too subjective, can be easily applied, and would have prevented me from investing in any one of the failed companies you mentioned.

If I followed a different strategy, than it would make sense.

But, yes, a good warning that I should stick to my investment principles and not venture outside of them.

That's an excellent suggestion! By examining the historical performance of a larger sample of companies meeting your criteria, you'll be better equipped to quantify the risks rather than simply declaring "that the chance of it happening it is so low, that..."

So what's stopping you? This is your strategy remember! Hop to it!

I did, hop to it, as you say. Back on page 1, I've provided a 10 year analysis showing that stop losses would have clearly been an inferior strategy to Buy and Hold.

I've done plenty more back testing on my investment approach and haven't seen anything yet that would make want to implement stop losses.

I agree that they are a necessary part of TA, but I can't recall a single authority on FA recommending them.

So exactly which part of "With minimum diversification this is the right thing to be doing." didn't you say in the post to which I was responding?

You nitpick one sentence out of my post.

The overall message of my post was that risk of (near)total loss can be reduced with minimum diversification, not that minimum diversification is the right strategy.

 

[KnowThePast]

Using my own experience.

• All Data: June 2007 to July 2013
• Total Stocks held = 50 (often multiple positions)
• Total stocks to go under = 4

Of those 4 i was holding 1 at the time it went under (100% loss), the other 3 were exited at 66% loss, 5.8% Gain and 0.9% gain.

And i buy stocks that are falling thus pre disposing myself to disastrous stocks and potential wipe outs and yet just 2% of my stock selections have proven 100% disastrous (to Me) over the last 6 years, a period of time covering the GFC.

Hi So_Cynical,

That's not too far off my experience.

My first stock experience goes back to 1997, although I didn't put serious effort (or money) into it until about 2007.

I've had 3 companies go under, out of about 100 that I invested into.

Looking back, most of the damages to my account were self inflicted. Tried many different things in the first 10 years, even day trading. Somehow ended not losing money, even made some, still surprised at that, considering all the silly things I was doing.

Started managing my super share investments around 2007, did pretty well through it, despite starting at the worst possible time. Mainly through buy and hold (sometimes sell).

After years of practicing this strategy in my super, I thought I'd start investing outside of it as well.

I now have a large dataset to backtest against, and from that I concluded that avoiding total failures is not guaranteed, but can be substantially reduced with proper due diligence.

I also find that long term (10+ years), it is near impossible to predict which good companies will appreciate 50% vs 1000%+. So it makes sense to invest in a few good companies, beyond what minimal diversification calls for. Not scattering your shot, as Buffet says, makes a lot of sense, but I don't think I ever had that much confidence about long term prospects of any company, that I thought it would clearly outperform all others.

 

[So_Cynical]

I also find that long term (10+ years), it is near impossible to predict which good companies will appreciate 50% vs 1000%+. So it makes sense to invest in a few good companies, beyond what minimal diversification calls for.

I have also found that to be true (above) and that goes for stocks that go straight up, sideways or straight down after entry...you just don't know and not knowing can work for you or against you depending on how you deal with that. I often think some people like the certainty that comes with locking in a loss, perhaps its the closure or finality of it, or perhaps they feel better 'doing something'.

 

[Julia]

It was from the highest point in 2008, the worst possible time you could enter the market, as the priced crashed soon afterwards. I certainly don't expect this to repeat too often, I would certainly expect most years to be substantially better!

If I had stop losses or other auto-sell criteria, I would have not only sold most of those stocks, but I would have sold them at the worst possible time.

I might be misunderstanding you but the above reads as though you are saying to have sold at close to the highest point in 2008 would have been the worst possible time. If you had had a moving stop loss in place to protect your profits how could you have 'sold at the worst possible time'?

To have done so would have preserved your profits and allowed you to wait the downturn out before buying back in at considerable advantage.
Perhaps you could clarify what you actually mean here.

Holding on to them until now proved to be a substantially better investment than an index fund.

Perhaps so. But is an index fund what you should be comparing your outcome with? Rather you should imo be thinking how you could have maximised your profit, and you could have done this by (as above) preserving not only your profits but your capital, then when an uptrend returned taking the opportunity to buy back in.
Given the market approximately halved during the downturn you'd have been able to buy about twice as many stocks at or near the bottom, plus of course as a further result, enjoy about twice the yield.

Yes everybody knows that now that they've gone under!

Exactly. They were all market darlings for some time.

I've no doubt that some of the more astute investors here at ASF (several of whom are contributors to this thread, including yourself) would have recognised the dangers and mitigated any perceived risks. It is important to note, however, that many analysts and investors failed to recognise the early warning signs!

As they also failed to even recognise the signs of the impending GFC itself. Why, otherwise, did so many investors lose half their asset base during the GFC as the learned advisers continued to admonish them to "just hold on, it will all be fine"?

 

[KnowThePast]

Hi Julia,

I might be misunderstanding you but the above reads as though you are saying to have sold at close to the highest point in 2008 would have been the worst possible time. If you had had a moving stop loss in place to protect your profits how could you have 'sold at the worst possible time'?

I bought those 16 stock in June 2008, when XAO was at around 6,000.
XAO subsequent declined all the way down to 3,200, now up to 4,900, change of -35%.
By holding on to those stocks until now I would have a profit of +36%.

To have done so would have preserved your profits and allowed you to wait the downturn out before buying back in at considerable advantage.

I would love to be able to do this, but I haven't seen anything to me convince me that I can time the market with a high enough degree of accuracy.

Perhaps so. But is an index fund what you should be comparing your outcome with? Rather you should imo be thinking how you could have maximised your profit, and you could have done this by (as above) preserving not only your profits but your capital, then when an uptrend returned taking the opportunity to buy back in.
Given the market approximately halved during the downturn you'd have been able to buy about twice as many stocks at or near the bottom, plus of course as a further result, enjoy about twice the yield.

I thought that comparing to an index was pretty much a universally accepted way of measuring performance?
This is not what I aim for, juts a measure of whether I should continue spending time on this, rather than putting my money in an index fund.

Exactly. They were all market darlings for some time.

As they also failed to even recognise the signs of the impending GFC itself. Why, otherwise, did so many investors lose half their asset base during the GFC as the learned advisers continued to admonish them to "just hold on, it will all be fine"?

But it is irrelant what people thought of them, or what their share prices were.

My investment strategy is based on assumption that corporate graveyard is a rare destination for companies meeting the following criteria:
- low or no debt.
- management with large ownership of the business.
- good ROC
- few acquisitions.
- a few other, less tangible criteria.

I am yet to see any examples that prove otherwise. All this is hard criteria that doesn't really need much human judgement. It should be easy to shut me up by providing sample of a 10 or so companies meeting this criteria where holding on to them for 10 years would prove to be a terrible investment....