Buy on the cannons, sell on the trumpets.

A lot of investors seem to be making the same big mistake.

Have you ever heard the saying, “Buy on the cannons, sell on the trumpets“?

I was reading a topic thread on Facebook the other week when one of the commenters mentioned an online dating website that he was looking at investing in. He was impressed with the company’s solid earnings growth over the last few years, so decided to take a closer look.

When he peered into the latest results, his initial enthusiasm dissipated. Instead of seeing an increase in revenue, as he was expecting, he saw a sizable drop. What he thought was a strong, stable growing company turned out to be a company that had just run into a major problem.

Do you pass on companies going through major problems?

……continue reading HERE

In this week’s issue:

• Weekly Commentary
• Strategy of the Week
• Stocks That Meet The Featured Strategy

WEEKLY COMMENTARY

Stockscores Market Minutes Video
Downtrends don’t turn in to uptrends overnight; stocks typically go through a three step process of trend reversal. This week, I highlight this bottom fishing chart pattern plus provide my regular weekly analysisView the video by clicking here.

Trade Less, Make More
Traders, particularly those who need to make money rather than those who would like to make money, tend to have a fear of missing out. They hear about a trading idea or find an opportunity with their own effort and make the trade with less thought than they might put into buying a microwave. They can invest thousands of dollars on an impulse, much like the drunken gambler who throws down $1000 on Five Red.

One reason for this sort of reckless approach to trading is the belief that trading ideas are like gifts. They only come along from time to time and you should feel grateful for the opportunity. If you spend 10 hours researching a company or receive the occasional bit of insight from someone who should know more than the rest of us, it’s easy to understand why you wouldn’t want to let a seemingly promising trade slip through your fingers. The problem is that this gratitude for trading ideas leads you to lower your standards and place trades that are not much more than a gamble.

Have you ever made a trade and then, just a few minutes or days later, asked yourself what the heck you were thinking? If you are normal, then it’s likely that you have because it is easy to focus on the dream of making a profit. You should focus your attention on the trading situation as it has been presented to you by the market rather than the words of an expert. Some trading opportunities are so well marketed that it’s hard to see the truth because you fixate on the profit potential that has been dangled before you as the prize.

It is critical to only take trades that meet the criteria of a strategy that you have found to have a positive expected value. Rather than look for a reason to take the trade, which is easy, look for a reason not to. Ask yourself, “If I buy this stock, who will be selling to me, and what does she know that I don’t know?” Looking at the other side of the argument will often highlight considerations that you have missed.

Being fussy is a lot easier when you recognize that the market-even a slow market-will give you opportunities. On the day I am writing this, a very slow summer trading day when the overall market is down, there are 63 stocks that made statistically significant abnormal gains. Out of the 15,000 stocks that trade in North America, you can usually find some kind of opportunity.

And if you can’t find a trade today, tomorrow or in the next week, eventually you will. There is always another bus coming down the road. If you miss one, just wait for the next.

I have found that you will actually make more money by trading less. If you maintain a very high standard for what trades you make, you will always pass on some trades that end up doing very well. By being selective, however, you will also avoid many marginal trades that would tie up your capital and then incur a loss. By being fussy and trading less, you end up taking only the very best trades and your results will be better overall.

It is easy to be fussy when the market is strong and there are lots of opportunities. It’s like fishing when every time you cast your line you get a bite. With that kind of success, you will quickly throw back any fish that is too small because you know there’s going to be something better coming along soon. You only take the best of the best.

When the fish stop biting and you spend hours with no bounty, you take the first fish that grabs your hook. It could be a tiny fish that you would never keep on even an average day, but with your desire to catch something, you keep it anyway. It would be better to have just not gone fishing at all.

You’ll do the same thing when trading a slow market. Eager to make a profit, you will take trades that show some potential even if they don’t meet all of your requirements. You will work hard to uncover a trade rather than wait for the obvious no-brainer trades that you take when the market is in a giving mood.

I like to say that in trading, when the going gets tough, the tough get lazy. You can’t control the market, so if the market is not giving you opportunities, it’s better to do nothing. Your hard work will not change what the market does.

This is hard for many people who have been programmed to relate hard work to success. If you try harder than the next person in a sport, you should get a better result. If you study harder for an exam, you should get a better mark. If you work longer hours at your job, you should make more money. In the stock market, if you work harder to find good trades, you will probably lose money.

The best trades are easy to find. Working hard to uncover something leads you to find questionable trades that you have to talk yourself into. It’s better to walk away when you have doubts.

This is not to say that hard work is not rewarded in trading. Traders who work hard at practicing their analytical skills or developing new strategies will be rewarded. People who devote their time and effort to improving their emotional control will be better traders. These are things that you can control and affect with hard work, but hard work won’t change what the stock market does.

STRATEGY OF THE WEEK

This week, I ran the Stockscores Simple Market Scan strategy which seeks stocks with good Stockscores and some of the characteristics of good chart patterns. Run the scan and the inspect the charts for stocks breaking from predictive chart patterns.

I did this based on Friday’s trading but focused on the longer term 3 year weekly charts. Here are some charts that I think show good potential for the months ahead:

STOCKS THAT MEET THAT FEATURED STRATEGY

1. ANV
ANV also trades on the TSX as T.ANV. The stock is breaking out of a cup and handle pattern with abnormal volume in a sector that has been doing well this year. Support at just under $5.

2. T.SII
T.SII looks like a great long term turnaround chart, having broken the downward trend line and now breaking higher from a rising bottom. Support at $3.

3. T.BIR
A good break through $9 resistance from a cup and handle pattern on the weekly. Support at $8.30.

References

• Get the Stockscore on any of over 20,000 North American stocks.
• Background on the theories used by Stockscores.
• Strategies that can help you find new opportunities.
• Scan the market using extensive filter criteria.
• Build a portfolio of stocks and view a slide show of their charts.
• See which sectors are leading the market, and their components.

  Disclaimer
  This is not an investment advisory, and should not be used to make investment decisions. Information in Stockscores Perspectives is often opinionated and should be considered for information purposes only. No stock exchange anywhere has approved or disapproved of the information contained herein. There is no express or implied solicitation to buy or sell securities. The writers and editors of Perspectives may have positions in the stocks discussed above and may trade in the stocks mentioned. Don’t consider buying or selling any stock without conducting your own due diligence.

Lessons on Value Investing from the World’s Greatest Success Story

If you have been in the investing world for any period of time you are undoubtedly familiar with the man who many label as the greatest investor of all time – Warren Buffet. For those who require a little background, Warren Buffet is the self-made billionaire who built an empire through an unwavering focus on the simplest tenets of value investing. For nearly 50 years, Warren Buffet has earned prominence as the genius behind Berkshire Hathaway and has generated its investors a staggering average compound rate of return of 19.8% per year (1965 – 2011). This has resulted in an overall gain of 513,055%, compared to the S&P500 which returned 6,397% including dividends. An investment of $1,000 would have grown to over $5.1 million with the power of compounding returns.

Many detractors to Buffet’s value-investment style claim that his success cannot be replicated by individual investors. Often cited is Buffet’s solid reputation as a capital allocator and the deep investigative resources of his investment company Berkshire Hathaway. Undoubtedly Warren Buffet is a genius and we would not expect that any but the most gifted individuals would ever be able to replicate his success in its entirety. Nevertheless we can easily dispel the myth that reputation and resources were the ingredients to his success. Going back to 1956, before Buffet was a world famous billionaire (or millionaire for that matter), he was a relatively unknown man who operating his first investment partnerships out of an office in his bedroom. The limited partnerships were started with his own capital and a few some contributions from family and friends. He had no world renowned reputation, no staff of highly-skilled MBAs, and no special resources outside of himself. Buffet recognized the most basic and useful facets of valuing investing and applied the concepts to generate great success. Throughout the years he has participated in numerous interviews and writes a letter to his shareholders on an annual basis. Through these small snippets of information the general public has been able to gain some insight into how Buffet views the investing world. The following are a couple of his most well read quotes with a little insight into how anyone can use them to better far more intelligent investors. 

“Price is what you pay. Value is what you get.”

Separating value from price is the most fundamental tenet of Buffet’s investment strategy. Pretty much everybody has a basic understanding of what the word “value” means but unfortunately this is rarely applied to investment decisions. There is a saying that most investors spend more time researching the purchase of their television set than they do their investments. This is largely due to a lack of knowledge and valuation skills which is why many investors rely on stock price movements as a signal of investment quality. When Buffet starts researching a stock he says he intentionally will not look at the market price. Instead he starts with valuing the underlying business as if it were a private company. He looks at the cash flow…he determines whether or not the business model is sustainable and if the earnings are being inflated by too much leverage (debt). Buffet then determines what we would pay for the actual company without any consideration for the fact that it is publicly-listed. If after making this determination the current stock price is significantly below his measurement of intrinsic value then he may move forward and make his purchase.

“I never attempt to make money on the stock market. I buy on the assumption that they could close the market the next day and not reopen it for five years.”

Don’t worry…nobody is planning on closing the market for the next five years. What Buffet is saying is that he doesn’t buy a stock with the intention of following the short-term market fluctuations and selling in and out on whims. When Buffet buys a stock, he is buying an ownership interest in an underlying company. This is largely the reason that Buffet is so successful. Rather than wasting his energy following day-to-day market oscillations (as many investors do), he focuses on the business that he has acquired and gauges success based on sustainable generation and growth of the underlying cash flow. Many businesses generate returns for their shareholders through the distribution of cash flow in the form of dividends. A successful company will also be able to grow their dividends over time. Eventually success is recognized in the markets. Although it can take time for value to be realized, there are very few examples of companies that produce strong and growing cash flow over time without either this eventually being recognized in the share price or by an independent buyer looking to acquire the company.

“We simply attempt to be fearful when others are greedy and to be greedy only when others are fearful.”

We are often asked by clients whether or not we utilize a timing strategy to move in and out of the markets with changes in the business cycle. Although market timing may appear to be a sound investment strategy, in practice, the results investors generate are far from astonishing. “Hindsight is 20-20, while foresight is legally blind”. The truth is that there are no magical indicators that will tell you (with consistent success) when to buy and sell stocks. If there were then we would expect to see at least one of these magical market timers (or technical analysts) on Forbes list of the world’s richest people (but we have not). Buffet as well does not subscribe to the traditional idea of market timing. He has however been able to apply his value investment methodology to creating a somewhat modified version of the strategy. If we take a step back to 2008 at the time of the stock market crash we will remember the fear that plagued the markets. Stock market prices dropped to levels not seen in over a decade causing private and professional investors to rush to the exits. Although fear was abundant and the outlook was grim, this was exactly the best time to be greedy with many very high-quality companies available for purchase at a fraction of their real value. If we go back to the summer of 2000, when the NASDAQ’s chart (along with the charts of many other exchanges) was nearly parabolic, investor optimism was high and greed pushed market valuations of internet stocks well beyond reasonable levels. This was undoubtedly a good time to be fearful. We would never suggest that you try and time the markets based on anyone’s assessment of market sentiment. This won’t produce any better results than any other market timing strategy. However, the next time market valuations have undergone expansion far beyond historical ranges, and experts are justifying the sentiment with the mantra “everything is different now”, you might want to consider separating yourself from the crowd and become a little more fearful. 

“Success in investing doesn’t correlate with I.Q….. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing.”

This has got to be my favorite quote from Warren Buffet. It gives hope to every ordinary investor who believes that they cannot compete with the pros. While Buffet is commonly referred to as the “smartest man in the room”, he himself openly confesses that his skills outside of capital allocation are fairly limited. And within this skillet Buffet utilizes only the simplest and most basic techniques in investment analysis. There are no super computers systems, no Nobel prize winning mathematicians, and certainly no new age strategies in the Berkshire Hathaway investment management office. The biggest asset (aside from their near $400 billion in capital) is their underlying philosophy that investment success is derived from purchasing high-quality, cash flow positive businesses at undervalued prices and holding those businesses over a long-term horizon. By controlling the emotions of fear and greed, individual investors can set themselves apart from the investment heard and create for themselves a very practical competitive advantage that the vast majority of people (including professionals) do not have.

Say you were in the market to purchase a private business. After months of searching you finally find an attractive opportunity. You are able to purchase a growing business, generating positive cash flow, with a solid and secure financial position, an effective and ethical management team, and a price that is significantly less than your assessment of the real intrinsic value. Assuming you are very positive on the long-term prospects of this new company and plan to own it long into the future, would you really care if the market of potential “private-business” acquirers dries up for a couple of years? You are not planning on selling the business and you are potentially benefiting from every dollar of cash flow that is generates (whether from dividends or ownership of a larger company in the event the cash flow is reinvested). In this situation, the astute business person would not spend their time following the day-to-day or minute-to-minute changes in the availability of potential acquirers.