Portfolios and Selling

#Good company gets inexpensive, how much to buy?

When an understood, good company gets inexpensive, we buy its stock. But how much?

(1)  Enough uninvested cash (CASH)
My rule is simple. Provided that I have enough uninvested cash, I put 10 percent of the portfolio in it. I’ve seen other good investors use infinitely more complicated guidelines, but none that I’ve found to be more practical.

If I’m not comfortable putting at least a tenth of the portfolio into an equity, I don’t want the equity. If my conviction is lower I don’t buy less, I buy none.

(2)  Strong conviction (COURAGE)
A strong conviction is important in part because right after a buy the price of a stock is almost certain to drop. That’s the corollary to another near-certainty: that the price paid for a stock is unlikely to be a low. Rock-bottoms don’t send out invitations. So knowing when one will happen is impossible. The astute investor counts on missing them.

Correspondingly, I prefer not to put more than a tenth of the portfolio into a single equity. This reduces the chance that I’ll lack the cash necessary to take advantage of other opportunities that emerge.



#Buying is one aspect of portfolio construction. Another is selling.

There are two problems with selling. 

1.  The first is taxes. 

The profitable sale of stock is taxable in most circumstances. Just how much this eats into long-term returns is best illustrated by example.

Picture two portfolios. Each starts with only cash, buys only non-dividend paying stocks, and liquidates after 30 years. Assume that any stock sales are subject to a total long-term capital gains tax rate of 30 percent.

Portfolio one uses all its cash to buy stock on the first day. It appreciates 15 percent before taxes every year. It doesn’t sell anything until the liquidation date, at which point it immediately pays any taxes due.


Portfolio two also uses all its cash to buy stock on the first day. It too appreciates 15 percent per year before taxes. But it churns its holdings annually. At the end of every year, it sells everything, and uses all the after-tax proceeds to instantly buy different stocks. When it liquidates after 30 years, it too promptly pays any taxes due.

Portfolio one would end the 30-year period with more money. But what’s striking is just how much more. It would wind up with over twice as much cash. That’s because every year when portfolio two paid its capital gains taxes, it whittled down the amount set to grow at 15 percent over the following year. In other words, ongoing tax payments stunted the power of compounding.

By contrast, portfolio one’s capital was never whittled down. It regularly got to multiply its 15 percent by a bigger number:

http://www.goodstockscheap.com/17.1.xlsx

Of course one could never count on an equity portfolio to appreciate at exactly 15 percent annually, and the chance of immediately finding stocks to replace just-sold ones is low. Plus the 30-year period is arbitrary, and a 30 percent tax rate doesn’t apply to everyone. But however simplified, this example
highlights the toll that frequent selling takes.


2.  The second problem with selling is alternatives. 

Companies that are understood and good don’t go on sale every day. They’re hard to find. So absent an acute cash requirement, each stock sale mandates a hunt for the next opportunity.



#When selling makes sense

Even with these problems, selling does makes sense in some instances. I see four.

(a)  The first is when price flies past value. 
If EV/OI is over 25, and there are no mitigating facts, I find it hard to justify holding.

(b) The second instance is when a company that originally registered as good turns out not to be. 
This could be because the original analysis was wrong. Perhaps the threat of new entrants was stronger than it first appeared, or a market thought to be growing really wasn’t. Or it could be because circumstances have changed. Maybe a once-mighty retail chain has come under pressure from online-only sellers, or a company that thrived under regulation has faltered in deregulation.

The cognitive bias of consistency can make it hard to see such instances. We may want to hold just to validate our buys. But analyses really can be wrong, and contexts really can change. Selling in such situations keeps a snag from ripping into both a realized loss and a missed chance to redeploy cash into a better opportunity.

(c)  The third instance is when one is bought out. 
Public companies sometimes get acquired. Such transactions often happen at a premium to the recent trading price. A vote may be put to shareholders on the matter, but for everyone other than major stakeholders, it’s perfunctory. One effectively has no say.

I’ve been bought out several times. I dislike it. It turns a pleasantly appreciating investment into a taxable event. But if profitable, given the absence of practical options, it makes sense to accept such sales.

(d)  The fourth instance is when cash is needed to make an investment that’s clearly better than one already held. 
The problem with this is that fresh ideas often glow with a special promise. They’re new. The hope bias gets a prime shot at causing mischief. As such, I get extremely suspicious of my reasoning when I think that I’m spotting such a circumstance. I’ve never actually sold one company for the specific purpose of buying another.



#When selling makes no sense

Two commonly cited reasons for selling puzzle me.

1.  One is rebalancing. 
It’s selling part of a stock holding because appreciation has caused it to represent a disproportionately large percentage of the portfolio.

Rebalancing makes sense to those who equate risk with total portfolio volatility. I don’t. So on the sell side, I’ve never seen the merits of this practice.

It makes more sense to me on the buy side, since unless part of a holding was sold, a decrease in its portfolio prominence means that its price dropped. One could now buy more of it cheaper. But on the sell side rebalancing looks to me like the anchoring bias in action.

2.  A second common reason for selling is to prove that an investment was a success (taking profits). 
The sale is seen as a sort of finish line. Underlying this perception is a view that cash is somehow more real than stocks.

It’s not. Cash and stocks are different forms that wealth can take. Unrealized gains are not endemically less concrete than realized gains. Selling doesn’t demonstrate investing competence any better than does intelligent holding.


Yet another reason for selling is Industry compensation
There’s an additional reason that selling happens. It relates only to institutional portfolios, like hedge funds. It’s about compensation.

Investment funds often pay managers 2 percent of assets under management per year, plus 20 percent of any gain above some hurdle. That 20 percent is applied to pretax returns. It’s blind to taxes. For this reason professionals may emerge as more enthusiastic about selling than would their limited partners. After all, unless they’re tax-exempt, the limited partners are the ones that come to bear the bulk of the tax liabilities born of the fund’s realized gains.

One faces great impetus to sell. It feels good. It’s conclusive. It turns the brokerage statement into a congratulations card. But it also triggers a tax expense and—short of a pressing need for cash—forces a search for the next underpriced equity.

When a sale is wise, its justification is distinct. It’s an overpricing, an analytical error, a contextual change, a buyout, or a better opportunity. Absent that clarity, I hold.



#Equity portfolio can generate cash through buyouts and dividends
Even without active selling, an equity portfolio can generate cash. It can do so in two ways.

1.  The first is through acquisitions, as mentioned earlier.

2.  The second is through dividends. 
Dividends can become sizable. This fact gets lost in the commonly quoted metric of dividend yield.

Recall that dividend yield equals annual dividends divided by current stock price. But to an owner, current only counts in the numerator.

When I first bought Nike stock, the dividend yield was around 2 percent. Over a decade later when I sold it, it was still around 2 percent. But by then my dividend yield—the current annual dividend divided by the price I’d paid for the stock—was closer to 10 percent. Dividends had gone up over time, but my cost hadn’t. That’s how dividends can become a booming cash source underappreciated by all but those who get them.



#Over time, good focused (concentrated) stock portfolios outperform diversified portfolios.
Remember that my portfolio is concentrated. It contains no more than a dozen names, and usually far fewer. On purpose, it’s not diversified. Many good equity portfolios are, but mine isn’t.


1.  Good focused portfolio versus diversified portfolio
I choose to concentrate because I’ve observed over time that good, focused stock portfolios outperform diversified stock portfolios. This is because diversified portfolios are more like an index. They have more names in them. The more a portfolio looks like an index, the more it behaves like an index. It’s hard to both resemble and outperform something.


2.  Bad focused portfolio versus diversified portfolio
Of course a bad focused equity portfolio can certainly lag a diversified stock portfolio.

Concentration isn’t enough to assure outperformance. But if it’s purposefully constructed, a focused group of inexpensively bought good companies is particularly promising.



#Sequestered Cash outside of the equity portfolio for  ordinary expenses 
While I don’t diversify within my equity portfolio, I do diversify outside of it. I always keep enough cash on hand to cover expenses for a few years. As I get older, I expect to increase this number of years.

1.  In Federally insured banks
This isn’t cash inside the equity portfolio waiting to be invested in stocks. It’s cash outside of the equity portfolio, held in federally insured banks. It will never be anything other than cash or spent.

Sequestering cash enables me to confidently ride the wild price swings guaranteed to come with a concentrated equity portfolio. It’s what lets me take the long view. When the price of my stock portfolio halved during the 2008 financial crisis, I didn’t panic. I knew that I could meet all of my expenses. There was no basis for panic.

Many governments insure bank deposits. Coverage varies by country. In America, the Federal Deposit Insurance Corporation generally guarantees up to $250,000. In the United Kingdom, the Financial Services Compensation Scheme stands behind £75,000. In Canada, the Canada Deposit Insurance Corporation backs C$100,000.

Because the whole point of sequestered cash is to avoid the scare that forces ill-timed stock sales, it’s wise to stay well under the insured limit. Opening up accounts at several different banks is not hard.


2.  In same currency as one's expenses Sequestered cash is best held in the same currency as one’s expenses. If it isn’t, foreign exchange rate fluctuations can hurt one’s ability to meet obligations.

As I write this, the British pound has slumped to a 30-year low against the U.S. dollar. This follows Britain’s decision to leave the European Union.1 Some American investors think the slump is overdone and have invested in the British pound.

To people whose expenses are in U.S. dollars, those pounds don’t count as sequestered cash. Instead, they count as a currency investment.



#These repositories for sequestered cash aren't really good
Two things that may look like good repositories for sequestered cash really aren’t.

1.   The first is certificates of deposit, or CDs. 

Outside of the United States they’re commonly called time deposits. They offer higher interest rates than do regular bank accounts. Money must stay in them for a predetermined period. If it’s withdrawn early, a penalty is applied that more than wipes out the extra interest.

If the CD interest rate is much higher than the regular interest rate, one could theoretically keep a portion of sequestered cash in CDs. The portion would have to be limited to that which shouldn’t be needed for the duration of the lockup period.

That said, I don’t use CDs. Since the timing of cash needs can surprise, I prefer to keep the focus of sequestered cash on costless accessibility.

2.   The other repository is cash-like funds (commercial paper). 
They too offer higher interest rates. An example is a fund that invests in commercial paper. Commercial paper is short-term notes issued by corporations.

Such cash-like vehicles usually behave like cash. One can pay bills with them. But I’ve seen instances when they don’t. During the financial crisis, an acquaintance of mine was surprised to learn that her financial institution had temporarily halted withdrawals from such a fund. She couldn’t make payments with it.

This potential—the inability to immediately liquidate—is the problem with these alternatives. The purpose of sequestered cash is to free one from worry during equity market gyrations. If what’s used for expenses ever can’t be used for expenses, that benefit is lost. One can wind up having to sell part of an equity portfolio when it’s underpriced, erasing the benefits of stock investing.


#Problems with cash
Cash has its own problems, of course. Inflation erodes its purchasing power over time. Expansionary monetary policies—governments printing money— exacerbate this. But if held in government-insured accounts under applicable limits, at least it’s always there. That availability is what makes the interim ups and downs of an equity portfolio’s price not only bearable, but almost trivial.





Summary
1. Conviction prepares one for the likely price drop that follows a stock buy.
2. Selling stocks can make sense 

• price flies past value, 
• when a company thought to be good turns out not to be, 
• in buyouts, or 
• when a clearly better opportunity emerges.

3. The problems with selling are taxes and alternatives.
4. Questionable reasons for selling include 

• rebalancing, 
• memorializing success, and 
• industry compensation.

5. Equity portfolios can generate cash without active selling through 

• buyouts and 
• dividends.

6. Good focused equity portfolios outperform diversified equity portfolios over the long term.
7. Cash sequestered for ordinary expenses in government-insured accounts makes equity portfolio price gyrations less troubling.


Reference:

Good Stocks Cheap by Kenneth Jeffrey Marshall 2017

Selling: The Hardest Decision of All

Many investors are able to spot a bargain but have a harder time knowing when to sell. 

• One reason is the difficulty of knowing precisely what an investment is worth. 
• An investor buys with a range of value in mind at a price that provides a considerable margin of safety. 
• As the market price appreciates, however, that safety margin decreases; the potential return diminishes and the downside risk increases. 
• Not knowing the exact value of the investment, it is understandable that an investor cannot be as confident in the sell decision as he or she was in the purchase decision. 

To deal with the difficulty of knowing when to sell, some investors create rules for selling based on specific price-to-book value or price-to-earnings multiples. Others have rules based on percentage gain thresholds; once they have made X percent, they sell. Still others set sale price targets at the time of purchase, as if nothing that took place in the interim could influence the decision to sell. None of these rules makes good sense. Indeed, there is only one valid rule for selling: all investments are for sale at the right price. 




Decisions to Sell

Decisions to sell, like decisions to buy, must be based upon underlying business value.' Exactly when to sell-or buy depends on the alternative opportunities that are available.

• Should you hold for partial or complete value realization, for example? 
• It would be foolish to hold out for an extra fraction of a point of gain in a stock selling just below underlying value when the market offers many bargains. 
• By contrast, you would not want to sell a stock at a gain (and pay taxes on it) if it were still significantly undervalued and if there were no better bargains available. 

Some investors place stop-loss orders to sell securities at specific prices, usually marginally below their cost. If prices rise, the orders are not executed. If the prices decline a bit, presumably on the way to a steeper fall, the stop-loss orders are executed. Although this strategy may seem an effective way to limit downside risk, it is, in fact, crazy. Instead of taking advantage of market dips to increase one's holdings, a user of this technique acts as if the market knows the merits of a particular investment better than he or she does.

Liquidity considerations are also important in the decision to sell.

• For many securities the depth of the market as well as the quoted price is an important consideration. 
• You cannot sell, after all, in the absence of a willing buyer; the likely presence of a buyer must therefore be a factor in the decision to sell. 
• As the president of a small firm specializing in trading illiquid over the-counter (pink-sheet) stocks once told me: "You have to feed the birdies when they are hungry." 

If selling still seems difficult for investors who follow a value investment philosophy, I offer the following rhetorical questions: If you haven't bought based upon underlying value, how do you decide when to sell?

• If you are speculating in securities trading above underlying value, when do you take a profit or cut your losses? 
• Do you have any guide other than "how they are acting," which is really no guide at all?

How Warren determines the right time to buy a fantastic business

HOW WARREN DETERMINES THE RIGHT TIME TO BUY A FANTASTIC BUSINESS

In Warren's world the price you pay directly affects the return on your investment. Since he is looking at a company with a durable competitive advantage as being a kind of equity bond, the higher the price he pays, the lower his initial rate of return and the lower the rate of return on the company's earnings in ten years. Let's look at an example: In the late 1980s, Warren started buying Coca-Cola for an average price of $6.50 a share against earnings of a $.46 a share, which in Warren's world equates to an initial rate of return of 7% [$.46 / $6.5 = 7%]. By 2007 Coca-Cola was earning $2.57 a share. This means that Warren can argue that his Coca-Cola equity bond was now paying him $2.57 a share on his original investment of $6.50, which equates to a return of 39.9% [$2.57 / $6.50 = 39.53%]. But if he had paid $21 a share for his Coca-Cola stock back in the late 1980s, his initial rate of return would have been 2.2%[$.46/ $21= 2.2%]. By 2007 this would have grown only to 12% ($2.57 / $21 = 12%), which is definitely not as attractive a number as 39.9%.

Thus the lower the price you pay for a company with a durable competitive advantage, the better you are going to do over the long-term, and Warren is all about the long-term. However, these companies seldom, if ever, sell at a bargain price from an old-school Grahamian perspective. This is why investment managers who follow the value doctrine that Graham preached never own super businesses, because to them these businesses are too expensive.

So when do you buy in to them? In bear markets for starters. Though they might still seem high priced compared with other "bear market bargains," in the long run they are actually the better deal. And occasionally even a company with a durable competitive advantage can screw up and do something stupid, which will send its stock price downward over the short-term. Think New Coke. Warren has said that a wonderful buying opportunity can present itself when a great business confronts a one-time solvable problem. The key here is that the problem is solvable.

When do you want to stay away from these super businesses? At the height of bull markets, when these super businesses trade at historically high price-to-earnings ratios. Even a company that benefits from having a durable competitive advantage can't unmoor itself from producing mediocre results for investors if they pay too steep a price for admission.

Trading and portfolio management from a value investing point of view.

Portfolio Management

Portfolio management is described as an on-going process that is never complete. 

While certain businesses may be fairly stable, its prices will fluctuate over time, and so the investor must constantly monitor the situation. 

Value investors are not into buying certain industries or business ideas without regard to price, and so price changes are a fundamental factor that drive portfolio decisions.

The portfolios need to be somewhat liquid. 

Investors are advised not to purchase their entire positions at one go, but rather to leave room to buy in at cheaper prices should the stock go down. 

A good test for an investor is to consider whether he would indeed buy more of the stock were it to drop; if he is not, he is probably speculating and should not be buying in the first place!

The Decision of When to Sell 

Determining when to buy a stock is usually a much easier decision for a value investor, since the stock at that time is trading below what the investor considers an adequate margin of safety. 

But when the stock is trading within the range of values the investor believes it to be worth, what is the investor to do? 

We can argue against selling after percentage gain thresholds or price targets have been reached.   

Instead, the investor should compare the investment to available alternative investments:

• It would be foolish to sell if there were no better investments and the stock was still undervalued, but 
• it would be foolish not to sell if there are better bargains around!

Read also:

• 
  
• Your investments using Mutual Funds or Money Managers
• Trading and portfolio management from a value investing point of view
• Value Investor's Opportunities in Distressed Securities
• Value Investing Opportunities in the Banking Sector
• Look at FUNDAMENTALS and POTENTIAL CATALYSTS when making investment decisions
• Where to look for Investment Opportunities
• Business value cannot be precisely determined. Make use of ranges of values
• Central elements to a Value Investing Philosophy
• The Philosophy of Value Investing and Why It Works
• Philosophy of value investing. Need to have clear strategies too
• How Wall Streets can create investment fads? The Junk Bond Market of mid-1980s
• Understanding these changes in the investment world allows investors to earn superior returns
• What's good for Wall Street is not necessarily good for investors
• Speculators, Investors and Market Fluctuations

WHEN to Buy by Buffett

Warren Buffett on When To Buy

Warren Buffett’s buying wisdom can be condensed into 2 statements:

1. Buy great businesses when they are trading at fair or better prices.
2. This occurs when short-term traders become pessimistic

The 8 quotes below clarify Warren Buffett’s thinking on when to buy great businesses.

“Long ago, Ben Graham taught me that ‘Price is what you pay; value is what you get.’ Whether we’re talking about socks or stocks, I like buying quality merchandise when it is marked down.”

In the quote above, Buffett explains that he acquired his value-focused mindset from his mentor Benjamin Graham. Graham was the father of value investing and a fantastic investor in his own right. It makes sense that his philosophies significantly influence Warren Buffett.

There is a stark difference in investing style between Graham and Buffett. Graham focused on deep value plays – businesses that were trading below liquidation value. These were typically poor businesses that were undervalued because they had such bad future prospects.

Buffett focuses on great businesses trading at fair or better prices, as the quote below clarifies:

“It’s far better to buy a wonderful company at a fair price than a fair company at a wonderful price”

Wonderful companies compound your wealth year-after-year. Poor quality businesses that are exceptionally cheap only grow your wealth once (when you sell them – hopefully for a profit).

Note that Buffett does not say to buy great businesses at any price.

“For the investor, a too-high purchase price for the stock of an excellent company can undo the effects of a subsequent decade of favorable business developments.”

Overpaying severely limits the growth of your wealth. If you pay for a large part of future growth today, you will not benefit from that growth down the line. Great businesses can be very overvalued…

“Most people get interested in stocks when everyone else is. The time to get interested is when no one else is. You can’t buy what is popular and do well.”

You don’t need to be a contrarian to do well in investing, but you do need to exhibit emotional control and be realistic.

Just as great businesses can be overvalued, they can also be undervalued.

“The best thing that happens to us is when a great company gets into temporary trouble…We want to buy them when they’re on the operating table.”

It’s not easy to buy great businesses when they are ‘on the operating table’. That’s because the zeitgeist is decidedly against buying – stocks become undervalued because the general consensus is negative. Intelligent investors profit from irrational fears.

“Be fearful when others are greedy and greedy only when others are fearful.”

Fear and market corrections create opportunities for more patient, long-term investors. The two quotes below expand upon this.

“So smile when you read a headline that says ‘Investors lose as market falls.’ Edit it in your mind to ‘Disinvestors lose as market falls—but investors gain.’ Though writers often forget this truism, there is a buyer for every seller and what hurts one necessarily helps the other.”

&

“The most common cause of low prices is pessimism—some times pervasive, some times specific to a company or industry. We want to do business in such an environment, not because we like pessimism but because we like the prices it produces. It’s optimism that is the enemy of the rational buyer.”

Paying too high a price is an investing risk that can be avoided (for the most part) by staying disciplined.

Buying is only half of investing. The next section covers when to sell.

http://www.suredividend.com/warren-buffett-quotes/#when to buy

When to Buy? FIVE powerful forces having extremely powerful influence on the general level of stock prices either by influencing mass psychology or by direct economic operation..

All types of common stock investors might well keep one basic thought in mind; otherwise, the financial community's constant worry about and preoccupation with the danger of downswings in the business cycle will paralyze much worthwhile investment action.

This thought is the current phase of the business cycle is but one of at least five powerful forces.  

All of these forces, either by influencing mass psychology or by a direct economic operation, can have an extremely powerful influence on the general level of stock prices.

The other four influences are:

1. the trend of interest rates,
2. the overall governmental attitude toward investment and private enterprise,
3. the long-range trend to more and more inflation, and 
4. possibly most powerful of all - new inventions and techniques as they affect old industries.

These forces are seldom all pulling stock prices in the same direction at the same time.

Nor is any one of them necessarily going to be of vastly greater importance than any other for long periods of time.

#  So complex and diverse are these influences that the safest course to follow will be the one that at first glance appears to be the most risky or riskiest.

#  This is to take investment action when matters you know about a specific company appear to warrant such action.

#  Be undeterred by fears or hopes based on conjectures, or conclusions based on surmises.

When to buy? You have some money to invest. Should you completely ignore the future trend of the business cycle?

Questions:

# Does this mean that if a person has some money to invest he should completely ignore what the future trend of the business cycle may be and invest 100% of this fund the moment he has found the right stocks and located a good buying point, as indicated above?

A depression might strike right after he has made his investment.

Since a decline of 40 to 50% from its peak is not at all uncommon for even the best stock in a normal business depression, is not completely ignoring the business cycle rather a risky policy?



1.   For those in the happy position of having a backlog of well-chosen investments bought comfortably below present prices.

Answers:  

This risk may be taken in stride by the investor who, for a considerable period of time, has already had the bulk of his stocks placed in well-chosen situations.

If properly chosen, these should by now have already shown him some fairly substantial capital gains.

But now, either because he believes one of his securities should be sold or because some new funds have come his way, such an investor has funds to purchase something new.

UNLESS it is one of those rare years when speculative buying is running riot in the stock market and major economic storm signals are virtually screaming their warnings (as happened in 1928 and 1929), this class of investor should ignore any guesses on the coming trend of general business or the stock market.

# Instead, he should invest the appropriate funds as soon as the suitable buying opportunity arises.



2.  For those NOT in the happy position of having a backlog of well-chosen investments bought comfortably below present prices.

Answers:

Perhaps this maybe the first time they have funds to invest.

Perhaps they may have a portfolio of bonds or relatively static non-growth stocks which at long last they desire to convert into shares that in the future will show them more worthwhile gains.

If such investors get possession of new funds or develop a desire to convert to growth stocks after a prolonged period of prosperity and many years of rising stock prices, should they, too, ignore the hazards of a possible business depression?

Such an investor would not be in a very happy position if, later on, he realized he had committed all or most of his assets near the top of a long rise or just prior to a major decline.

This does create a problem.  However, the solution to this problem is not especially difficult - as in so many other things connected with the stock market, it just requires an extra bit of patience.

# This group should start buying the appropriate type of common stocks just as they feel sure they have located one or more of them.

# However, having made a start in this type of purchasing, they should stagger the timing of further buying.

# They should plan to allow several years before the final part of their available funds will have become invested.

By so doing, if the market has a severe decline somewhere in this period, they will still have purchasing power available to take advantage of such a decline.  

If no decline occurs and they have properly selected their earlier purchases, they should have at least a few substantial gains on such holdings.

This would provide a cushion so that if a severe decline happened to occur at the worst possible time for them - which would be just after the final part of their funds had become fully invested - the gains on the earlier purchases should largely, if not entirely, offset the declines on the more recent ones.

No severe loss of original capital would, therefore, be involved.


Additional notes:

There is an equally important reason why investors who have not already obtained a record of satisfactory investments, and who have enough funds to be able to stagger their purchases should do so.

#  This is that such investors will have had a practical demonstration, prior to using up all their funds, that they or their advisors are sufficient masters of investment technique to operate with reasonable efficiency.

In the event that such a record had not been attained, at least, all of an investor's assets would not be committed before he had had a warning signal to revive his investment technique or to get someone else to handle such matters for him.

When to buy? Great companies that ran into temporary corporate troubles and those with yet to be recognised worthwhile improvement in earnings, maybe buying opportunities.

1.  Great companies that ran into temporary corporate troubles maybe buying opportunities.

In short, the company into which the investor should be buying is the company which is doing things under the guidance of exceptionally able management.

A few of these things are bound to fail.

Others will from time to time produce unexpected troubles before they succeed.

The investor should be thoroughly sure in his own mind that these troubles are temporary rather than permanent.

# Then if these troubles have produced a significant decline in the price of the affected stock and give promise of being solved in a matter of months rather than years, he will probably be on a pretty safe ground in considering that this is a time when the stock may be bought.





2.  Buying the right sort of company with a worthwhile improving  in earnings that has not yet produced an upward move in its price.

All buying points do not arise out of corporate troubles.

Another type of opportunity sometimes occurs.

What is the common denominator?

# It is that a worthwhile improvement in earnings coming in the right sort of company, but that this particular increase in earnings has not yet produced an upward move in the price of that company's shares.

Whenever this situation occurs the right sort of investment may be considered to be in a buying range.

Conversely, when it does not occur, an investor will still in the long  run make money if he buys into outstanding companies.

However, he had then better have a somewhat greater degree of patience for it will take him longer to make this money and percentage-wise it will be a considerably smaller profit on his original investment.



----------------------


Additional notes:

Questions:

Does this mean that if a person has some money to invest he should completely ignore what the future trend of the business cycle may be and invest 100% of this fund the moment he has found the right stocks and located a good buying point, as indicated above?

A depression might strike right after he has made his investment.

Since a decline of 40 to 50% from its peak is not at all uncommon for even the best stock in a normal business depression, is not completely ignoring the business cycle rather a risky policy?

When to Buy? When to Sell? Learning from Philip Fisher describing a fund's investment into American Cyanamid share.

When to Buy?

Philip Fisher wrote:

"Immediately prior to the 1954 congressional elections, certain investment funds took advantage of this type of situation.  For several years before this time, American Cyanamid shares had sold in the market at a considerably lower price-earnings ratio than most of the other major chemical companies.  I believe this was because the general feeling in the financial community was that, while the Lederle division represented one of the world's most outstanding pharmaceutical organizations, the relatively larger industrial and agricultural chemical activities constituted a hodge-podge of expensive and inefficient plants flung together in the typical "stock market" merger period of the  booming 1920's.  These properties were generally considered anything but a desirable investment."

"Largely unnoticed was the fact that a new management was steadily but without fanfare cutting production costs, eliminating dead wood, and streamlining the organization.  What was noticed was that this company was'making a huge bet' - making a major capital expenditure, for a company its size, in a giant new organic chemical plant at Fortier, Louisiana.  So much complex engineering was designed into this plant that it should have surprised no one when the plant lagged many months behind schedule in reaching the break-even point.  As the problems at Fortier continued, however, the situation added to the generally unfavourable light in which American Cyanamid shares were then being regarded.  At this stage, in the believe a buying point was at hand, the funds to which I have already referred acquired their holdings at an average price of 45 3/4.  This would be 22 7/8 on the present shares as a result of a 2 for 1 stock split which occurred in 1957."

"What has happened since?  Sufficient time has elapsed for the company to begin getting the benefits of some of the management activities that were creating abnormal costs in 1954.  Fortier is now profitable.  Earnings have increased from $1.48 per (present) common share in 1954 to $2.10 per share in 1956 and promise to be slightly higher in 1957, a year in which most chemical (though not pharmaceutical) profits have run behind those of the year before.  At least as important, 'Wall Street; has come to realize that American Cyanamid's industrial and agricultural chemical activities are worthy of institutional investment.  As a result, the price-earnings ratio of these shares has changed noticeably.  A 37 percent increase in earnings that has taken place in somewhat under 3 years has produced a gain in market value of approximately 85 percent."



Since writing these words, the financial community's steady upgrading of the status of American Cyanamid appears to have continued.  With earnings for 1959 promising to top the previous all-time peak of $2.42 in 1957, the market price of these shares has steadily advance.  It now is about 60, representing a gain of about 70 percent in earning power and 163 percent in market value in the five years since the shares referred to were acquired.


In 1954 Cyanamid stock was purchased by "certain funds" referred to by Philip Fisher in his original edition.  These funds are no longer retaining the shares, which were sold in the spring of 1959 at an average price of about 49.  This was of course significantly below the current market (60) but still represented a profit of about 110 percent.



When to Sell?

The size of the profit had nothing whatsoever to do with the decision to sell.

There were two motives behind the decision.

1.  One was that the long-range outlook for another company appeared even better.  While not enough time has yet passed to give conclusive proof one way or the other, so far comparative market quotations for both stocks appear to have warranted this move.

2.  There was a second motive behind this switch of investments which hindsight may prove to be less credible.  This was concern that in relation to the most outstanding of competitive companies, American Cyanamid's chemical (in contrast to its pharmaceutical) business was not making as much progress in broadening profit margins and establishing profitable new lines as had been hoped.  Concern over these factors was accentuated by uncertainty over the possible costs of the company's attempt to establish itself in the acrylic fiber business in the highly competitive textile industry.  This reasoning may prove to be correct and still could turn out to have been the wrong investment decision, because of bright prospects in the Lederle, or pharmaceutical division.  These prospects have become more apparent since the shares were sold.  The possibilities for a further sharp jump in Lederle earning power in the medium-term future center around (1) a new and quite promising antibiotic, and (2) in time a sizable market for an oral "live" polio vaccine, a field in which this company has been a leader.  These developments make it problematic and a matter that only the future will decide as to whether this decision to dispose of Cyanamid shares may not have been an investment mistake.  





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Additional Notes:

http://myinvestingnotes.blogspot.my/2010/09/common-stocks-and-uncommon-profits-by.html

WHEN TO BUY

Contrary to Buffett, Fisher is looking for companies that "will have spectacular growth in their per-share earnings." (Buffett is primarily concerned with consistent and handsome returns on equity.) Buffett and Fisher do agree on the worthlessness of macroeconomic forecasting. Fisher writes, "The conventional method of timing when to buy stocks is, I believe, just as silly as it appears on the surface to be sensible. This method is to marshal a vast mass of economic data…I believe that the economics which deal with the forecasting business trends may be considered to be about as far along as was the science of chemistry during the days of alchemy in the Middle Ages." Fisher prefers to buy into outstanding companies when their earnings are temporarily depressed, and so consequently is the share price, because of a new product or process launch. "In contrast to guessing which way general business or the stock market may go, he should be able to judge with only a small probability of error what the company into which he wants to buy is going to do in relation to business in general."

Stock monitoring and when to sell
• Use a three-year rule for judging results if a stock is
underperforming but no fundamental changes have
occurred.
• Hold stock until there is a fundamental change in its
nature or it has grown to a point where it will no longer
be growing faster than the overall economy.
• Don’t sell for short-term reasons.
• Sell mistakes quickly, once they are recognized.
• Don’t overdiversify—10 or 12 larger companies is
sufficient, investing in a variety of industries with different
characteristics.

When to Buy? Economic forecasting business trends cannot be safely used as a basis for your investing action. Stay with superbly selected growth stocks.

The heart of successful investing is knowing how to find the minority of stocks that in the years ahead will have spectacular growth in their per-share earnings.

Is there any reason to divert time or mental effort from this main issue?

Does not the matter of when to buy become of relatively minor importance?

Once the investor is sure he has definitely found an outstanding stock, isn't any time at all a good time to buy it?

The answer to this depends somewhat on the investor's objective.

It also depends on his temperament.



The consequence of buying just before a big stock market crash.

An example of this would be the purchase of several superbly selected enterprises in the summer of 1929 or just before the greatest stock market crash of American history.

In time, such a purchase would have turned out well.

But 25 years later, it would provide a much smaller percentage gain than would have been the case if, having done the hardest part of the job in selecting his companies properly, an investor had made the small extra effort needed to understand a few simple principles about the timing of growth stocks.

In other words:

• if the right stocks are bought and held long enough they will always produce some profit.
• usually, they will produce a handsome profit.
•  however, to produce close to the maximum profit, the kind of spectacular profit one hoped for, some consideration must be given to timing.

The conventional method of timing when to buy stocks.

This is just as silly as it appears on the surface to be sensible.

This method is to marshal a vast mass of economic data.  From these data conclusions are reached as to the near- and medium-term course of general business.

More sophisticated investors will usually form opinions about the future course of money rates as well as business activity.

Then, if their forecasts for all these matters indicate no major worsening of background conditions, the conclusion is that the desired stock may be bought.   

It sometimes appears that dark clouds are forming on the horizon.  Then those who use this generally accepted method will postpone or cancel purchases they otherwise would make.


The objection to this conventional approach.

The conventional approach is not unreasonable in theory.  

The objection is that in the current state of human knowledge about the economics which deal with forecasting future business trends, it is impossible to apply this method in practice.

The chances of being right are not good enough to warrant such methods being used as a basis for risking the investment of savings.

This may not always be the case.


Economic forecasting business trends cannot be safely used as a basis for your investing action.

It might not even be the case five or ten years from now.  At present, able men are attempting to harness electronic computers to establish "input-output" series of sufficient intricacy that perhaps at some future date it may be possible to know with a fair degree of precision what the coming business trend will be.

When, if ever, such developments occur, the art of common stock investment may have to be radically revised.  Until they occur, however, the economics which deal with forecasting business trends may be considered to be about as far along as was the science of chemistry during the days of alchemy in the Middle Ages.

In chemistry then, as in business forecasting now, basic principles were just beginning to emerge from a mysterious mass of mumbo-jumbo.  However, chemistry had not reached a point where such principles could be safely used as a basis for choosing a course of action.


Rarely, economic forecasting is useful or safe.

Occasionally, as in 1929, the economy gets so out of line that speculative enthusiasm for the future runs to unprecedented proportions.

Even in our present state of economic ignorance, it is possible to make a pretty accurate guess as to what will occur.

However, it is doubtful if the years when it is safe to do this have averaged much more than one out of ten.

They may be even rarer in the future.

(Read:  Year 2008 - Buffett Calls The Market Again...And He's Never Been Wrong
http://myinvestingnotes.blogspot.my/2016/01/year-2008-buffett-calls-market-againand.html0



If, then, conventional studies of the near-term economic prospect do not provide the right method of approach to the proper timing of buying, what does provide it?

The answer lies in the very nature of growth stocks themselves.



Common Stocks and Uncommon Profits
Philip Fisher

The case of the market declines and unsuccessful stock investments.

There is a vital difference here between temporary and permanent influences.

A price decline is of no real importance to the bona fide investor unless it is either very substantial - say, more than a third from cost - or unless it reflects a known deterioration of consequence in the company's position.


In a well defined bear market many sound common stocks sell temporarily at extraordinarily low prices.

• It is possible that the investor may then have a paper loss of fully 50 per cent on some of his holdings, without any convincing indication that the underlying values have been permanently affected.

A significant price decline is of importance to the investor.

• He would have been well advised to scrutinize the picture with some care, to see whether he had made any miscalculations.
• But if the results of his study were reassuring - as they should have been - he was entitled then to disregard the market decline as a temporary vagary of finance, unless he had the funds and the courage to take advantage of it by buying more on the bargain basis offered.

The Reasons for Selling and for Buying a Stock

For every single trade, there is always a buyer and a seller.

The Reasons for Selling

Seller:  "This stock stinks.  I can make more money somewhere else."

Seller:  "I need money for my new car."

The Reasons for Buying

Buyer:  "This company is going to make me some money."

Buyer:  "This company is going to make me some money."

There are a few reasons for selling a stock, but there is usually only one reason for buying a stock.  :-)

The seller thinks the stock stinks, whereas the buyer thinks the company is great.
The seller thinks the stock is still good but he needs the money, and the buyer bought because he thinks the company is great.

Thousands of orders a day cause the market price of a company to move up and down.  However, the market price of a stock is determined only by a small number of players and not by all of the people.

Wondering when you should exit the market? Use Lynch's rule of thumb.

Wondering when you should exit the market? Use Lynch's rule of thumb.

Should we all exit the market to avoid the correction?  Some people did that when the Dow hit 3000, 4000, 5000, and 6000. 

• A confirmed stock picker sticks with stocks until he or she can't find a single issue worth buying. 
• The only time I took a big position in bonds was in 1982, when inflation was running at double digits and long-term U.S. Treasurys were yielding 13 to 14 percent. I didn't buy bonds for defensive purposes. 
• I bought them because 13 to 14 percent was a better return than the 10 to 11 percent stocks have returned historically. 

I have since followed this rule: 
When yields on long-term government bonds exceed the dividend yield on the S&P 500 by 6 percent or more, sell stocks and buy bonds. 


As I write this, the yield on the S&P is about 2 percent and long-term government bonds pay 6.8 percent, so we're only 1.2 percent away from the danger zone. Stay tuned.

So, what advice would I give to someone with $1 million to invest? The same I'd give to any investor: Find your edge and put it to work by adhering to the following rules:

With every stock you own, keep track of its story in a logbook. Note any new developments and pay close attention to earnings. Is this a growth play, a cyclical play, or a value play?Stocks do well for a reason and do poorly for a reason. Make sure you know the reasons.
Stocks do well for a reason, and poorly for a reason.

1. *Pay attention to facts, not forecasts.
2. *Ask yourself: What will I make if I'm right, and what could I lose if I'm wrong? Look for a risk-reward ratio of three to one or better.
3. *Before you invest, check the balance sheet to see if the company is financially sound.
4. *Don't buy options, and don't invest on margin. With options, time works against you, and if you're on margin, a drop in the market can wipe you out.
5. *When several insiders are buying the company's stock at the same time, it's a positive.
6. *Average investors should be able to monitor five to ten companies at a time, but nobody is forcing you to own any of them. If you like seven, buy seven. If you like three, buy three. If you like zero, buy zero.
7. *Be patient. The stocks that have been most rewarding to me have made their greatest gains in the third or fourth year I owned them. A few took ten years.
8. *Enter early -- but not too early. I often think of investing in growth companies in terms of baseball. Try to join the game in the third inning, because a company has proved itself by then. If you buy before the lineup is announced, you're taking an unnecessary risk. There's plenty of time (10 to 15 years in some cases) between the third and the seventh innings, which is where the 10- to 50-baggers are made. If you buy in the late innings, you may be too late.
9. *Don't buy "cheap" stocks just because they're cheap. Buy them because the fundamentals are improving.
10. *Buy small companies after they've had a chance to prove they can make a profit.
11. *Long shots usually backfire or become "no shots."
12. *If you buy a stock for the dividend, make sure the company can comfortably afford to pay the dividend out of its earnings, even in an economic slump.
13. *Investigate ten companies and you're likely to find one with bright prospects that aren't reflected in the price. Investigate 50 and you're likely to find 5.

http://myinvestingnotes.blogspot.com/2012/01/whats-best-way-to-invest-1million-peter.html