Warren Buffett: Volatility in the Market

Market Volatility

What should you do?

If you own a farm or an apartment, you do not get a quote on them every day or every week.

The value of a business depends on how much in terms of cash it delivers to its owners between now and judgment day and I don't think it changes in 10% in a 2 months period if you are looking at it as a business.

Anything, I mean, anything can happen in the market; that is why don't borrow money against any securities.  Markets don't have to open tomorrow.  You can have extraordinary events.


You can get some of the instruments that people don't understand very well that has a lot of fire-power.

Billionaire Ray Dalio: Don't take on debt until you've asked yourself this question

Thu, 25 Oct 2018

Many young people are deep in debt: Millennials between the ages of 25 and 34 have an average of $42,000 of debt per person and members of Gen Z (ages 16 to 20) already have an average debt of $4,343. And as interest rates rise, that debt is often becoming more expensive to pay off.

Billionaire investor Ray Dalio, the founder of the world's largest hedge fund, Bridgewater Associates, advises young people to do a bit of analysis before they agree to take out a loan.

"Be very careful about debt," Dalio tells CNBC Make It. "Some is good and some is bad."

When it comes to borrowing money you'll have to pay back at a higher cost — anything from credit card debt to student loans to home mortgages and auto loans — Dalio suggests asking yourself one question: Will the debt help you save or earn more money in the future?

"Debt that produces more cash flow than it costs is good," Dalio says. For example, taking a loan to complete an advanced degree that will raise your salary above the cost of the loan's monthly payments and interest is a good form of debt, according to Dalio.

Another type of good debt is the kind that forces you to save money over time. For example, monthly payments on a home mortgage are a type of forced savings, he says, because you are socking away money into an asset you can later sell.

Since Americans often struggle to save (the personal savings rate has hovered around 6.6 percent in the U.S. since June) forced savings can be an important mechanism for Americans to store wealth without being tempted to spend it.

"Debt that creates forced savings, which is greater than you would save if you didn't have it, like buying a house, will produce good debt," Dalio explains.

Unlike taking on debt to earn more or to save more, getting a loan to buy something that won't help you in the future is a bad idea.

"Debt for consumption, or for anything that doesn't produce more income than it costs, is bad debt," Dalio says.

Racking up credit card debt by shopping for clothes or dining out and not paying off the balance at the end of the month is an example of bad debt. The average interest rate on credit cards is close to 17 percent, and consumers spent over $100 billion on credit card interest payments and fees in the last year, according to data from Magnify Money.

As a rule, Dalio prefers to avoid taking on debt whenever he can.

"I'm personally very debt and risk averse — probably too much so," he says. "That's probably because my dad lived through the Great Depression and war and he impressed upon me the freedom from worry one gets from having savings and no debt."

Dalio is worth an estimated $18 billion, according to Forbes, and founded Bridgewater Associates in his two-bedroom apartment in New York in 1975. From its founding through 2017, Bridgewater returned the biggest cumulative net profit for a hedge fund ever, according to data from LCH Investments.

"I never had significant personal debt, and I built Bridgewater without borrowing a dime or raising a dime from outside equity, and I made sure it has significant savings," Dalio says. "Besides having peace of mind, it gave me the power of knowing that I could never be knocked out of the game."



https://www.cnbc.com/2018/10/23/ray-dalio-ask-yourself-this-question-before-taking-on-debt.html

Gabelli's Approach (GAPIC Approach)

What makes a great value investor?

1.  Patience

Buying a piece of business.
What is a business worth?


Mario Gabelli's approach (GAPIC approach)

1. Gather the data and look at all the public information.
2. Put the data by rearranging it.
3. Project
4. Interprete and
5. Communicate

Graham-Dodd Net-Net Approach

• 1 million shares outstanding
• Price per share $10
• Cash and Receivables  $12 per share
• Thus, you will be buying below net current asset value in the public market.

2.  Cumulative knowledge of industry over extended period of time.

For example, by following the auto industry, farm equipment business and entertainment business for 40 years, you can adopt to changes quicker.  If the stock market (Mr. Market) comes down because of Brexit, you can see which company makes an interesting opportunity.  Are they weakened up and how much time you have to hold it?



Private Market Value with a Catalyst versus Market Price

In value investing, how do you close the gap between the market price and the book value, assuming you bought with a gap of 20% below the book value?

We aim to narrow the spread between the Private Market Value with a catalyst and the Public Price of the security.

• What element is visible to a strategic buyer or an interested corporate buyer?
• We do not necessarily look at book value.
• What multiple of cash flow minus capital expenditure (EBITDA) would you pay to own the business?
• How quickly EBITDA grows?  Will it be affected by inflation or deflation?
• Are the cash flows, subscription revenues (cable TV cash flows) or transaction revenues (price of sugar spikes up giving lots of gains)?  How much or what multiples would you pay?
• We look at book value versus value of business and that value can change over time.

In leveraged buy-out or private equity transactions:

• What multiple will you sell the business 5 years from now?
• What kind of return on your equity investment are you looking at?
• How much debt can you raise to finance the purchase today?
• Also, how much debt can another raise 5 years from now who wish to the same thing?

Time Horizon

$40 billion fund.
Turnover 10% per year.
Holding period for stocks about 10 years.

https://www.gabelli.com/gamco/value_strat.cfm

Definition of a Stock Bubble

Definition of a stock bubble


A bubble occurs in a stock when:

1.  Implausible assumptions are applied to justify its present price using normal valuation (e.g.  DCF) models.

2.  There are people buying at these prices ignoring these implausible assumptions.


Based on this defintition, Tesla is a bubble while Apple and Microsoft are not at current prices.  

Gerald Loeb: Timeless Trend Following Wisdom

Gerald Loeb: Timeless Trend Following Advice

Gerald Loeb (July 1899 – April 13, 1974) was a founding partner of E.F. Hutton & Co., a renowned Wall Street trader and brokerage firm. He is the author of The Battle For Investment Survival.

One of the early trend following pioneers? Indeed.

Wisdom from Gerald Loeb

1. The most important single factor in shaping security markets is public psychology.

2. To make money in the stock market you either have to be ahead of the crowd or very sure they are going in the same direction for some time to come.

3. Accepting losses is the most important single investment device to insure safety of capital.

4. The difference between the investor who year in and year out procures for himself a final net profit, and the one who is usually in the red, is not entirely a question of superior selection of stocks or superior timing. Rather, it is also a case of knowing how to capitalize successes and curtail failures.

5. One useful fact to remember is that the most important indications are made in the early stages of a broad market move. Nine times out of ten the leaders of an advance are the stocks that make new highs ahead of the averages.

6. There is a saying, “A picture is worth a thousand words.” One might paraphrase this by saying a profit is worth more than endless alibis or explanations…prices and trends are really the best and simplest “indicators” you can find.

7. Profits can be made safely only when the opportunity is available and not just because they happen to be desired or needed.

8. Willingness and ability to hold funds uninvested while awaiting real opportunities is a key to success in the battle for investment survival.-

9. In addition to many other contributing factors of inflation or deflation, a very great factor is the psychological. The fact that people think prices are going to advance or decline very much contributes to their movement, and the very momentum of the trend itself tends to perpetuate itself.

10. Most people, especially investors, try to get a certain percentage return, and actually secure a minus yield when properly calculated over the years. Speculators risk less and have a better chance of getting something, in my opinion.

11. I feel all relevant factors, important and otherwise, are registered in the market’s behavior, and, in addition, the action of the market itself can be expected under most circumstances to stimulate buying or selling in a manner consistent enough to allow reasonably accurate forecasting of news in advance of its actual occurrence. The market is better at predicting the news than the news is at predicting the market

12. You don’t need analysts in a bull market, and you don’t want them in a bear market.

https://www.trendfollowing.com/gerald_loeb/

Which is Better: Dollars in the Hand or "in the Bush"?

Professional investment managers strongly favour corporations which can plow back a high percentage of earnings into growing their business.

Does this always pay?

Or should the investor prefer his dividends?

For every example of a company that has compounded its growth by wise investment of its cash there are several that would have done better to pass their surplus on to their stockholders.

Very rarely, one finds a management that can do both.

• For example:  Company XYZ paid out almost 70% of its earnings in dividends.  It has invested its cash flow internally to maximum advantage.  Its shareholders have had their cake and eaten it too.

Expected Profits

The normal way for management to look upon proposed investments is to estimate the expected amount of profit.

This varies from industry to industry.

In any case,it would be unreasonable to invest company funds unless the expected return was substantial.

One finds far too much reinvestment that fails to pay off.

It is difficult for management to understand that in some cases stockholders are paid off better with their company dead than alive.




Examine the past record.

Correct judgement of management policy can only come from a full understanding of the problems involved.

It will pay the investor well to look beyond the superficialities of figures showing totals put back into business by management.  

Consideration should be given to the past record.

How have plow-back expenditures actually turned out?




There is no hard-and-fast rule.

Some stockholders profited enormously by management spending.

Other stockholders suffered through management hoarding.

Many unwise investments were made by corporate management at the wrong time.

Some very wise one were made at the right time.

This is an often overlooked factor which you should include in your analysis of stocks to buy.

If pricing is right, one leading stock is all that is necessary to buy.

If pricing# is right, one stock - the leader if it can be recognized - is all that is necessary to buy.

Or perhaps, two or three stocks of different degrees of risk.

The practice of diversification among dozens of issues is sheer folly for medium or even fairly large securities accounts.

No mixed list can do as well as the prime leaders.




Selection of too many issues is often a form of hedging against ignorance.

• Some people imagine falsely that it is safer.
• One can know a great deal about a very few issues, but it is impossible to have a thorough knowledge of all the ones which go into a diversified list.  
• The chance of errors in judgment is thus increased by diversification, and certainly keeping posted on a broad list after it is purchased is much more difficult than keeping posted on a few very select shares.

# Right price coincides with right timing

If one is trading for rapid profits .....

If one is trading for rapid profits, one must concentrate in those stocks that will give one the action one seeks.

Safety in the trading should come not from the selection of "safe" stocks # :

• a slow mover or 
• a cheap issue or 
• worse yet, a group of such shares.   

Real Safety

Safety should be by concentration in the one outstanding, fast-trading leader that is jumping in the right direction.

There is more safety and more profit in so timing one's buying in the one outstanding, fast-trading leader type of issue that when one gets a report on the purchase,  the bid is then already in excess of what one has paid.

One cannot afford to be wrong in such a fast-moving issue and one is sure to be

• much more certain about one's opinion before one acts to get in than in the case of a slow issue, and 
• likewise much more watchful to get out quickly if the stock doesn't act as anticipated or reverses its action.  

Here is the real safety.

Here also is a chance to build a backlog of profit which is partly a safety fund against future errors.



Use of Margin

In the same way, a sizable position in an issue, even on margin if that is what the individual's situation calls for, is relatively safer than the imagined security of having something paid for and locked up.

One is more careful establishing the margin position and one watches it more carefully.



Final Message

In short, know you are right and go ahead.  If in doubt, stay out.




Additional Notes:

# The issue which is "safe" because it is low and cheap is ordinarily a poor mover, usually creeping or backing and filling without getting much of anywhere while the sensational trading moves are practically all in shares which have broken out of the accumulation stage.

# With regards to these "safe" stocks, it is likely to be most exasperating during a rising market when other shares are scoring rapid advances; and during a period of decline when one is long, then the slow action of the safe stock will lull one into a sense of false security.

"High Priced" versus "Low Priced" stocks

High Priced stocks may be undervalued

Frequently the highest per share prices represent the lowest total valuation for a company when price is multiplied by shares outstanding and compared with total earning power and other figures.


Why high priced stocks can be favourable?

I generally favour issues selling at high prices per share.

They are more often to be in the rapid-growth stage.

They are likely to have a better-grade following.

Think possible profits on percentage basis

One should regard one's possible profits more on a percentage basis than on an absolute dollar basis.

A move to $10 from $5, is $5, but certainly no one would think a move to $130 from $125, meant the same thing.

Traders will not see anything dangerous in the doubling of a low-priced share to 10, from 5, though they will avoid, fear, and occasionally, even sell short a stock that moves to 175 from 125, or $50, when an issue in that class actually would have to rise to $250 to double.

It is quite useful to have a logarithmic chart just as a reminder. 

A "log" chart shows such movements in proper scale and tends to temper the judgement.



High-Priced stocks very occasionally can be available at low prices

Very occasionally, once in a good many years, normally high-priced stocks can be bought for low prices. 

This is so obviously advantageous, if one has the cash at the time and the foresight.



Low Priced stocks with small capitalizations

Sometimes one can buy low-priced stocks of companies that also have small capitalizations, and realise some very amazing profits.  

However, it should be realised that the possibilities of selecting one of the few a make good, and selecting it at the right time, are quite slight.



Low-Priced stocks with large capitalizations

Low -priced shares with huge capitalizations are usually quite undesirable.

Always write down the reasons, pro and con, before making a purchase or a sale

Tip to the Investors:  Always Write it Down

Writing down your reasons for making an investment should save you in your investing.

What you expect to make?
What you expect to risk?
The reasons why?

Always write down the reasons, pro and con, before making a purchase or a sale.

• Major successes in some investors were invariably preceded by a type of written analysis.  
• Sudden emotional decisions have generally being disappointments.
• Writing things down before you do them can keep you out of trouble.  
• It can bring you peace of mind after you have made your decision.
• It also gives you tangible material for reference to evaluate the whys and wherefores of your profits or losses.

Quality Not Quantity

I have seen many analyses, some involving many pages of information.

In practice, quantity doesn't make quality.  

There is invariably one ruling reason why a particular security transaction can be expected to show profit.

• Writing it down will help you find it.
• It will help you judge whether it is really as important as your first inclination suggests.

Are you buying just because something "acts well"?

Is it a technical reason - 

• a coming increase in earnings or dividend not yet discounted in the market price, 
• a change of management,
• a promising new product, 
• an expected improvement in the market's valuation of earnings?

In any given case you will find that one factor will almost certainly be more important than all the rest put together.



Reward/Risk Ratio

Writing it down will help you estimate what you expect to make and it is important that this be worthwhile.

Of course, you will want to decide how much you can afford to lose.

There will be a level at which you will decide that things have not worked out and where you will sell.

Your risk is the difference between your cost and this sell point; it ought to be substantially less than your hopes for profit.

You certainly want to feel that the odds as you see them are in your favour.



Much More Difficult:  When to Sell

All this self-interrogation will help you immeasurably in the much more difficult decision:  when to close a commitment.

When you open a commitment, whether it is a purchase or a short sale, you are, so to speak, on your home ground.  Unless everything suits you, you don't play.

But when you are called upon to close a commitment, then you have to make decisions, whether you see the answer clearly or not (analogy:  being stuck on a railway crossing with the train approaching).

• You don't know what to do -but you have to do something.  
• Go backward, go forward - or jump out.

If you know clearly why you bought a stock it will help you to know when to sell it.  

• The major factor which you recognized when you bought a security will either work out or not work out.  
• Once you can say definitely that it has worked or not worked, the security should be sold.

One of the greatest causes of loss in security transactions is to open a commitment for a particular reason, and then fail to close it when the reason proves to be invalid.

• Write it down and you will be less likely to find yourself making irrelevant excuses for holding a security long after it should have been sold.
• Better still, a stock well bought is far more than half the battle.

Careful Investors look for Signs of Quality Management

One of the main factors determining the success of a corporation is the competence of management.

Buy into companies with "good management."


But in practice, how do you know?

• Ideally you begin by meeting management.  However, the door is open to very few and the ability to assess it is just as limited.
• The practical approach is to begin by looking at the record.

Practical Approach:  Looking at the Record

If a company's earnings are increasing, this is one piece of evidence pointing to good management.

• However, the results must be measured against others in the same industry.  
• Otherwise, a management which swims with a favourable tide may get more credit than it deserves.  

Often a superior management fighting bad conditions is unjustly criticized.


Type of Management Counts

Is the company in question headed by an old-fashioned entrepreneur who has made management a one-man show?

Or does it have good management in echelon depth which can survive the retirement or death of its chief executive?


Officers' shareholdings

One aspect of management worth noting is the extent to which the officers own their own shares.

Broadly speaking, it is advantageous for the officers to have a stake in ownership.

It makes a difference whether they own the stock

• because they want it or 
• because they are stuck with it.

You should consider whether they

• acquired it through inheritance, 
• bought it on option, or 
• bought it in the open market.  

Likewise, where possible, consider the purchase date and price paid.



Close Watch Pays Off

One of the many ways of making money in securities, is through a close watch on management.

Watch and understand the changes where companies have been in difficulty, their stocks depressed and general dissatisfaction expressed and where a new management comes in and invariably begins by sweeping out the accounting cobwebs.

• Everything is marked down or written off so that the new management is not held accountable for the mistakes of the old.  
• Very often dividends which were imprudently paid are cut or passed.  
• Thus an investor at this juncture often gets in at the bottom or the beginning of a new cycle.
• A recent example:  TESCO London.

Conclusion:

Attempting to evaluate management, even though you cannot get all the answers, is worth all the effort it entails.



Related post:

Management Compensation
https://myinvestingnotes.blogspot.com/2010/04/buffett-1994-in-setting-compensation-we.html

"Come Back" Fallacy

One quote often mentioned on many occasions is that "Stocks recover if held long enough."

The stock market is full of examples of stocks of investment grade that have never "come back."  Some have vanished entirely.




"Come Back" Fallacy

There are examples of many stocks that were prime investments in the past or were darlings of investors in the past.   They are now selling at a fraction of the prices they once commanded.  They have never "come back."

It should be realized that even when stocks do come back, the original investor benefits very little if it takes the stocks a long time (20 to 30 years) to do so.  During that period,

• his life, needs and desires have changed,
• the value of money has changed, and 
• in the meantime, other opportunities have slipped by.

The Better Approach

So, it is much better to accept a loss, if you can, while it is still moderate - say 10% or so. 

If the stock really runs away from you, usually it is better to take a substantial loss and start anew than to be tied hopelessly to something which you wouldn't buy if you had the cash.

"To buy low and sell high." Keep 2 important things in mind.

One common stock market "fallacy" is the way to make the most profit is "to buy low and sell high."

It is a beautiful idea if you can do it. 

The truth is, no one knows what is low or high.


Some examples:

• In the recent severe bear market in 2007, many people who saw their stocks decimated a great deal thought they were low.  They never dreamed they would go even lower.

• By the same token, once the stocks started to go up in 2009, many people said, "I wont be caught again; I won't buy them unless they are really cheap."  Of course, they have never been at those low levels since.  They never became "really cheap."

• I have seen people sell stocks which they thought were high, based on what they had been previously, and the stocks went higher and higher.  Then news became public that justified the rise, and what had seemed high previously didn't look high any more in the light of new developments.  

• The same works in reverse.  Perhaps a stock seems low in relation to its dividend.  It goes lower and lower.  Then the dividend is passed or cut and the supposed "bargain" is no bargain at all.

Keep 2 important points in mind


At some point, stocks are genuinely "low" or "genuinely "high."  You may be successful in knowing what that point is if you keep two things in mind.


1.   First, remember that stocks invariably become "undervalued" or "overvalued."

• They overshoot their logical goals or levels

2.  Next, be sure you feel you have a special reason for expecting a turn or change especially when you are trying to buy low.  

• You surely don't want to own a stock that is cheap enough - but stays cheap.  
• So you must feel that you can see improvement or recovery reasonably soon ahead.

Conclusions:

"Buy low, sell high" is one of those wonderful market fallacies or ideas which may work out well for those who can learn the ropes. 

It can be a rather expensive idea if it is just applied as a generalization.

How "safe is your money? Think about money from the standpoint of what you think it will buy now and later.

"Money is (always) safe"

Money is only good for what it will buy.

Its purchasing power has been decreasing steadily over the ages.

It certainly isn't safe in the sense intended by the hoarder or the frightened widow.




"Keep your money working"

This is just as much of a fallacy in its way as thinking that "Money is (always) safe."




Middle Path

You would do best steering a middle course.

Think about money from the standpoint of what you think it will buy now and later.

If you feel it will buy more later, hang on to it.

If you feel it will buy less,

• spend it for something you are intending to buy; or 
• invest it if you think investments will be more costly later.

Think of money as you do of anything else that fluctuates.

Switching Capital: Replace 10% of your diversified investments annually

These are three grim factors that can damage your investment performance:

• the wrong industry, 
• a weak management and 
• over-market pricing of transient growth or profits - 

Are you fast enough to switch capital?

Capital is like a rabbit - it darts away at the first sign of danger!

Are you certain you watch your capital closely enough to flee from smoke before it becomes fire?

To do this successfully you must not only be alert to change but ready and willing to act.




Keep your eyes on the businesses

It is up to you as an investor to

• watch the progress of your companies and 
• switch your investments if your managements fail to keep up with the changing time.  

It takes superior management to adopt to change.  

It takes superior management to build worthy successors to follow in their footsteps.




Replace 10% of your diversified investments annually

Investors should make a conscious effort to do some switching in their portfolios. 

I think at a minimum they could switch 10% of a list of diversified investments annually.

If you own 20 stocks, surely replacing 2 can only help in keeping your investment in step with constantly changing investment factors.

Additional notes:

Newsletters of the First National City Bank of New York.

It tabulated the changes which occurred among the hundred largest U.S. manufacturers between 1919 and 1963.

These largest corporations are not always the most profitable.

Sheer size gave no guarantee of profitability or permanence.

While almost invariably at some stage in their growth, these companies were attractive investments, there was danger if you overstay your market.

1919 list:   100 largest U.S. manufacturers

1963 list:   Only 49 left

Comparison of just these two dates ignored the turnover.  In the interim numerous firms entered and left the group.

Many companies produced a single spurt of growth which could not be sustained.

Many factors were responsible.  An unfavourable change in the outlook for their industries was the major cause.

It boiled down to the always prime factor of management.

The greatest changes were in transportation companies.  It was asking too much to profit from selling horses and buggies in a gasoline age.

The National City letter concluded that to achieve success and hold it, 

• corporations must secure a primary position in growing markets, and, 
• they must be adoptable enough to shift into new fields and open up and to fill new needs.

It is up to you as an investor to watch the progress of your companies and switch your investments if your managements fail to keep up with the changing times.

None Since 96!  (Morgan Guaranty survey of stocks in Dow Averages since 1896)

A Morgan Guaranty survey compared the stocks that had been part of the Dow Averages since 1896.

Continual evolution, shifting investor preferences and the alterations in the actual composition of business activity resulted in not a single issue remaining on the list for the entire 68-year period.

Only American Tobacco and General Electric were on the 1912 and 1964 list, but both were on and off several times.

One of the least reliable guides to investing is popularity.  

• The transportation industry at that period contributed many once-popular investments that had vanished and had all but done so.  
• The carnage in streetcar lines and other utilities had been enormous.  
• Likewise in early automobile leaders.

Investors should make a conscious effort to do some switching in their portfolio.

The three reasons that can damage your investment performance are the wrong industry, a weak second echelon in management and over-market pricing of transient growth or profits.

The intelligent and safe way to handle capital is to concentrate.

Diversification

The beginner in investing needs diversification until he learns the ropes.

Diversification is an admission of not knowing what to do and an effort to strike an average.



Concentration is the intelligent and safe way

The intelligent and safe way to handle capital is to concentrate.

If things are not clear, do nothing. 

When something comes up, follow it to the LIMIT.

If it is not worth following to the limit, it is not worth following at all.



How to start?

Always start with a large cash reserve.

Next, begin in one issue in a small way. 

If it does not develop, close out and get back to cash. 

But if it does do what is expected of it, expand your position in this one issue on a scale up. 

After, but not before, it has safely drawn away from your highest purchase price, then you might consider a second issue.




Greatest Safety:  Putting all your eggs in one basket and watching the basket

The greatest safety lies in putting all your eggs in one basket and watching the basket.

You simply cannot afford to be careless or wrong. 

Hence, you act with much more deliberation.

Of course, no thinking person will buy more of something than the market will take if he wants to sell, and here again, the practical test will force one into the listed leaders where one belongs. 

The less active a stock and the further distant the market, the more potential profit I need to see in it to make it worth buying.

It is purely a personal matter whether an investor feels that efforts at safety are more important than trying to get the maximum out of investing.



Stocks in the same business cycle

Diversification between the position of varying companies in their business cycle or as between their shares in their market price cycle is a very important consideration. 

Dividing one's funds between three or four different stocks which happen all to be in the same sector of their cycle can often be discouraging or dangerous.

After all, the final determinant of investment success or failure is market price.

• For example, industries which are in the final stages of a boom with rapidly increasing earnings, dividends and possibly split-ups, often offer shares high in price but apparently rapidly going higher.  There is a sound justification for an investor who knows what he is doing to buy into such a situation, especially for short-term gains, but it would be quite dangerous for him to put all of his funds in three or four such stocks.

• On the other hand, we naturally all seek deflated and cheap bargains, but very often shares like this will lie on the bottom much longer than we anticipate and if every share we own is in this same category, we may do very badly in a relatively good market.

Conclusions:

The greatest safety for the capable, lies in putting all one's eggs in one basket and watching the basket.  

The beginner and those who simply find their investment efforts unsuccessful must resort to orthodox diversification.

Greatest Care must be taken in Buying Convertible Bonds

Some common popular bonds in the market in recent years are the

• convertible issues and 
• bonds with warrants to buy stock attached.

Convertibles are popular because they seem under certain conditions to combine 

• a degree of bond dollar safety 
• with a chance of profit.

Profits can be made by careful selection, pricing and timing of these bonds.

Market price of convertible bonds

The market price of a convertible bond is a 

• combination of estimated true current investment value
• plus a premium for the current value of conversion privilege, if any.  

This premium varies with 

• the estimated opportunity to make a profit, 
• the length of time the privilege runs and 
• other factors.

The greatest care must be taken in buying convertibles.

The most common mistake is to look too closely into 

• the size of the premium or 
• the closeness of the conversion price on the bond to the current market for the stock into which it can be converted.

You should look first into the stock for which it can be exchanged.

• If you care to make a profit, this must go up.  
• You must start by being fundamentally bullish on the equity.  
• Only then can you look into the mathematical factors governing the price of the convertible bond.

An Ever-Liquid Account (Concept)

An Ever-Liquid Account

In its operation, an ever-liquid account is normally kept fully un-invested; i.e., in cash or equivalent only. "Equivalent" means any kind of really liquid short-term security or commercial paper.

Book values and market values are always kept identical.

Income is real income; i.e., interest, dividends, capital gains realized and realizable, less capital losses taken or unrealized in the account, which is always marked to market.




Cash and Equivalent (Beginning of period)

add Income:  
interest
dividends
capital gains realized
capital gains realizable

less losses:
capital losses taken
capital losses unrealized in the account


Cash and Equivalent (End of period)




How to keep the account truly ever-liquid?

Income and appreciation are obtained in the ever-liquid account by entering the stock market as a buyer when a situation and trend seem clearly enough established so that a paper profit is present immediately after making the purchase.

In order to keep the account truly ever-liquid, one must use a mental or an actual stop on all commitments amounting to some predetermined percentage of the amount invested (e.g. 3% stop loss or 10% stop loss).

One does not make a purchase unless one feels rather sure that the trend is sufficiently well established to minimize the possibility of being stopped out.  Yet it will happen occasionally anyway.

The decision of what and when to buy is made on a personal basis using various yardsticks best understood by individual investors.




Concentrated purchases of single issues

This investment philosophy leads into concentrated purchases of single issues rather than diversification, because one of the primary elements in the situation is that one must know and be convinced of the rightness of what one is doing.  

Diversification as to issue and type of investment is only hedging - a method of averaging errors or covering up lack of judgement.




Profiting from trends and pyramiding

This ever-liquid method also rarely calls for attempts to buy at the bottom, as bottoms and tops are actually impossible to judge ordinarily, while trends after they are established and under way can be profitably recognized. 

It is a method that leans towards pyramiding; i.e., towards following up gains and retreating before losses.  Such an account, properly handled, bends but never breaks. 

"Averaging down" is, of course, completely against this theory.

With mistakes, there is no cheaper insurance than accepting a loss quickly

Nevertheless, in investing, mistakes will be made.

And when they are, there is no cheaper insurance than accepting a loss quickly.  

That is the tactic of retreat than capitulation.



Serial losers

It would be very difficult for an investor losing, say, 5% to 10% each time on a succession of ventures, to continue to lose time and time again without checking his errors or stopping altogether.



Long term hold irregardless

A buyer who holds regardless of unfavourable news or action can become involuntarily locked in his "investment" for years and often, no amount of future waiting can extract him from his predicament.

It is important to regard the situation with an open mind, unbiased by a bad stale position, and it is important to be able to act each time convictions are very strong.

Unless losses are cut, such an attitude and such action are impossible.

Psychology and Investing: Herding

Stock Ideas

There are thousands and thousands of stocks out there.  Investors cannot know them all.

In fact, it is a major endeavor to really know even a few of them.

But people are bombarded with stock ideas from brokers, television, magazines, Web sites, and other places.





Herding Behaviour

Inevitably, some decide that the latest idea they have heard is better idea than a stock they own (preferably one that is up, at lead), and they make a trade.

In many cases the stock has come to the public's attention

• because of its strong previous performance, 
• not because of an improvement in the underlying business.

Following a stock tip, under the assumption that others have more information, is a form of herding behaviour.





Temporary Comfort from investing with the Crowd or a Market Guru

This is not to say that investors should necessarily hold whatever investments they currently own.

Some stocks should be sold, whether because

• the underlying businesses have declined or 
• their stock prices simply exceed their intrinsic value.

But it is clear that many individual (and institutional) investors hurt themselves by making too many buy and sell decisions for too many fallacious reasons.  

We can all be much better investors when we learn to select stocks carefully and for the right reasons, and then actively block out the noise.

Any temporary comfort derived from investing with the crowd or following a market guru can lead to fading performance or inappropriate investments for your particular goals.