Monday, 4 August 2008

Portfolio Management - Defensive & Offensive strategies

Strategies for maintaining your portfolio as advocated by Better Investing is simple and can be followed. You sell your shares if you:

1) need cash for emergencies

2) defensive management of your portfolio when a stock's fundamental has turned bad, and

3) offensive management of your portfolio to maximise/optimise returns.



Selling and Holding mistakes Checklist (Part 5 of 5)

A. Common Selling Mistakes

􀂆 Price is down, but fundamentals remain solid
􀁻 Prices fluctuate for reasons that are not always rational.
􀁻 The price will follow fundamentals in the long run.
􀁻 Consider buying more shares.

􀂆 The company has short-term problems
􀁻 Do not make a rapid decision.
􀁻 Look at the long-term impact of the news.

􀂆 Selling winners to lock in gains
􀁻 If you sell all your winners, you will be left with losers.
􀁻 If your winners are high quality companies, they are likely to
become even bigger winners.

􀂆 Selling because the price reaches a predetermined limit
􀁻 An executed stop-loss order will bring you less money than if
you sell at the current price.
􀁻 A limit order at a higher price, without regard to fundamentals,
may generate additional taxes and eliminate your chance of
future gains.

B. Common Holding Mistakes

􀂆 When fundamentals deteriorate
􀁻 If your evaluation indicates this is a long-term problem, holding it
is likely a mistake.
􀁻 If you wouldn't buy this company today, don't hold it.

􀂆 Trying to get even when you have a paper loss
􀁻 You can't change the past; what matters is the future.
􀁻 Would another stock be a better investment? Prepare an SCG.
􀁻 Remember the NAIC Rule of 5.
􀁻 You may be able to offset some capital gains with this loss.

􀂆 Holding inherited stocks out of loyalty
􀁻 These stocks may be inappropriate for your financial situation.
􀁻 The person who left you the stocks would want you to do what is
best for your circumstances.

􀂆 Not following your stocks after purchase
􀁻 "Buy and hold" does not mean "buy and forget." Companies change.
􀁻 Keep up with the news on the company.
􀁻 Maintain your SSG and PERT.

To Sell or to Hold Checklist (Part 4 of 5)

To Sell or to Hold Checklist

Company: ______________________________
Prepared by: ____________________________
Date: _______________

A. Consider Selling

􀂆 If you need cash
􀁻 Consider selling shares that will improve diversification.
􀁻 Consider selling the stock with lowest potential return.
􀁻 Consider selling the lowest quality stock .

􀂆 If company's fundamentals deteriorating
􀁻 Slowing or falling sales growth is warning sign.
􀁻 Check TTM growth rates in PERT A.
􀁻 Read about peers, industry, and economy to determine if problems
short or long term. Sell if problems appear long term.
􀁻 Consider selling if management keeps making excuses.
􀁻 Increasing long-term debt may be warning. Look at graph in NAIC
Stock Analyst or your favorite financial website.

􀂆 Adverse management changes
􀁻 CFO departs unexpectedly
􀁻 Several key executives depart
􀁻 Death of several key executives

􀂆 Significant increase in competition
􀁻 Watch to see if it affects profit margins in SSG and PERT A.

􀂆 Product problems
􀁻 Decline in pipeline, e.g., drug companies
􀁻 Same-store sales declining, e.g., retail companies
􀁻 Worsening product mix
􀁻 Increasing dependence on one or two products

􀂆 Customer problems
􀁻 Customer base shrinking
􀁻 Company becoming overly dependent on one or two customers

􀂆 Company's debt rating has been lowered
􀁻 Can be forewarning of future problems

􀂆 Indications of fraud or accounting problems
􀁻 Investors will be last to know if company falsifying financial data.
􀁻 If the source of information is credible, sell fast.

􀂆 Uncontrolled raw material costs
􀁻 If company doesn't hedge, it may have to pay higher prices for the
materials, which will hurt profit margins.

􀂆 Stock appears significantly overvalued
􀁻 Update SSG. Do not use overly conservative judgments.
􀁻 Forward RV is over 150%
􀁻 Upside-downside ratio is below 1
􀁻 Potential total return is less than money market fund or CD

􀂆 If you want to diversify your portfolio
􀁻 If one stock becomes large percentage of portfolio, try to add to
other positions.
􀁻 If you don't have money to add to smaller holdings, sell a portion of
the large position.
􀁻 If stock is a very small percentage of portfolio, add to it or sell it.

􀂆 If you want to improve portfolio quality
􀁻 Look for a higher quality company and compare them with SCG

􀂆 If company is acquired
􀁻 Do SSG on acquiring company. Sell your stock if SSG of acquirer
doesn't meet your standards.

􀂆 Take capital loss
􀁻 Can sell stocks in taxable account at a loss to offset capital gains
􀁻 Can use another $3,000 of capital losses to offset ordinary income
􀁻 Evaluate stock for repurchase after 30 days to avoid wash sale.

B. Consider Holding

􀂆 When there is temporary bad news
􀁻 Read about peers, industry, and economy to determine if
problems are temporary.

􀂆 If it is near the end of the quarter
􀁻 Consider holding to see the earnings release

􀂆 The price is down, but the fundamentals are strong
􀁻 Update your SSG and PERT and check the fundamentals

Evaluating Changing Fundamentals (Part 3 of 5)


Company: ___________________
Ticker: ___________________
Prepared by: ___________________
Date: ___________________

Douglas Gerlach



o EPS or revenue growth is slowing or falling.
· Company may be entering a new stage of slower growth or stagnation.
· If considering additional purchase, use caution. The worse a company performs, the better a value it may appear on the SSG.

o Quarterly pre-tax profits are falling.
· Use PERT graph to evaluate PTP.
· Three quarters of consecutive declining PTP are a danger sign.
· Five consecutive declining quarters are usually a definitive sign to sell.

o Cash flow is diverging from net income.
· If free cash flow is falling while net income is stable or rising, company may be "propping up" profits.

o Other fundamentals are deteriorating.
· Accounts receivable rising faster than sales.
· Inventories rising faster than sales.

o There has been an uncertain change of management.
· Dynamic company leader retires, replacement has questionable qualifications.
· Senior executives leave en masse.
· Those responsible for past success are no longer with the company.

o Company faces direct or indirect competition.
· Competitors threaten to affect the company's long-term prosperity.
· Companies with very high profit margins are often susceptible to increased, cutthroat competition.

o Company faces uncertain product cycle.
· Company is too dependent on single product.
· No new products in pipeline (such as pharmaceutical companies).

o Company has uncontrolled raw material costs.
· Can harm profit margins.
· If company doesn't hedge, they may have no option but to pay higher prices for necessary materials.

o Company is the victim of fraud or "accounting irregularities."
· If the books are being cooked, investors will be last to know.
· No way for investors to know if management is lying, or auditors are covering up.
· Get out fast; these are not quality companies.

o Company's debt rating has been lowered.
· Can often be an early warning sign of greater problems in the future.


· Don't hesitate to sell in retirement accounts where taxes aren't an issue.
Don't automatically buy because a stock falls in price; re-evaluate as if new.
If you won't purchase additional shares of a fallen stock, why would you continue to hold it?
Don't "wait to get your money back" from the stock – it doesn't know you own it.
· Don't be paralyzed by uncertainty.
· Don't be an ostrich with your head in the sand –
face up to the problem.
· Remember NAIC's Rule of Five.
· Use Challenge Tree to continually upgrade your portfolio.
· Think "replace," not "remove."

Stock Sale Considerations (Part 2 of 5)



Not so good reasons

x To "lock in a profit."
· WARNING: Trading results in higher taxes and commissions, and lower returns.
· Concentrate on cutting losses instead of "protecting your gains"

x Stock has reached predetermined limit.
· WARNING: Sell limit orders generate certain tax liability, possibly at higher rates.
· Eliminates the chance of any future growth in that stock.

x "Stock hasn't done anything."
· WARNING: Prices don't move in linear, consistent fashion, but in spurts.
· Remember that price growth follows profits, eventually.
· Determine if a stock is languishing for a reason.

x Company is subject of temporary bad news.
· WARNING: Avoid knee-jerk reactions, though market may respond negatively.
· Re-evaluate to determine possible long-term impact of news.

x Company has missed earnings estimates by small amount.
· WARNING: Focus on long-term, not short-term results.
· Re-evaluate to determine if there is a fundamental shift underway at the company.

x An analyst has downgraded the stock.
· WARNING: Analysts have short-term, not long-term, objectives.
· May have lowered rating to protect realized gains, not due to long-term potential.

Good reasons

o To raise cash.
· Consider it an opportunity to prune underperformers.
· If you don't have any underperformers, then consider tax impact of selling.

o To raise cash for club withdrawal.
· Consider it an opportunity to prune underperformers.
· Don't sell highly appreciated stock, transfer shares to departing member instead.

o The stock is possibly overvalued.
· Relative Value using forward PE is greater than 150%.
· Stock is in sell zone on SSG.
· Projected total return less than long-term returns on bonds.

o To take a capital loss.
· Sell stocks at loss in taxable accounts to offset any gains.
· Part of year-end portfolio review.
· After offsetting losses, can use $3,000 of capital gains to offset ordinary income.
· Evaluate for repurchase after 30 days (to avoid wash sale rule)

o To upgrade quality or expected return of portfolio.
· Determine round trip cost, amount to invest in new stock after taxes and commissions.
· Use Toolkit Challenger or Stock Analyst Cost of Switching tool to evaluate.
· Use NAIC Challenge Tree to evaluate.

o Because fundamentals have changed.
Proceed to Section C*. (*See next post)

Stock Selling Guide - Gain/Loss Worksheet (Part 1 of 5)

Douglas Gerlach


1 Cost basis of shares owned (Total amount invested) $
2 Total value as of this date $
3 Pre-tax loss/gain $ (= 1 - 2 )
4 Capital gains taxes due (if any) $
5 Round-trip commissions (to sell, then buy a replacement) $
6 After-tax loss/gain* $ (= 3 - 4 - 5)
(* This is also the starting amount of potential new investment)

Friday, 1 August 2008

Investment, speculation and gambling

It is commonly thought that investment, is good for everybody and at all times. Speculation, on the other hand, may be good or bad, depending on the conditions and the person who speculates.

It should be essential, therefore, for anyone engaging in financial operations to know whether he is investing or speculating and, if the latter, to make sure that his speculation is a justifiable one.

Investment, speculation and gambling (Security Analysis, Ben Graham.):

1. Graham defined investment thus:
An INVESTMENT OPERATION is one which, upon THOROUGH ANALYSIS, promises SAFETY OF PRINCIPAL and a SATISFACTORY RETURN. Operations NOT meeting these requirements are speculative.

The difference between investment and speculation, when the two are thus opposed, is understood in a general way by nearly everyone; but it can be difficult to formulate it precisely. In fact something can be said for the cynic's definition that an investment is a successful speculation and a speculation is an unsuccessful investment.

The failure properly to distinguish between investment and speculation was in large measure responsible for the market excesses and calamities that ensued, as well as, for much continuing confusion in the ideas and policies of would-be investors.

2. Graham's addition criterion of investment: An investment operation is one that can be justified on BOTH QUALITATIVE and QUANTITATIVE grounds.

Investment must always consider the PRICE as well as the QUALITY of the security.

Main points:______________

INVESTMENT OPERATION: rather than an issue or a purchase.

PRICE: is frequently an essential element, so that a stock (and even a bond) may have investment merit at one price level but not at another.

DIVERSIFICATION: An investment might be justified in a group of issues, which would not be sufficiently safe if made in any one of them singly.

ARBITRAGE AND HEDGING: it is also proper to consider as investment operations certain types of arbitrage and hedging commitments which involve the sale of one security against the purchase of another. In these rather specialised operations the element of SAFETY is provided by the combination of purchase and sale.

THOROUGH ANALYSIS: the study of the facts in the light of established standards of safety and value, including all quality of thoroughness.

SAFETY: The SAFETY sought in investment is not absolute or complete; the word means, rather, protection against loss under all normal or reasonably likely conditions or variations. A safe stock is one which holds every prospect of being worth the price paid except under quite unlikely contingencies. Where study and experiences indicate that an appreciable chance of loss must be recognized and allowed for, we have a speculative situation.

SATISFACTORY RETURN: is a wider expression than "adequate income", since it allows for capital appreciation or profit as well as current interest or dividend yield. "Satisfactory" is a subjective term; it covers any rate or amount of return, however low, which the investor is willing to accept, provided he acts with reasonable intelligence.


For investment, the future is essentially something to be guarded against rather than to be profited from. If the future brings improvement, so much the better; but investment as such cannot be founded in any important degree upon the expectation of improvement.

Speculation, on the other hand, may always properly – and often soundly – derive its basis and its justification from prospective developments that differ from past performances.

GAMBLING: represents the creation of risks not previously existing – e.g. race-track betting.

SPECULATION: applies to the taking of risks that are implicit in a situation and so must be taken.

INTELLIGENT SPECULATION: the taking of a risk that appears justified after careful weighing of the pros and cons.

UNINTELLIGENT SPECULATION: risk taking without adequate study of the situation.

Investment Policies (Based on Benjamin Graham)

Summary of Investment Policies

US Savings Bonds (FDs or Amanah Sahams for Malaysians)

(1) INVESTMENT FUNDS bought at reasonable price.
(2) Diversified list of primary common stocks (BLUE CHIPS) bought at reasonable price.

C. INVESTMENT CHIEFLY FOR PROFIT: 4 approaches are open to both the small and the large investors:
(1) Representative common stocks bought when the MARKET level is clearly LOW.
(2) GROWTH STOCKS, when these can be obtained at reasonable prices in relation to actual accomplishment – GROWTH INVESTING.
(3) Purchase of securities selling well BELOW INTRINSIC VALUE – VALUE INVESTING.
(4) Purchase of WELL-SECURED PRIVILEGED SENIOR ISSUES (bonds and preferred shares).
(5) SPECIAL SITUATIONS: Mergers, arbitrages, cash pay-outs.

(1) Buying stock in new or virtually new ventures (IPOs) .
(2) TRADING in the market.


(Portfolio A: Cash, FDs, Bonds Portfolio B: Mutual funds, Blue chips)

(Portfolio C: Buy in Low Market, Buy Growth stocks at fair value, Buy value stocks i.e. bargains, High grade bonds and preferred shares, Arbitrages)

For SPECULATORS: Portfolio D
(Should set aside a sum for this separate from their money in investing.)


Types of Investors

Graham felt that individual investors fell into two camps : "defensive" investors and "aggressive" or "enterprising" investors.

These two groups are distinguished not by the amount of risk they are willing to take, but rather by the amount of "intelligent effort" they are "willing and able to bring to bear on the task."

Thus, for instance, he included in the defensive investor category professionals (his example--a doctor) unable to devote much time to the process and young investors (his example--a sharp young executive interested in finance) who are as-yet unfamiliar and inexperienced with investing.

Graham felt that the defensive investor should confine his holdings to the shares of important companies with a long record of profitable operations and that are in strong financial condition. By "important," he meant one of substantial size and with a leading position in the industry, ranking among the first quarter or first third in size within its industry group.

Aggressive investors, Graham felt, could expand their universe substantially, but purchases should be attractively priced as established by intelligent analysis. He also suggested that aggressive investors avoid new issues.

Read also:
Are You an Intelligent Investor?
(Check out the table in this site for rules for defensive versus enterprising investors.)