|
If you didn't have questions, the "Selection
Universe" itself, and the refined and filtered "Value
Stock Watchlist" would be just another stock picking
gadget, easy to slip into like a well worn pair of loafers. This is
not your ordinary list of hyped up "story" stocks. It is
the result of applying a time tested set of selection rules, concepts,
and experiences, to a pre-selected group of securities that are of a
known level of quality i. e., Investment Grade
only. Here's a fairly comprehensive
Question and Answer [more accurately, a
Question & Discussion] list that should
help you to use the Value Stock Buy List Program productively. Remember,
the program is designed to follow the investment process defined and explained
in "The Brainwashing of the American Investor". The
more times you read it, the better your performance will be. Steve
Selengut has been kind enough to answer some questions about his
methodology. Here are my questions (and some that he has fielded
directly). with his responses. (If
you have additional questions, please send them to: brainwashed@optonline.net.)
|
|
Within
the S & P Quality Rating, Additional Factors & Numbers:
|
The Specimen Stock
Worksheet included in the Brainwashing Book lists only two non-price
items: S & P Rating and Current Yield. Why aren't such fundamental
standards as P/E Ratio included there?
- The Selection Methodology presented in
"Brainwashing" is a management technique employed to
simplify, organize, and control the decision making process so that
a consistent approach to stock selection, and trading, evolves...
the KISS Principle. A basic assumption, and the rationale for using
the S & P letter rating system in the first place, is that their
thousands of analysts consider the important fundamentals in
determining the Quality rating.
- A key problem that most users of
investment letters, newspapers, chart selection techniques, and
computer models have in common is the inability to make decisions...
simply because they have much too much information and opinion in
front of them. The Selection Universe removes the "analysis
paralysis" and provides an efficient tool for identifying
buying opportunities.
- As you become more experienced as a user
of the Value Stock Buy List Program, you will find that the vast
majority of the stocks you purchase will fall within the "Lower
P/E" category. Generally speaking, stocks that make the Watch
List will have reasonable P/E ratios, but there can be exceptions.
- When making the final selection from the
"Watch List" candidates for purchase (and before you have
the experience referred to in the Brainwashing Book) it may be wise
to use P/E and/or other Stock Guide data (profitability, current
ratio, institutional holdings) to select your daily "Best
Buys".
|
When you refer to
"profitability", are you referring to more than the fact that
the company is paying a dividend?
- Yes, absolutely. I focus on the right
hand columns of the "Stock Guide" ( Earnings per Share) to make certain that
there are no recent negative numbers (a recent operating deficit). It's not uncommon for
companies to pay a dividend for a while after they begin
leaking oil. A dividend cut or omission won't be far behind. We want
both, profits and dividends.
- Always keep in mind that a bad
"quarter", in a generally profitable long term
picture, sets the stage for those good quarter to quarter
comparisons that Wall Street gets all excited about down the road.
Such "earnings surprises" always make the news, and often
cause a severe decline in market price.
|
I stay away from companies with a
"current ratio" [Current Assets vs. Current Liabilities] less than
1. Does that seem like a reasonable threshold to you?
- For the most part, but there are certain
industries where the current ratio can't be calculated [financial
companies]. Also, if there is a lot of inventory [retailers], I like
a higher ratio. If everything else looks good, see if there is a
simple explanation for a negative number. If not, find something
else.
|
Could you refresh my memory about the
significance of the Guide's Institutional Holdings columns?
- The more institutional interest there is
in a stock, the more likely it is that there will be the kind of
volatility we need for successful trading, and the amount of trading
volume we need for instant liquidity. Also, analysts follow the
larger holdings, creating more news and more volatility. These are
the guys who buy on good news and sell on bad.
- Although I've never tried to come up with
a "level" of institutional popularity that is the best,
I'd tend to avoid issues where there seems to be very little
interest.
|
There are Investment Grade Securities that generate very little trading
volume. Are they included in the Selection Universe?
- No, they are purposely excluded if they
average less than 5,000 shares per day, because the trading methodology
really does require liquidity in Common Stocks. Some newspapers
include only the x,xxx most active issues in their listings, and this
may be an inconvenience for travelers without Internet access.
- On the other hand, many investors will have
CEFs (Closed End Funds) in the Fixed Income portion of their portfolios, and these trade
in much smaller volumes. When selling, this needs to be taken into
consideration because, believe it or not, even small traders can
affect market prices. It's not unusual for me to trade positions a few
hundred shares at a time, based on the supply and demand numbers.
|
|
Dealing with S & P
Downgrades:
|
When a stock is downgraded S & P, how long
thereafter do you stay away from it?
- That's really a function of how low it
goes. I'll get out ASAP if it goes below "B+", taking even a
minor profit or loss as soon as I'm aware of the change. Then, if it's
a larger loss, I'll consider it a candidate for "ATH" loss
taking, but some judgment is certainly required. For example, when IBM
went to "B" status years ago and Dupont did the same more
recently, I held out for those small profits. With a less well known
or widely held issue, say good bye as quickly as possible.
- Downgrades between the "A" categories are not
as significant to me, dependent again on my familiarity and experience
with the company as a trading vehicle. I don't give up too
easily on issues that I've had good experience with, and even though
the overall trading objective can be somewhere between four and seven
months, you will always have situations that you wind up holding on to
for much longer periods. There won't be many, and it's perfectly
acceptable to take a smaller profit or even a small loss on a
seriously long holding.
- A downgrade to B+ should raise a cautionary
flag, but it's nothing to be too afraid of, unless your overall
portfolio seems to lean in the B+ direction. I've made a lot of money
over the years at this end of the Quality spectrum and such a
downgrade may just turn out to be an excellent buying opportunity.
Keep in mind that we are looking at the bigger and stronger companies
in the first place and that many of these become more attractive as
takeover candidates at lower prices.
|
How often have you found that the S & P
rating was totally wrong?
- Within the "Brainwashing" book
methodology, there are management controls (checks and balances) that
warn of problems at the companies we invest in. Specifically, a cut in
or elimination of the dividend, and an S & P downgrade of the
stock below investment grade. Rarely is there a situation where
serious trouble won't come to our attention in time through one of
these mechanisms.
- I can think of only three glaring instances
over the years where an Investment Grade Rating held up to the very
end: Ames, Enron, and Friedman's. But, and key to the overall methodology,
major individual portfolio disasters were avoided because of
individual security % of portfolio diversification rules that must
never be violated and which must always [absolutely always] be
calculated using The Working Capital Model.
- Also, in each instance, profits had been
made on the security more than once prior to the disaster.
|
|
The "Buy
More" Decision (Averaging Down):
|
Should the opportunity to add to an existing holding (25% to 30% below
original cost) be considered before adding a "new" opportunity
to the portfolio?
- Generally, I won't buy more of an existing
holding if I have an adequate supply of new opportunities to choose
from. Stocks that go down this much on news or because they are in a
weak sector (the drug companies, for example) don't seem to bounce
back as quickly as the newbies.
- I also won't consider buying more of a
stock that has been downgraded to "B" or lower. These
become candidates for the "ATH" decision.
|
|
Assuming that the "fundamentals" haven't
deteriorated, and that the current buy list isn't wonderful, is the
"30% down from cost basis" a hard number or a guideline?
-
I stick to the 30%
faithfully, although I do consider it a guideline rather than a strict
rule. As your experience grows you'll be able to judge better, but
there is nothing wrong with doing nothing. Buying should always be
done slowly.
|
|
What is the "ATH"
decision, and what is it used for?
-
Most of the investment world
worships the bottom line Market Value of portfolios, and such a focus
(without an understanding of too many things to mention here) causes a
book full of problems. Within the "Working Capital Model"
method of portfolio management, Market Value is compared with net
deposits to determine if and when a portfolio is at an "All Time
High" Profit Level.
-
When it is clear that an ATH
has been achieved, the portfolio should be looked at carefully to cull
the worst performer, at whatever the realized capital loss. Issues
that have fallen below investment grade must be eliminated eventually,
and this is the least painful time to do so.
-
Be careful not to get carried
away with this process. Examine weakness in fundamentals, not in
market price, and if you have a choice between more than one loser,
pick the one that loses the least capital... it will give you more to
work with than the others.
-
Major losers (although quite
rare) need to be dealt with or your Working Capital Totals will become
unrealistic. Again, when the portfolio value is at an ATH, in spite of
that holding, it is the right time to bite the bullet.
|
|
Speaking of CEFs (Closed End Funds):
|
Why can't the Value Stock Buy List Program be used with respect to
CEFs?
- The stock selection strategy of the
"Brainwashing" book tracks individual, Investment Grade,
Common Stocks. Although CEF common shares represent individual
Investment Companies, the investment purpose is significantly
different. The CEF shares are being purchased because they represent
the experience of a diversified portfolio of Fixed Income or Equity
Securities.
- Yes, you should still look to sell them and
move on to another if the 10% gain objective is reached, but there is
no need to look for a 20% decline in price for a purchase decision.
With a fixed income fund, focus on the yield, avoiding those that are
unusually high or low, and diversify with a maximum of 10% to 15% if
possible.
- Yes, I do use Equity CEFs, and not just in
very small managed portfolios, where they are the primary security.
When the "Buy List" shrinks to 10 or fewer issues, you can
"steal" some Capital Gains dividends while continuing to
participate in a broad rally with one or two of the best CEFs. With an
Equity Fund, diversify with a maximum of 15% to 20% in portfolios
under six figures, and normally above that level.
- I absolutely never touch an Index
CEF.
- For a more complete discussion, and links
to other websites (click
here).
|
What do you use to rate the quality of CEF's?
- Actually, I don't use a rating guide at
all. Remember that these are portfolios of securities of a
(presumably) less risky nature so an absolute rating of quality might
be a little hard to believe in. I look at the range of price movement
over a minimum of three to five years to assess risk based on the
current price, and try to avoid buying at extremely high historical
levels.
- The next issue is reasonableness of the
yield vs. the amount of leverage used. Avoid excessively high or low
leverage in the same way that you avoid excessively high or low
yields.
- The relationship to NAV is certainly
important to consider, but don't let it become the primary issue.
- The S & P Stock Guide is "still
the one". Most of the information you need is provided, toward
the back of the book.
- A significant issue, and this is something
you need to develop, is confidence and experience with these
securities both generally and specifically. It takes time and
patience.
- Remember, the ability to trade is a
secondary benefit of fixed income CEFs.
|
Do you have some volume number for CEFs below which you wouldn't
purchase one of them?
- No, not really. In Fixed Income CEFs, low
volume may be symbolic of the satisfaction of existing shareholders
with a steady, dependable cash flow, and not a real shortage of
shares. If the price is right, they'll trade. Think about the
underlying security... built to hold on to.
- Another reason for lower volume, at this
time of year (3rd or 4th Quarter), could be the habit of some CEFs to
pay their Capital Gains and/or "special" dividends after
January 1st. This is always something to consider, and information
that you can ask your broker to investigate.
- On the flip side, it's generally a good
time to buy CEFs after all of the irregular dividends have been sent
to shareholders,,, theoretically, the prices should be a bit lower. So
check the early year volume to get the big picture.
- Here's a rare tax note. When you own CEFs,
it's likely that some of the dividends you receive in January will be
"booked" as the prior year's income... check with your
accountant before you rush to get that 1040 on its way.
|
How does one determine how much leverage a CEF might be using to boost
it's yield?
- Go ETF Connect: http://www.etfconnect.com/education/fundamentals_etf.asp
- Click on "Fund Sponsors" and find
the drop down menu on the left side of the page. Scroll down to the
appropriate company name and select it. Then locate the symbol of the
fund you are researching.
- Finally, scroll down through the Fund
details until you locate the information on Preferred Shares and
"leverage %".
- Take a look at a dozen or so to get a feel
for the "normal" amount of leverage. Note that leverage only
sounds like a bad thing. It's an excellent business practice, and one
that is used in all fields... not just by investment companies.
|
|
The NASDAQ Exclusion
Issue:
|
In the book, you mention that there is no reason why this approach
wouldn't work with NASDAQ stocks. Do you ever trade the Investment Grade
Issues there?
- In the 25+ years that I've been fine tuning
this methodology, I just haven't had the need to go there, although
the specific stock selection rules would certainly apply. However, my
"Statistics That Matter" are based on the NYSE alone, and I
would avoid getting involved in securities that trade within a Market
that is generally known as a more aggressive and speculative medium.
- Also, the Brainwashing Book only reasons
that the approach should work with NASDAQ stocks. That possibility has
never been tested.
|
|
Science or Art:
|
What's become clear to me over the three years
I've been using this approach is that there are aspects of both art and
science inside. Do you agree?
- Absolutely, and that is totally a function
of the amount of experiences that is reflected in the overall
methodology. The science is a near-equal partner with the management
art that applies it to the day to day decision making, and all of this
takes place within a structured and well thought out portfolio
investment plan.
- However, it is not "rocket
science", and not even one fancy formula is necessary to do it
profitably!
- Interestingly, I think that there is more
Psychology than Mathematics and Finance involved, on both an
individual and on a group basis, but that's all covered in the book.
- In my experience I've found that engineers
and attorneys have the most difficulty with it while retailers and
generalists have the least. The three people who I personally know
have been using the approach since 1979 are a Restaurateur, a
Dentist/Orthodontist, and a Manager.
|
What do you think about taking smaller (say 5% to 7%) profits if you
can do so fairly quickly? I have had several that didn't make 10% and I've
watched them move back to about even.
- This question comes up often. 10% is a
target, not a hard and fast rule. Three sevens beats two tens in this
game as well.
- Experience will hone your profit taking judgment.
On an old position, any profit is just fine. Quick profits take the
best advantage of the "McDonald's Principle", and there is
always something else to buy. If not, the market will correct soon
anyway.
- Never hold on above the target 10%, but
there is no shame in 5%. Remember, you'll never get poor taking
profits.
|
|
Miscellany/Observations:
|
In the "Brainwashing" Book, the subject
of Insider Trading Activity is barely touched upon, if at all. Why?
- The KISS principle strikes again! There are
a lot of people following this information on a regular basis...
particularly the institutions. This type of activity finds its way
into price fluctuations and adds to volatility. I feel that it is just
another of the thousands of different pieces of information that you
could look at if you wanted to but really don't need to deal with at
all. It's in there!
- There's a statement about the word
"know" in the Brainwashing book. It doesn't exist in the
Investment World. So if insider trading figures make you feel like you
"know" something, you are probably wrong.
|
|
If All Else Fails, Please Read the
Instructions...again:
|
Do you have a one page summary of the rules for operating within your
methodology?
- Having the rules on one page, as you put
it, would be a big (but convenient) mistake. There are some rules and
many guidelines, I've found that many people take an
"engineering" approach to the methods I describe. That's not
necessary or recommended. These are decision making thoughts and
approaches to be implemented as things happen during the trading day
and for the overall long term goals of the portfolio.
- It's more important to understand the
concepts and the rationale for the guidelines than to commit the
guidelines to memory.
|
|
I’m really interested in
starting a portfolio based on the ideas outlined in "The Brainwashing
of the American Investor" and I’d like to know the risk-side of the
equation. What’s the average % draw down for a typical
portfolio?
-
I don't pay much
attention to Market Value "draw down", I expect it. The
larger it gets, the more opportunities either for "buy more"
or for new portfolio additions there will be. This is a basic
principle: you must learn to love corrections almost as much as you
love rallies...they're just not as much fun.
|
|
Expectations:
|
Historically speaking, how often would you expect
to be right?
- Just like any other decision-making
methodology (and that's really what we are talking about here), there
are going to be some mistakes. The better the decision-making, the
more successful the enterprise. I've been managing other people's
money this way since 1979, and the vast majority of clients have 60%
or more of their assets in Equities. I think that speaks to the
effectiveness of the methodology.
- My expectation is that I will make money on
more than 90% of the stocks I choose, that I will be able to take a
profit in an average time frame of well under six months, and that the
average net/net gain will be within a % or two of my 10 % target. This
is on an un-annualized basis and without considering dividends.
- I would guess that, for what ever reason,
most individual investors make money (meaning realized capital gains)
on less than 50% of their selections.
- This is the value of the Value Stock Buy
List Program. It provides a realistic and easy to use decision-making
framework that provides profit making opportunities in a relatively
safe environment... most of the time. Very valuable indeed.
|
|
Send your questions to Mark:
brainwashed@optonline.net
|
