James:
I understand your desire to try and buy companies below book
value because I tried to do the same thing about a year ago, but
I have since found that there are things much more important
than book value. Buffett points out that book value can evaporate
very quickly. He gives an example of the textile equipment that
berkshire sold for pennies on the dollar, and this was fairly
new equipment at the time he liquidated. Peter Lynch also
warns of the dangers of relying only on book value because
during liquidations, the equipment and other products is usually
sold for pennies on the dollar. If you buy a poor company
because of the low price to book ratio, you have very little
downside protection. As an example of this, last September I
bought 2000 shares of BEST at $0.19 a share. Their last annual
report showed a book value of over $7.00. When they liquidated,
there was *nothing* left for the shareholders. So much for
book value. I didn't lose very much money but it taught me
an important lesson.
If you really want to do short term trading I would recommend
a different strategy than relying only on book value. This
strategy involves buying solid companies that have just been
downgraded by the analysts because they didn't meet earnings
expectations. The downgrade usually causes many institutional
investors to dump the stock causing a sharp dip in prices.
If you picked a solid company as defined by other value parameters
such as ROE, low debt, and good margins, the dip will usually
be temporary. A good place to find these kind of stocks is
when they hit the most active screens at www.nasdaq.com. If
there is a similar place for NYSE stocks I would appreciate
if someone would show me where they are. The spotlight section
of SI is also a good place to look for tech stocks.
Before I give an example of how I apply this technique. I just
want to make a quick defense of the buy-and-hold-the-good-stocks-
for-the-long-term strategy. Graham, in The Intelligent Investor,
warns us against trying to trade in the short term. The biggest
problem is that it puts the value investor in the wrong mindset,
and an investor's biggest asset this that they have the proper
perspective on what "Mr. Market" is currently saying. When a
value investor succums to the irrational nature of the short
term market, then he gives up his biggest advantage, which is that
of having a rational basis for valuing a stock. Short term
stock trading is the best way to be lured into this irrational
mode of thinking. Furthermore, Graham, warns that if an investor feels the need to trade for the short term, that they should use
a separate account from the account that they use for their
long term trading. I like Buffet's technique of having a group
of stocks they he plans to keep forever, and another group of
stocks that he buys because he thinks that they are are great
deal. These stocks are usually sold when they become fully
valued.
Another writer that I would recommend, if you really want to do
short term trading, would be Peter Lynch. This is kind of a
tounge-in-cheek suggestion because Mr. Lynch also warns his
readers against selling their stocks too soon. Mr. Lynch
offers great suggestions for finding value and growth stocks.
Since, I also have this urge to do some short term trading
I'll now give you an example of how I do it. Keep in mind that
I only do short term trading in my IRA so that I don't have
a taxable event for every trade, and that I do absolutely
no short term trading in my non-IRA account. Also, in my IRA
account, I have a few stocks that I plan to keep for a long
time. Last Friday I was watching the big movers on Nasdaq
and I noticed two stocks, IDXX & ESST, that had some big drops
because of earnings disappointments. I did some fast research
on these stocks and noticed that they had little or no debt,
good margins, and a good ROE. In less than 10 minutes after first
noticing the big drop I took positions in each of the companies.
Today I closed out both of those positions at a little over
5% profit. Not bad for less than a weeks holding. I closed
out the positions because ADBE had an earnings disappointment
today and I wanted to buy into their 10% drop.
In summary, I would rather be a long term holder of
stocks but because I also have a desire to do some short term
trading. To do my short term trading, I have allocated a
portion of my IRA for the purpose of short term trading.
If I make a mistake, I can afford to hold on to the stock
for longer periods of time than a regular short term trader.
Profitible Investing,
Oliver |
