New Sunday Times Feature - Diary of a Private Investor

[cremeegg]

Lots of important questions there.

I would like to respond to one point.

Do you, for example sell/reduce if the PE ratio hits a level well beyond the long term norm for the sector and the specific stock? Conversely, do you buy back/add when the PE falls below that norm, always given that the news-flow does not indicate any reason for the change in price.

As a stock picker, who has chosen to step away from the fundamental "buy the market' rule, you do not have a set rule for when to sell either.

You should know why you bought the share originally, because some positive attribute was not reflected in the price, if you still believe this to be true, hold, otherwise sell. Knowing why you bought should answer the when to sell question.

 

[Colm Fagan]

Do you, for example sell/reduce if the PE ratio hits a level well beyond the long term norm for the sector and the specific stock?

To quote Harold Macmillan, "events, dear boy, events" are what cause me to sell/reduce my exposure to a specific stock (or possibly increase my exposure). If something happens that changes the picture from what I thought, I will obviously review my decision. Of course, by the time I learn of a new event, the price will already have moved, so the decision is whether the price change is a reasonable reflection of the changed circumstances. I definitely do NOT set price limits - up or down - for selling.
A specific example is an announcement yesterday morning by a company in which I hold some shares. The announcement caused the price to fall 15%. It was bad news OK, but I think the market over-reacted, so I'm now thinking of increasing my holding.

 

[redartbmud]

cremeegg

I do take your point, but I also hold the opinion that the market regularly mis-prices a share, over a short time frame.
If I am watching the price patterns in my individual investments, maybe I can recognize these events.
Whilst accepting that I prefer to buy and hold a share forever, or until the story changes fundamentally, should I take
advantage of a temporary dip in the share price, with a view to selling those shares when the price corrects?

Say I make a 3-5% 'profit' on the trade, and keep that difference in shares, I am achieving the following objectives:
1. Adding 'free' shares to my holding.
2. Reducing the average cost per share, using the running cost for valuation purposes.
3. Increasing my dividend yield.

It may only be marginal, on one trade, but say that I trade that share 20 times, over 3 years, the cumulative effect will begin
to become significant.

I am also making capital work. It is unlikely that I will ever be fully invested in the market.
By deploying a proportion of the available cash, on say a one month basis, to make 3%, I believe that I
have made a satisfactory return, by recycling my cash around the market.

 

[joe sod]

There has been a very lively debate, in the last several days. The Woodford and ethics investing debate has been very lively indeed.

It has been very well discussed now the mistakes that Neil Woodford made, he has now become a "fallen angel". It is very easy now because of his big fall recently to retrospectively look back at everything he did and his successful strategies over many years and through 2 stock market crashes and completely discount them. Investing in tobacco stocks was a successful strategy , ethics should not come into it as tobacco is a legally traded commodity like alcohol like airline tickets like petroleum. It is not my responsability to chaperone grown adults into what they should or should not put into their bodies

 

[cremeegg]

as tobacco is a legally traded commodity like alcohol like airline tickets like petroleum. It is not my responsability to chaperone grown adults into what they should or should not put into their bodies

I agree, society has legislated that tobacco, alcohol, gambling etc are legal, why should put ourselves above that judgement.

Look at it the other way round, would we say that even though society has banned x activity, I see no harm in it and so I will do business with that, my opinion is better than the law. Most of us would stay from any activity that was illegal even if we did not disapprove.

ethics should not come into it

I would not go that far, there are certain legal activities that I personally would not like to deal in, (tobacco and arms) but an "ethical investment approach" is too goody two shoes for my liking.

 

[cremeegg]

I also hold the opinion that the market regularly mis-prices a share, over a short time frame.

Undoubtedly it does.

However to profit from that you must recognise that in a timely manner, with sufficient profit to cover the transaction costs.

Thats difficult. And undoubtedly you will be wrong at least occasionally, and that may cost more than the profit on several correct calls.

I always think stock picking is like playing chess. Anyone can learn to how to play chess, anyone can understand everything Gary Kasparov did, can follow his games, can see his thinking. There is loads of commentary out there to explain it all. I can even recognise his mistakes on occasion.

Substitute the market for Gary Kasparov and stock picking for chess. None of that means I can beat Gary in a chess match.

 

[EmmDee]

Lots of important questions there.

I would like to respond to one point.



As a stock picker, who has chosen to step away from the fundamental "buy the market' rule, you do not have a set rule for when to sell either.

You should know why you bought the share originally, because some positive attribute was not reflected in the price, if you still believe this to be true, hold, otherwise sell. Knowing why you bought should answer the when to sell question.

If I recall (Colm please correct me if I'm wrong), one of the criteria around the strategy is the expected return including dividends. So a view on the stability (or growth potential of them) is an important factor.

In that case, given a long term framework, the variances in price become less significant as your return is fixed when you buy. A stock gaining significantly in value doesn't change you % return. A price drop allows you increase your return if there is evidence that dividends will continue as before.

Judging whether the stock price is fully "priced in" is (as mentioned) a tough one to get right. I don't think that should be the primary criteria

 

[Colm Fagan]

one of the criteria around the strategy is the expected return including dividends

Yes. For me, it's all about the expected future return, including dividends, starting from the current price.

price become less significant as your return is fixed when you buy.

I don't think I agree. The return is never fixed. The future is always uncertain, so our expectations for what the future holds are constantly changing.

A stock gaining significantly in value doesn't change you % return. A price drop allows you increase your return if there is evidence that dividends will continue as before.

If a stock's price rises, but my expectations for future earnings and dividends are unchanged, it becomes less attractive, so I'm more inclined to sell. Conversely, if the price falls and my expectations are unchanged, I'm more likely to increase my holding, so I agree with the second part, but not the first part.

 

[cremeegg]

If a stock's price rises, but my expectations for future earnings and dividends are unchanged, it becomes less attractive, so I'm more inclined to sell.

Surely this depends on your original reason for buying. If you originally saw some advantage to the stock which the market had undervalued, is this still the case. The increase in price may fully reflect your original insight or may just mean that the marker is beginning to see things your way. Once the market begins to develop a new understanding, it usually acts on that for some time.

Conversely, if the price falls and my expectations are unchanged, I'm more likely to increase my holding, so I agree with the second part, but not the first part.

If the price falls you have a greater dilemma. You have to ask yourself, do I still think my original understanding was correct even though the market has moved the other way. Only if you are still confident would you buy more. If sentiment is running against you, be careful. Remember Keynes.

 

[redartbmud]

cremeegg

You are quite correct about the possibility of a price fall, after I have purchased a 'trading' holding.
My purchases are made, after a fall in the share price, and there have not been any news flows eg, company announcements, broker updates etc.
The value of shares purchased is relatively small, compared to the value of the core holding.
If I do get my timing wrong, and the share price falls further, I am happy to hold those shares, until the price rises again, and I can sell at a profit.
It may well be that I pick up a dividend along the way.
Even with the increased number of shares, my average running cost should be well below the current market price, so I am relaxed.
My expectation is for the share price to return to a more normal level, and it is a share that forms a key holding in my portfolio.
Should the story fundamentally change, and I dispose of the entire holding, I would expect to sell, at an overall profit, but I would then take a loss on the last purchase within that number.

 

[Colm Fagan]

Hi @cremeegg
We're not too far apart, but I think there's a fundamental difference in how we view the market, which is encapsulated in your final comment. I presume you're referring to Keynes' observation that the market can stay irrational for longer than you can stay solvent. Keynes was a great man for leverage in his stock market dealings, so prolonged market irrationality was a major concern to him. I do have some leverage, but I think it's at manageable levels. Otherwise, I don't give a hoot about market irrationality, provided the fundamentals are OK. As I said in an earlier posting, my ideal holding period is forever. In that context market irrationality - even for a prolonged period - isn't a concern. I am decumulating (I'm not sure if that's an acceptable word, but everyone knows what it means) so irrationality should matter to the extent that I'm obliged to sell stocks to meet my income needs. I have found, however, that dividends deliver the bulk of my decumulation requirements, thus reducing the need to sell.

 

[EmmDee]

I don't think I agree. The return is never fixed. The future is always uncertain, so our expectations for what the future holds are constantly changing.

I should have been more clear - assuming dividend levels remain the same, your annual % return remains fixed irrespective of stock movements.

If a stock's price rises, but my expectations for future earnings and dividends are unchanged, it becomes less attractive, so I'm more inclined to sell. Conversely, if the price falls and my expectations are unchanged, I'm more likely to increase my holding, so I agree with the second part, but not the first part.

If you're expectations for future income streams remain the same as when you purchased, and if you had invested as a long term play, why would a price increase make it less attractive. You would continue with the same income stream on your original purchase cost.

If you have a "price target" or a capital gain target I can understand. I guess it comes back to the question of defining the objective when making the initial investment and acting when that objective is met

 

[Colm Fagan]

Hi @EmmDee

If you're expectations for future income streams remain the same as when you purchased, and if you had invested as a long term play, why would a price increase make it less attractive. You would continue with the same income stream on your original purchase cost.

You seem to think current market value is irrelevant. It fundamentally changes the equation. Suppose I bought at 80, for a dividend of 4 a year. My running yield was 5%. If the price has now risen to 100, and the dividend is unchanged, my running yield has fallen to 4%. If I can find something that now yields a safe 5%, I'll sell the one that's NOW giving me only 4% and buy the other one.

 

[joe sod]

Otherwise, I don't give a hoot about market irrationality, provided the fundamentals are OK. As I said in an earlier posting, my ideal holding period is forever. In that context market irrationality - even for a prolonged period - isn't a concern.

the problem is how do you know you are correct in your assessment that the market is irrational, the market could be correct and you (im not referring to you personally but any investor) could be wrong. For examply Neil woodford assessed that the market was overly negative on ftse stocks so he bought more (maybe he was correct and was not given enough time or he was just wrong). If Neil woodford can be wrong on market irrationality what hope is there for joe bloggs in assessing whether the market is irrational.

 

[Colm Fagan]

the market could be correct and you (im not referring to you personally but any investor) could be wrong.

Then I'm just plain wrong. Irrationality doesn't come into it. I've often been wrong in my assessments of stocks. I've admitted it many times in my column. Having the humility to accept your mistakes is essential for long-term survival. Neil Woodford was hubristic and couldn't believe he could get things wrong. That led to his downfall.

 

[EmmDee]

Hi @EmmDee


You seem to think current market value is irrelevant. It fundamentally changes the equation. Suppose I bought at 80, for a dividend of 4 a year. My running yield was 5%. If the price has now risen to 100, and the dividend is unchanged, my running yield has fallen to 4%. If I can find something that now yields a safe 5%, I'll sell the one that's NOW giving me only 4% and buy the other one.

Hi.

I don't think it is irrelevant but it doesn't change your yield run rate - that is baked in at the start (assuming no change in dividend). To use your example, if you buy at 80 for a yield of 4 (5%). If the price goes to 100, you are still getting 5% because it is still €4 on your original capital outlay of €80. Any new investment will get 4% as you say - so it might affect whether you increase your investment or it might alter the equation for somebody else looking to copy your approach

So if you were considering switching investment - you would need to find something that beats 5% not 4%.

 

[cremeegg]

Hi.

I don't think it is irrelevant but it doesn't change your yield run rate - that is baked in at the start (assuming no change in dividend). To use your example, if you buy at 80 for a yield of 4 (5%). If the price goes to 100, you are still getting 5% because it is still €4 on your original capital outlay of €80. Any new investment will get 4% as you say - so it might affect whether you increase your investment or it might alter the equation for somebody else looking to copy your approach

So if you were considering switching investment - you would need to find something that beats 5% not 4%.

That seems wrong to me. Just arithmetically.

If you bought Stock A at 80 for a 5% yield and now the price had moved to 100 (so now yielding 4% on the market price), you could sell Stock A and buy any Stock B with a yield of say 4.5% (or any number greater than 4%) and be better off that you were.

 

[Colm Fagan]

Hi @EmmDee
@cremeegg is obviously right. History is bunk. At this stage the price I paid originally is irrelevant.

 

[EmmDee]

That seems wrong to me. Just arithmetically.

If you bought Stock A at 80 for a 5% yield and now the price had moved to 100 (so now yielding 4% on the market price), you could sell Stock A and buy any Stock B with a yield of say 4.5% (or any number greater than 4%) and be better off that you were.

The yield change is only relevant for those who buy at the revised price. If you buy something for €80 which pays €4 per annum you are receiving 5% yield. If that asset changes price to €100, you are still receiving €4 on your initial €80 - you are still receiving 5% yield. If I buy the asset at €100, I only get 4% but that doesn't change your return until you change your holding.

If you then look around for a better % return, you need to beat 5%. In absolute terms you are thinking you need to beat €4 but in fact that's because you are converting capital gain (the 80 to 100) - you sell the asset and have a larger capital base. But to get the same % yield you need to beat €5 not €4. Which may be a valid choice if looking at absolute € income rather than % yield.

 

[EmmDee]

Hi @EmmDee
@cremeegg is obviously right. History is bunk. At this stage the price I paid originally is irrelevant.

Hi - just saw this.

I obviously don't think it is irrelevant. But there may be other factors to be taken into consideration