Parts Lessons

“Hello.”

“Wax, we gotta calling all cars, double naught spy, sure enough emergency.”

“We do?”

“Wax! Where have you been man! You betcha we do! It looks like we're all doomed.”

“We are?”

“Wax, you listen good, I mean real good, cause you gotta tell me what to do. You hear me Wax? You gotta tell me.”

"Turn left."

"What? Turn left? What the hell are you talking about Wax?"

"Actually that was going to be my question to you Ray Bob. Just what are you talking about?"

"Just that the Dow was down 533 points, the S&P was down 64 points, and the Nasdaq was down 147 points."

"Wow. Those are pretty big declines for one day."

"Not one day Wax, a week! Those are the declines for a week!"

"You know I thought all this time you were kidding me about not paying any attention to the news. But I believe you're serious Wax. You really don't pay attention to the news."

"Why should I Ray Bob. It's all happened before. Do you really think this is the first time the markets have had big declines? No, they've had them before and they'll have them again, so I don't see the need for a calling all cars emergency."

"Ray Bob?"

"What."

"I know it looks sorta scary, but we've talked about all of this before.

"Remember when me and you and Mary Alice sat on the pier over at the barge terminal awhile back and we sorta had this conversation? Remember I kinda went through the simple things I do to manage my investment risk and Mary Alice was just sorta hanging on your shoulder, her hair falling around the side of your face?"

"Remember Ray Bob?"

"The sun was just starting to set, and Mary Alice got up to get us an iced tea from the commissary and when she stood the sun came right through that thin little sun dress she had on and highlighted her good parts? Remember that Ray Bob."

[sigh]

"Wax, that's my girlfriend your talking about."

"No you big dummy, that's your future I'm talking about. And if you don't stop acting like some sorta maroon every time the stock market goes down, flopping around and flapping your gums like a lunatic, that future is gonna be a lonely one."

"Can you walk me back through all of that again Wax. I was probably paying more attention to Mary Alice that day than what you were saying."

"Gee...ya think?"
…

For many people, weeks like the markets had last week just serve to validate that the stock market is a big scary place, with lots of shouting and screaming, little scraps of paper, cable TV, satellite radio, and indoor plumbing!

And having been on the floor of the NYSE several years ago, I can tell you that while it isn’t scary, it certainly can be intimidating.

Over the years, I have developed an investment style that works well for me. While it certainly isn’t foolproof when it comes to investing, it does contain steps that, if followed, will serve to help mitigate my investment risk.

So once I have an equity, or equities, that I think I would like to add to my portfolio, I try and follow these simple investing steps.

Get a general understanding of how the company makes its money

I cannot tell you how many times I have listened to investors tell me about some stock they own and as I listen to the usually one-sided conversation, I find that they don't have the slightest idea what the company does! So at least take the time to know a little bit about what you are going to spend your hard earned money to own.

Make sure that there is no news about the company you weren’t aware of

There are many many places on the internet that allow you to search for company news. Do it. You may find some company that has great numbers, and you can't wait to grab a few shares, only to find out that the CEO was recently caught with his finger in the cookie jar, or that the company just lost some huge lawsuit. While knowing something like this may not change your opinion of the company, it may drive the price down lower. Your wallet will thank you.

Find out when the last stock split was

There used to be lots of times that I felt like jumping up and down and screaming at the top of my lungs thinking I had just discovered a stock that the market hated. Usually I had mentally spent the money I was going to make on the stock. Then I found out that everything was so lovely because the stock had recently split 3 for 1. Oh well.

Determine what you believe is a reasonable value for the stock

This is probably the simplest and the hardest thing there is to do. Any measure that you are comfortable with will work. If P/E is your measure then use P/E. If current price is your measure then use current price. If free cash flow value, leveraged buyout value, enterprise value, equity value, whatever, is your valuation measure, then great, use it.

If you need more information about valuation, try going here.

Divide your reasonable value number by two (2) to determine your buy target

This is the Ben Graham margin of safety. You have figured out what to you is a reasonable value for a stock. But as I mentioned earlier the markets can be a scary place. There are lots of pitfalls waiting for the average investor, not to mention that most of us simply don't have time to watch our investments all day.

Buying stocks at a discount to what you believe is a reasonable value, makes it easier to sleep at night. I mean if you could buy a house valued at $100,000 for half price, would you feel like you couldn't make the payments?

Multiply your reasonable value number by 1.05 to determine your first sell target

When you buy stocks using a margin of safety, you have all sorts of options. One of the options I like to use is the sell half option. The question is how do you know when it's time to do that?

For me, I multiply my reasonable value number by 1.05. When the stock price gets to that number, or somewhere in that vicinity, I sell half of the shares.

And what about the rest of the shares? At that point your cash basis in the stock has been significantly reduced, heck in some instances you may have already gotten your money back and a small profit!

While I don't always practice what I preach, often to my chagrin, at this point it may not be a bad idea to practice the technique that most of Wall Street, and of late many financial writers, have been saying you should not practice any more because it simply doesn't work.

It's a technique called buy and hold. If it's costing you little to nothing to hold shares in a stock, then why not hold the shares? Especially if there is a dividend associated with the them.

Determine what percentage of your portfolio you want the stock to occupy

Of all the things there are to understand about investing, portfolio management has to be the least understood of any of it.

Personally I think portfolio management is the least understood because it requires the most effort and the most discipline.

My approach is simple. Let's say the maximum number of stocks I want in my portfolio at any one time is 33. If each one of them occupies a 3% position, then 33 times 3 means I am 99% invested.

I use 33 because over the years I have learned that owning to few stocks, just like owning to many stocks, doesn't help me mitigate my risk. While 33 stocks is the optimal number, at times, I have held as many as 36 stocks.

At the moment I have 28 stocks in my brokerage account. There is no definite number, so don't feel as if you must have a certain number of stocks in the portfolio.

You also need to know that I have never been 99% invested. I may have gotten up as high as 75% several years ago, but I would say on average, I stay about 60-70% invested, meaning I have 60-70% of my portfolio invested in equities at any one time and 30-40% invested in cash.

Also as part of my risk mitigation/portfolio management strategy I won't take a 3% position when I add a stock to my portfolio. Instead I usually take a 1% or 1.5% position.

If the stock goes up, I follow my sell half strategy. If the stock goes down, I follow my buy more strategy until reaching the x% limit I have set for a particular stock.

One last thing is my cash, the funny looking green paper with dead presidents on it. Believe it or not cash is an investment. Perhaps having a majority of your nest egg in cash isn't as glamorous as owning shares of Google (Nasdaq: GOOG), but the idea behind portfolio management is to make the nest egg you have grow with as little risk as you are willing to take on.

Gambling on stocks like Google and other stocks du jour, may seem like you are growing your nest egg, but what about over the longer term? Think the Googles of the world are going to be around when you need your nest egg?

Find another stock

Life for most of us is not static, changes happen, usually all to frequently. Because the stock market is no different, you need to constantly be on the lookout for your next investment.

I'm not saying you have to pour over countless financial reports and all the rest. What I am saying is that you should set aside some time to look at your portfolio and think about what comes next.

Was there any significant news about a company whose stock you may own? How is the price? Do you need to add to or subtract from the shares of any of your holdings? Do you need to add a new stock to replace the shares of XYZ company?

In other words, just have look around. I mean it is your money.

Personally, not being a newspaper reader person, I do my portfolio review stuff on Sunday mornings. I go to a few websites and scan the articles. If I see a stock I think I might like to own, I add it to my watch list and move on. Eventually, I'll get around to understanding what some of the companies on my watch list do to make money, and also what I think a reasonable value for the stock of those companies might be.

Then when the price of this new stock gets to a low enough point, I'll take a position, starting my investing cycle over once again.

As to stock research, there are thousands and thousands of websites you can visit. Most are simply taking up space on the internet. However there are some great ones out there.

The Motley Fool for instance has an excellent website called CAPS, where regular folks pick stocks and provide a little information about why they like or dislike the stock and whether they think the stock price will move up or down. I use the site often when researching a stock.

At present the CAPS site is free, but a $26 a year Motley Fool membership is required.
…

"Thanx Wax. All the things you said, I know are things I need to do. But when stuff like this big drop in the markets happens, all I can see is the future slip'n away, and it gets sort a scary."

"Ray Bob, take it from somebody that has a helluva lot less future left than you do, and believe me when I tell you that the future isn't scary, it's just unknown. The thing that makes the future seem scary is that as we grow up we loose our sense of wonder."

"Tomorrow, you and Mary Alice spend some time in the park. Pay attention to the younger kids, from toddler age to say 6 or 7. Watch their expressions. It's the wonder of things new, the joy of not knowing that they shouldn't be doing something that makes them throw their heads back and laugh. The word "no" hasn't attached itself to their brains yet, so they haven't had a chance to forget all the things they knew, when they got here."

"It's simply the wonder of life Ray Bob. The good stuff, the real good stuff, and the bad stuff too. And all I'm suggesting to you is that you let it all happen. Once you've done that, I have a feeling big swings in the stock market won't seem scary at all."

"You're right Wax, I just let it all get to me, what the wedding being just a few weeks away and all."

"And I know your right about the wonder of things, Mary Alice tells me about stuff like that all the time. Like I said I just over reacted, [grinning] sorta like that evening down at the pier."

"Ray Bob, I told Earl a couple weeks back, that I may be old but I'm not dead. When I see a pretty girl, and that includes Mary Alice by the way, I'm gonna look, that's just the way it is. It's not wishful thinking on my part, it's just admiration of something my eyes find soothing, and Mary Alice is definitely soothing."

"You have no idea just how soothing those parts you noticed at the pier can be Wax. [sigh] Them are some really great parts."

"Ray Bob...a tip of the cap to you buddy, cause yep, they really are...great parts."

Wax