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Mike Arnold, Indievestments (266 clicks)
CFA, value, growth at reasonable price, event-driven
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In this column, I want to provide some observations on overall market sentiment as the indices continue to move higher. Last night, I watched Too Big To Fail for the first time, which highlighted the euphoria emanating the national psyche during the housing boom, and subsequent dysphoria and carnage experienced in the fall out and bust. It reminded me of the opening dialogue in one of my favorite movies all-time, Rounders. To quote:

Listen, here's the thing. If you can't spot the sucker in your first half hour at the table, then you are the sucker. Guys around here will tell you: you play for a living. It's like any other job. You don't gamble. You grind it out. Your goal is to win one big bet an hour, that's it. Get your money in when you have the best of it, and protect it when you don't. Don't give anything away.

Get your money in when you have the best of it, and protect it when you don't. That might be the most succinct, understandable and commonsense advice ever spoken, especially in terms of investing. Your friend makes $50,000 a year and just bought a $750,000 home? Sell your stocks. Then sell your house and rent.

Say it with me again, get your money in when you have the best of it, and protect it when you don't.

What does that mean when investing in common stocks? Really, it means a few things.

First, have a unique insight with respect to a subject business' operating model that isn't fully understood, commonly articulated or appreciated by others.

For example, Amazon (AMZN) looks appealing for that very reason. Just today, on Fast Money, the pundits argued that Amazon loses money on everything it sells. Patently absurd; gross margin on sales was 26.6% in Q1 2013. The operating "investments" (i.e., fulfillment center build out, etc.) are masking the net margin potential for Amazon in the short term, while Amazon continues to scale out its powerful platforms. Sales only grew 24% (currency adjusted) year-over-year in Q1 2013, when most other companies can only muster marginal top line growth in this economic environment.

Second, if you don't have a unique insight, avoid the investment.

Based on what I listen to or read about commodity plays like NovaCopper (NCQ) and certain gold miners like NovaGold (NG), it seems reasonable that those sorts of investments are undervalued. But I have absolutely no expertise in how to value a gold miner (i.e., an NPV analysis modeling extraction costs, future commodity prices, cash flow timing issues), let alone the true value of the commodity in which they mine and sell. So I take a clue and avoid.

Third, take advantage of irrationality of market participants.

Case in point: investors were so infatuated with Apple (AAPL) in the fall of 2012, that most everyone thought Apple was going to $1,000/share. It's hard not to get excited when 56 out of 57 professional analysts rated the stock a buy or strong buy at those price levels. But once investors lose sight of the mounting risk of an appreciating security price, overvaluation is almost certain to occur.

Interestingly, though, Amazon continues to trade higher, but common wisdom among analysts and investors is that it is wildly overvalued. What is absent in the Amazon stock quote is unbridled euphoria; rather, the stock is derided as the next 'big short.' If you would rather bet against common wisdom, the contrarian play is to go long Amazon.

Conversely, the stock market was giving away Terex (TEX) for $12/share in late 2011, equating to a market value of about $1.2 billion at the time, on fears of a global slowdown. The stock subsequently rose to $36/share in Q1 2013, based on exuberance of a global infrastructure recovery.

The problem is, by the time Terex reached $36/share, the risk/reward ratio shifted against investors. The rich valuation left the company with a smaller margin for error in executing its business plan (and meeting investors heightened expectations) in a difficult environment, especially in Western Europe where it has significant operations in certain of its businesses.

By listening to the Caterpillar (CAT) latest conference call, warning investors of a difficult business environment for capital goods makers, and being cognizant of the stagnating economic activity in Europe during 2012, Terex became a sell when it reached the $30's. That isn't to say I don't believe in the global infrastructure build out theme, I'm just waiting until investors get more pessimistic on the capital goods makers, and ascribe a lower price tag, before I consider owning Terex again. If Terex doesn't trade down to my limit order, so be it. I'll be protecting my capital when I don't have the best of it.

Conclusion:

The markets are governed by human behavior first, and fundamentals second. Investors should first be keenly aware of the overall market sentiment when considering investing in marketable securities (or houses), and second nail down an independent assessment of underlying value. Buy when the market is pessimistic and gives away the security at far below the intrinsic value assessment.

Don't be the sucker at the table. Only invest when the odds are stacked in your favor and don't give anything away.

Source: Invest Like A Rounder: Don't Give Anything Away