The first lesson learned, in four of the five stocks that we wrote about in our article "Our Worst Performing Picks," is that we didn’t adhere to our own rules. One rule is to side-step stocks that have had recent cuts or no annual increase in the dividend. At the time, we didn’t wait to confirm if Masco (MAS) would increase its dividend in April 2008. Also, we didn’t wait to see what would happen after the dividend cut by Nucor (NUE) in March 2008. The concept of confirmation is incredibly important in Dow Theory, and by ignoring this principle we cornered ourselves with bad recommendations.
What we should have done is wait one full year after the cut, or lack of an increase, to determine the viability of the company. Keep in mind that a cut in the dividend isn’t a death sentence. In fact, cutting a dividend might be the best management move to make. However, current shareholders of the company might abandon the stock if they have a policy to hold stocks with a steady dividend (as we advise investors to do). We jumped the gun on Masco and Nucor when all the economic tealeaves were saying things weren’t looking good. I mean, how could we ignore the fact that a home building supplier and a steel maker were going to have some troubles with a declining housing market?
The next rule that we violated was not issuing a sell on Illinois Tool Works (ITW) and American National Insurance (ANAT) after substantial gains in a short period of time. Illinois Tool Works rose 9% in one month, while American National Insurance rose 15% in less than one month. It is not that we want to be traders; however, if the market gives you in one month what is considered to be the historical annual average gain over the last 100, 50, 25, and 10 years then we should thank our lucky stars and move on. In the 15 recommendations that were made in 2008, 10 were successful and exceeded the historical long-term market averages. We had nothing to prove yet we managed to allow these opportunities to get away from us.
On the matter of Mine Safety Appliance (MSA) there are no explanations that it didn’t succeed. To think that we’d be 100% on the mark every time would be fooling ourselves. Mine Safety Appliance was simply a bad recommendation on our part; that is, unless you bought the stock at substantially lower levels.
There are several points that must be made about our investment strategy. First, we’re trying to take responsibility for the recommendations that we make. We don’t want to make a recommendation and leave it hanging out there in the open without accountability. Too often we see Strong Buy, Buy, Accumulate, Strong Conviction, Hold and Market Perform recommendations without the clarity that is needed for investors. Adding to the lack of clarity is the issue of the absence of sell recommendations. Our Investment and Speculation Observations are meant to alert an investor to start their own research. Our Sell recommendations are meant to alert investors that exceptional gains have been made, compared to the historical average, and that selling wouldn’t be the worst strategy. Although we issue sell recommendations, investors can clearly chose what they wish to do if they actually bought a stock that we issued an observation on.
We also want to demonstrate that what we’re doing is a matter of discipline that can be applied by anyone. We’d like to believe that what we’re doing is more than just randomness and luck. We’ll probably be proven wrong soon enough. However, until that time comes we’ll continue to gladly show our mistakes that happen to be exceptions that prove our rules.
When we make a recommendation, our goal is to buy the stock at a lower point than the recommended date. We assume that an investor or trader has to do some due diligence before deciding to invest in our recommendations. This means that if the stock ran up then don’t buy but if the stock fell since the recommendations and the fundamental attributes are intact despite the relatively low price then an acquisition of the stock might be in order.
Finally, we use the investment/speculative observation date and price as the worse case scenario for our recommendations. We hold ourselves to this as an objective measure of whether we’re making the right calls or not. If we’re right then great however, if we’re wrong then we modify the method. Since codifying our approach, we’ve had very little need to make changes. Make no mistake, we’re ready and willing to change if necessary. So far we’re able to say that luck has been on our side for quite a while.
Disclosure: No Positions