I submitted my first article on Seeking Alpha almost exactly a year ago. I honestly enjoy not only articulating why I am buying a stock, but believe that spelling out exactly the investment thesis makes me a better investor. I am not allowed to cut corners and skip out on important due diligence steps required to invest successfully either. If I do, then not only will the stock likely lose me money, but I'll have dozens of smart readers pointing out my mistakes.
For me too, accountability is important. I have too many friends that actually invest alongside me (or so I believe), not to feel responsible for the performance of my recommendations. While I no longer manage a portfolio for institutional accounts, I still feel that sense of duty to be transparent and honest with myself.
What I found in reviewing the list of names and the performance, is that while choosing good stocks obviously makes a difference in investing and generating alpha, almost as important is following a stop loss rule. While every investment deserves a fair shake, one also has to be cognizant of the fact that we make mistakes in investing. Limiting the damage from those mistakes is almost as important as picking good names.
Below, I will illustrate my winners, losers, and the returns generated off of my recommended names.
To summarize: since last August I have written 40 some odd articles. 21 of them came with a real buy or sell recommendation. In every single case below, I purchased the stock either shortly before or after making the recommendation.
The results are as follows and in order of the recommended date. (That is, my most recent article was on FTI Consulting (FCN) at the bottom):
I patterned this after Barron's, by assuming an investment in the S&P500 (SPY actually) as a benchmark on the same date the stock was recommended.
Overall the Alpha generated by this portfolio was 4.5%. Not bad for 12 months and total returns of almost 15% are quite close to the returns of my own equity portfolio.
It was also a lot higher than the MSCI EAFE world stock market index, which is up approximately 6.7% including dividends since August 19, 2011. Given that there are 5 international equities on this list, it may make more sense to compare this group to the EFA. Doing so would imply 8% of alpha.
Generally there were 16 winners (up more than 5%), 3 losers (down more than 5%), and 2 flat names. The flat names were written about quite recently too, so probably too early to tell. (For the record Liberty Media's (LINTA) tracking stock split on Friday August 10, so the stock price reflects the combined new LVNTA stock plus LINTA).
What I also wanted to illustrate was the power of a stop loss rule. Here, in the far right column, I illustrate a stop loss on 2 of the names that fell more than 15% (and about where I sold them):
This shows how important a stop loss strategy is. A 10-15% stop loss ratio improved the performance of the portfolio by 260 basis points from 14.7% to 17.3%. That would yield over 7% of alpha compared to the market, or returns almost 70% higher than the market.
That is a tremendous difference given that it is over one year time period, and only necessary on two stocks out of 21. Imagine what that would do over a decade or two. I do follow these rules religiously, and the math tells you that you should do the same. By the way, I also recommend selling Aurizon Mines (AZK), a name that just hasn't lived up to expectations for a variety of reasons. As of now it's down around 15%.
My trading strategy is to purchase a new name in 2 or 3 separate trades over a month or two. Once a full position is established, then if the stock is down 10-15%, sell it. A name that falls more than 15% indicates something is particularly wrong in my analysis, whether at the micro or at the macro level. Selling is good way to clear your head and rethink the position too.
Psychologists say that the human mind is risk averse, hating to realize losses so that people tend to hold on to losses for too long, waiting to get back to their cost basis. Perhaps human ego simply refuses to admit to making an error. We do live in a world where 75% of the people believe they are in the top 25% of intelligence. I am happier being rich and dumb than poor and smart.
Investors also tend to sell their winners too soon. So, while it may sound cliché, the phrase "Keep your winners and sell your losers" is right on target. At one point, I actually sold my Apple (AAPL) after a big run, at around $530. Fortunately I bought it back at $550, but it's a great example of being over-eager to realize a gain. Now I owe taxes on those gains too!
By the way, if I have a name that runs up 30-40% for example, I tend to sell 30%-40% of my shares, or perhaps more. Sprint (S) is a great example of this. With the recent run up in the stock, I sold 1/3 of my shares. I still have a position that is bigger than my original sized position, so likely will sell a few more.
A stock like Sprint is a lot riskier now that it has moved higher, and position rebalancing keeps the risk down. Furthermore, if Sprint falls 15% from here, I will not ride it back down to my original cost basis. I tend to follow the stop loss rule, from the highest price attained by that name.
Keep in mind, these are just my suggestions. Take them with a grain of salt. For me, these rules allow me to override my instincts, which usually are emotionally biased based on entry point and ego, and often not logically sound.
It's vitally important to revisit your stocks that lose money. I re-read my Hewlett Packard (HPQ) piece to see what went wrong, and on the surface it seems that the thesis is still intact. In fact there were some fairly prescient calls there. I surmised that new guidance would be $4.00 per share for 2012, which turned out pretty much on target (4.05 - 4.10). I also felt that the company would decide not to spin off the PC division and get out of the acquisition business. That also turned out to be the case.
However, being right and making money are different things. I bought too early, didn't foresee the market share gains that tablets would make, underestimated the severity of corporate customer defections and the time involved in turning around such a big company. Net net, I lost money. Is the business model broken? No, but it's still under duress.
Interestingly, it was an article that generated quite a few ho-hum comments regarding the stock. Here is a good example:
the price and your arguments make a compelling idea to purchase...but as a consumer, HP products have been junk for years, their customer service is horrid...I don't have faith in the company to pull it's head out of it's a**. Like it's said above, in this tech industry, things move fast. Look how quickly dell fell out of the spot light.
I think at 5x forward earnings, there isn't a whole lot of downside at Hewlett Packard anymore, so I might re-establish this position. But I will look very carefully before buying this one back. And while one or two negative comments on an idea are typical, it should be noted when there are lots of well reasoned bearish arguments.
In the case of the other loser stock, YPF, I also got stopped out with approximately 15% losses. Rumors of an impending nationalization of YPF were well publicized before the stock tanked, and seeing such a fundamental change in the story made this one an easier call. I didn't feel like waiting around to find out how much the government was going to steal from me.
But even not seeing the news, following a stop loss would have prevented the total meltdown in the name, which had a hugely negative impact on the portfolio.
I was surprised by how big a difference a good stop loss rule can make, particularly if the fundamentals change on one of your stocks. I also like rebalancing, that is selling a portion of winners after a 25% rally, or simply selling the name if it gets to your target price. For the record, I did sell Family Dollar (FDO), probably too early, but I am not complaining about a gain either. Happy investing.
Additional disclosure: I am long almost all of the names listed.