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Charlie Anderson
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I am currently a student. I use a mix of technical and fundamental analysis to arrive at investing prospects and then do in-depth analysis.
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  • Technically-Timed Value Investing: A Pick From A New Strategy

    Technical analysis and value investing are two of investing's most powerful strategies, yet their fundamental beliefs contradict each other.

    John Murphy defines the basis of technical analysis in Technical Analysis of the Financial Markets:

    "There are three premises on which the technical approach is based:

    1. Market action discounts everything.

    2. Prices move in trends.

    3. History repeats itself."

    Value investing is defined by Morningstar.com in a description of Benjamin Graham's The Intelligent Investor:

    "Value investors seek to purchase assets at prices that are substantially below the assets' true, or intrinsic, value."

    I thought that here, at their definitions, I would find the basic conflict. Below I will identify the source of conflict and address it.

    The second tenet of technical analysis can be dismissed. Its truth is dependent upon an assessment of the Random Walk Hypothesis, which contradicts it. I will leave this question unresolved, because for everyday purposes, we can look at a price chart and see trends. Trends are an applicable tool of technical analysis, and do not conflict with value investing. This is because nothing about trends precludes prices from moving in certain ways. If anything, prices would trend towards their intrinsic values.

    The third tenet is almost universally agreed upon. Human nature has not changed drastically over the centuries. This sentiment is even more recognizable as phrased by philosopher George Santayana: "Those who cannot remember the past are condemned to repeat it." Again, this universal idea is not contradictory to value investing.

    The first tenet of technical analysis directly counters the definition of value investing. If the market discounts all information in its price, then value investing should be fruitless. The company's intrinsic value and its stock price should be identical. This, however, seems laughable in light of the success of Benjamin Graham and Warren Buffett. Thus we are left with a choice: value investing, or technical analysis?

    By a modification of the first tenet, the two philosophies can be logically reconciled, paving the way for a new approach that combines the best of both.

    If the market is made up of individual actors, then market action is the composite opinion of the investing community. When Murphy says that this action "discounts everything," we generally hold that he means the following: "market action reflects a rationally derived consensus about intrinsic value given all currently available information." The crux and the failure of this statement are in the word rationally. As evidenced by the rise of behavioral finance, market actors are not universally or consistently rational. If rationality prevailed, crises would only apply to governments and bubbles would only be found in bathtubs. The evidence that people are not rational is too voluminous to count. What, then, does market action discount?

    Market action discounts everything as perceived by market actors. By adding the second clause, the confusion surrounding technical analysis is largely addressed. Proponents say that technical analysis is nothing more than applied social psychology; a view recognized by the word perceived. Detractors attack the first claim of technical analysis: that the market is rational and efficient. Although the Efficient Market Hypothesis (EMH) has lost the luster it had at the University of Chicago in the 1990s, this modified first tenet no longer implies the EMH. Instead, it allows for inefficiencies due to wavering market perceptions. Thus technical analysis and value investing can work together both logically and practically. A combined strategy gets the best of both approaches by looking for stocks priced below their intrinsic values with technical evidence that the market's perception of their fundamentals is turning.

    Despite having its headquarters in Las Vegas, American Pacific Corporation (NASDAQ:APFC) is the opposite of glamorous. It has been manufacturing chemicals since 1955. In 2008, I unfortunately bought shares from another trader also standing on the edge of the precipice. Like everything else, it took a nosedive that fall. A year later I rediscovered it. In this post, I make a case for American Pacific based on the synthesis outlined above. The business was boring, but it produced solid free cash flow and the balance sheet was stable. Meanwhile, it traded at $4 per share, a support point that had been tested and had held about once every five years since 1988. The probability that it would hold a sixth time was very high, and the fundamentals did not present any reason that it would not. I bought in, and the thesis worked. I ended up selling far too soon, but that is the subject of another article.

    (click to enlarge)courtesy of FreeStockCharts.com

    Running a screen based on this article in Fortune Magazine, I found another company that currently fit this mold well. John Deere & Co (NYSE:DE) has all the signs of a successful long-term company: industry-beating margins and returns on equity and assets, sustained high revenue and earnings growth, and a solid balance sheet. Within the framework of these solid fundamentals, Deere is in the middle of a very bullish chart pattern.

    (click to enlarge)Courtesy of FreeStockCharts.com

    The share price has slid into a triangular holding pattern after a solid uptrend that brought the stock back to its all-time high. As is traditionally the case, this pattern is accompanied by declining volume as shown at the bottom of the graph. It indicates an outsized chance of an upside breakout.

    In the coming weeks I will publish a more detailed explanation of this strategy as well as more stocks that it recommends right now.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

    Additional disclosure: My portfolio is fully invested. This is the only reason I am not looking to buy shares of John Deere & Co.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Jun 10 8:09 AM | Link | Comment!
  • 2012 Performance Review

    The short answer is that, in 2012, my portfolio did not perform. While the S&P 500 was up 11.7% with dividends, the equity portion of my portfolio rose 1.8%. This increase was solely due to dividends, which contributed a 2.5% gain to overcome capital depreciation of 0.7%. Inflation stood at 1.7%, so I missed 2012. The market rose 10% in real terms, and my portfolio was flat. If the first goal is to prevent losses due to inflation, I have a silver lining. Since it's a thin lining, I will spend the rest of this review discussing why I failed to earn money in 2012 and my plan going into the latter half of 2013.

    I did not own companies that took part in the broad market rally of 2012. I have developed a strategy of buying mediocre large caps at extremely low prices. This strategy is questionable in comparison to the more popular practice of buying great companies at fair prices. To my mind, however, the relative quality-value mismatch is the same as long as one can ensure (1) solvency, (2) that a turnaround is likely, and (3) that it is worth waiting for a turnaround. In 2012, turnarounds did not materialize for France Telecom (FTE), Transocean (NYSE:RIG), or ArcellorMittal (NYSE:MT).

    I have developed a three-part strategy to pass the three tests listed above. To ensure solvency, I check for relatively positive free cash flow, manageable debt levels, credit ratings, and secondary financial health metrics. Number two is basically an assessment of the company's prospects. I have been using Morningstar's rating system as my primary means of assessment because as a student I have been too busy to conduct extensive research myself. While waiting for these potential recoveries, I have demanded hefty dividends as my fee for waiting. Thus all three of these companies were bought for having passed the tests of (1) financially soundness, (2) five stars on Morningstar, and (3) a high dividend yield.

    France Telecom was bought for the reasons listed above, and I have held it because they have not changed. I sold Transocean in 2012 because the dividend came into question due to financial stability concerns. This broke the first and third tests simultaneously. ArceloMittal had the added benefit of Jeremy Grantham's statistical proof that the century-long downtrend in iron ore prices has ended. Since my initial theses for France Telecom and ArcelorMittal still hold, I still own them.

    At a personal psychological level, I have found that I fail not at the point of analysis or execution, but patience. From NRG Energy to American Pacific to Priceline, I sell too early. Since this type of value investing requires years to pan out, I will continue to wait. In the meantime, I plan to publish analyses of these three companies this summer.

    In 2013, my returns will probably be even worse than in 2012 as these companies continue to underperform the market significantly.

    Disclosure: I am long MT, FTE.

    Additional disclosure: I also own shares of NOV as of this spring.

    Jun 07 12:48 PM | Link | Comment!
  • 2011 Performance Review
    My performance this year was awful. The only bright spot was total trading, which was way down. In all other areas I underperformed and lost out. My portfolio lost nearly a quarter of its value this year, even as the market stayed flat. This was mainly because I tried to time the market and failed. My average losses reflected this fact in that my average loss on positions held for two weeks or less was 16% greater than the average loss on positions held for less than one month. Nearly all of the positions I closed this year lost money. This represents a fundamental flaw in my approach: I have been too aggressive and I have not taken the time to learn about my companies. Going forward, this is an issue that I must address.The only bright spot (I guess) was the amount of trading I did. I executed 35 trades in 2011, down from over 100 in 2010. My average holding period also increased from 26 to 57 days, although this fails to acknowledge positions I still hold (which would increase the value for 2011). A large percentage of my poor performance was contributed by the third quarter, when I tried to time the market numerous times, only to fail.

    Going forward, I plan to protect myself from myself by letting my portfolio rest. I have increased my bond exposure by 10%, moving into a high yield fund. I like my holdings, and I need to be more patient.
    Jan 08 4:46 PM | Link | 1 Comment
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