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I’m a private investor who manages my own four portfolios, and a half dozen more for family members. My focus is long term, but I also trade some short-term opportunities. I'm fortunate to have worked for a NYSE-traded financial firm for the decade up to 2010, but I'm not an adviser and my... More
  • My Approach To Stock Investing, Part 3 6 comments
    Sep 25, 2013 6:07 PM | about stocks: AET, BX, HCI, MWA, MEG, MGA, RJF, TRN, WMB, XRM

    My Instablog posts expand on my overarching investment approach so that everyone who reads my opinions on specific stocks also has access to the general strategy behind each call. So, even though they're not usually repeated in each individual article, the strategies and tactics discussed herein apply to all of my stock calls.

    I hope that my writings are a helpful resource to complement the due diligence of other investors, but my writings are never intended to replace the due diligence that each investor should do.

    Here are parts 1 and 2 of these ramblings.

    1. "Talking Your Book"

    "Those who stand for nothing fall for anything."

    Alex Hamilton

    The "talking your book" and "no skin in the game" criticisms are really the two sides of the same coin and both are fairly common claims so I'll explain and clearly state my position on both. If a person owns the stock they're evaluating, they're often accused of "talking their book", as though that were inherently the same as "pumping." However, the fact is that pumping is actually precisely the opposite -- talking up a stock that one doesn't really believe in as an attempt to unjustly inflate the price and make a profit before dumping it (aka, the "pump & dump").

    The truth is that everyone in the stock market "talks their book", as they should, since it only makes sense to talk about the stocks one knows the most about. In fact, people who say they don't talk their book are usually the ones being disingenuous. The exceptions are people who know intimately know more stocks than most people and are, therefore, actually able to intelligently talk about stocks they don't own. That almost exclusively means analysts, fund managers, etc. So, book talk is only a problem when someone is foolish enough to act on it exclusively, without knowing the book performance and without doing their own homework. In other words, complaining that others "talk their book" is a blame projection tactic of the lazy investor who once burned himself by buying a stock he heard someone talk about without doing any due diligence. If it turns out that book talk was about a bad book, it's the lazy investor's fault for blindly following a bad book, not anyone else's.

    Many people are understandably hesitant to bring up even the best stock-picking performance because it's often interpreted as bragging. However, if I ask someone about their portfolio performance track record and they have no good answer, it's my own fault if I choose to follow their lead, not theirs. Personally, I regularly update my portfolio performance on SA and, if anyone ever wants to know my returns from a specific stock, all they have to do is ask. Just know that I will only ever discuss percentages, since I like to think I'm smart enough not to real dollar amounts of my personal finances on the interweb.

    So, I absolutely do talk my book, since the stocks I won are the ones I spend countless hours researching and know enough about to have an (arguably) worthwhile opinion. The fact is that works the same for most everyone does when they comment on any stock, unless they research stocks for a living. However, that's not inherently for any dubious reason, as some people who don't really understand investing would have others think. I actually like to see other people make money so, when I have good ideas, I try to share them with anyone and everyone who will listen. In fact, I regret missing so many opportunities in recent years to share with the SA community the many picks I've had that turned into 3 or 4 baggers (AET, BX, HCI, MWA, MEG, MGA, RJF, TRN, WMB, XRM, etc.). For reasons I now realize were silly, I waited way too long to become an SA contributor and, in the meantime, often shared my best ideas in StockTalks or comments; only for someone else to pick up the often under-the-radar idea and run with it, a few times even by posting an article restating my exact thesis, down to the wording.

    Anyway, the bottom line is that it is natural to talk our book, since the stocks we own are the only ones we know well enough to talk about. For me, it's challenging to keep up with the many stocks that I own and I'm not comfortable potentially influencing other people's opinions if I may not know enough about a stock, so I talk about stocks that I don't own infrequently. However, it does happen and it probably happens more with me than most retail investors simply because, over a period of decades, there are so many stocks that I currently own, have owned or have done copious research on for some other reason. I believe it's the first of this series of Instablogs where I discussed the fact that I actually have three separate portfolios (though I now only actively manage one of them) and manage at least a half dozen more at all times. Thus, I'm pretty well informed a more individual stocks than the average person.

    2. "No Skin In The Game"

    "I have drawn the line, and I am still on this side of it."

    ― Caroline Kettlewell

    Talking about stocks that we don't currently own is where the other side of the "talking your book" coin comes into play, which is the "no skin in the game" criticism. Some people who don't really understand the world of investing often claim that anyone who doesn't currently own a stock doesn't have any "skin in the game" and, therefore, can't evaluate the stock. These people apparently don't understand that most research analysts are actually precluded from owning any stock they cover.

    I've known many professional analysts personally and the fact is that they're most always exceptionally smart and dedicated with a higher level of integrity than most people. It just so happens that they're also human so they are indeed wrong sometimes, just like the rest of us. So, the issue is absolutely not that they don't really have the conviction in their calls that they claim, or intentionally mislead investors as part of some diabolical plan because they don't appear to have any "skin in the game". In fact, the reality is that analysts actually have more skin in the game than investors since, if they do cross the legal lines that the uninformed constantly accuse them of crossing, they lose their job and entire livelihood forever, not just the relatively small portion of their money they have in one stock, which is all that's at stake for an investor.

    Furthermore, no one can afford to, nor would it even make any sense to, buy every stock that we research. At about 25, the number of stocks in my actively-managed portfolio is now half what it was just a few years ago, but it's still more than most retail investors. That's not to mention the stocks I own in other portfolios. So, there are very many stocks that I've researched for many years and that my opinions on have proven to be correct, but that I don't own for any combination of many reasons (sector, industry or market cap redundancy, etc.).

    Most of my comments are about stocks I currently own, but I've often done copious research on stocks I don't yet or no longer own. So, yes, I am indeed still qualified to discuss those stocks and I occasionally do, regardless of whether I might appear to have "skin in the game". To be frank, I'm not writing for the type of investor who thinks in terms of "skin in the game" so I actually prefer that those folks not read antying I write. The bottom line is that it's every individual's responsibility to decide how much weight they put on the opinions of others. If I write about a stock an my opinion turns out to be wrong, first of all, that has nothing to do with whether or not I won the stock. Second, anyone who buys any stock based on the opinion of any one other person needs to hire a financial adviser and hang up thier self-directed investor hat because they are not qualified to wear it.

    3. Stop-Loss Orders

    "Failure is not our only punishment for laziness; there is also the success of others."

    ― Jules Renard

    The point of including that quote is not at all to suggest that everyone who uses stop-loss orders is lazy. I absolutely do know better. The point is that, when we sell out a position at a fire-sale price because a market maker sees our stop price and decides to execute it (right before pushing the stock higher); not only do we lose, but the other side of the trade wins at our expense and without doing a thing to earn the win. They were simply handed a forfeit win as a result of our lack of awareness. Considering the immense amount of work I put into my investments, that's among the most unacceptable ways to lose money in the market.

    So, I haven't used automatic stop-loss orders in many years and don't recommend them for anyone other than short-term traders. In this era of HFT (high-frequency trading) and computer-driven exchanges, the chances are too high for a "flash crash" or technical glitch to sell out an entire portfolio at ridiculously low prices that no investor could ever fully recover from. Some will argue that the solution is to use a trailing stop instead of a true maximum loss level. However, trailing stops are just as bad since they just get constantly picked off by market makers, leaving unaware investors trading in and out of positions every other week, or every other day, for no good reason.

    Risk management is the most important aspect of investing, but when a risk management method costs more than it saves, it's time for a new method. So, if an investor isn't willing to monitor a portfolio and make thoughtful decisions about holdings, it's really best to just invest through an adviser. The reason I only said "willing" and didn't include "able" in that last sentence is because the many tools available today make it virtually impossible for anyone who is willing, to somehow be unable to manually execute trade orders quickly and easily.

    To expand on one alternative, I'll just use the actual example of how I manage my own portfolios. For every investment holding, I have price alert notifications set up through my brokers and multiple backup sources like Google Finance, etc. Price alerts from each of about a half dozen separate sources are sent directly to my phone, email and desktop trading platform. In other words, if any holding takes a sudden turn south, I'll have texts, emails, phone calls and carrier pigeons coming at me from every direction within seconds. Ok, you caught me ... "carrier pigeons" was a bit of hyperbole.

    As you might've noticed, I already factored in the various excuses people often come up with like "what if my phone battery dies" or "what if an email from my broker doesn't get through my spam filter". I've also heard more extreme counter arguments, but I've concluded that, if there were ever a day when all cell service, the entire interweb and all wired phone lines all went offline at the same time and the market happened to crash at the same time; it's a pretty safe bet that all stock exchanges would either go offline too, or they would intentionally halt trading. That's not to mention the fact that, if all of that actually happened, it would be the result of a major catastrophe, so we'd all have much bigger problems than our stock prices to worrry about since we'd likely be out foraging berries for dinner in Mad Max land.

    Anyway, whether via a phone app, tablet, desktop or phone call; there are always many ways to execute trade orders quickly and easily. If I ever get notified that a stock, or entire portfolio, has dropped to my threshold; I can literally go all cash out of many dozens of positions within about 10 minutes (if there were ever such an extreme situation where I felt that made sense). Sure, I might take very minor losses in that time, but if I'm not both willing and able to lose tiny portions of the money I use to buy stocks, I shouldn't use that money to buy stocks.

    Plus, when the stock market makes an extreme drop in one day; it's typically short-lived and is usually a time to buy, not sell, which is what's at the core of the reason stop-loss orders can be so dangerous. The market drops that are of greater concern are the ones during events like the "great recession"; wherein the descent actually occurs over a period of days, weeks or more, which allows plenty of time to cash out with minimal losses. Therefore, in my view, stop-loss orders are no more than a means to make it easier and faster to make the worst possible investment decisions, as well as make them automatic and irreversible.

    There is obviously more to risk management, but on this particular aspect, I consider the bottom line to be -- if I don't have the time to be a self-directed investor with a complete asset-protection plan in place, I should not be a self-directed investor.

    I've referenced many stocks throughout this series of Instablogs in order to help me make my points more clearly by using actual examples. I own or have owned all of them and plan to write articles about most of them.

    Thanks for reading and please leave comments on the above topics since that's part of the reason I've posted this -- in case those smarter than me are generous enough to explain why I might be thinking about any of these topics in a less than ideal way.

    Here are parts 1 and 2 of these ramblings.

    Disclosure: The author is long AET, BX, HCI, MWA, MEG, MGA, RJF, TRN, WMB, XRM.

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Comments (6)
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  • Esekla
    , contributor
    Comments (2295) | Send Message
    You asked for opinions on this, so see here for mine:

    5 Dec 2013, 06:48 PM Reply Like
  • DAG1996
    , contributor
    Comments (3066) | Send Message
    Author’s reply » @Esekla, Thanks for commenting. I see that you wrote an article on a stock that you have a short position in, but the comment you linked to doesn't really convey your opinions on the "talking one's book" and "skin in the game" criticisms I've discussed.
    5 Dec 2013, 07:22 PM Reply Like
  • Esekla
    , contributor
    Comments (2295) | Send Message
    Huh? I just clicked on it and the comment addresses exactly that, although it doesn't use those terms. To cut to the chase, it basically says that although having skin in the game definitely implies bias, I don't see any correlation between bias and quality of analysis. It goes on to give reasons for the lack of correlation.


    Let me know if what you're seeing differs. Maybe something wrong with the comments system? That wouldn't exactly be a first.
    5 Dec 2013, 07:30 PM Reply Like
  • DAG1996
    , contributor
    Comments (3066) | Send Message
    Author’s reply » I guess that's where the confusion comes in ... I haven't read all 40 of the comments on your article for context so it was unclear what you meant ... the "no skin in the game" claim refers to when someone comments on a stock they don't own ... you seem to be talking about the opposite ... since your piece is in support of a position you hold, that would be "talking you book".


    In any case, perhaps it's just semantics, but I think we've come to the same conclusion, but via different routes ... I do consider there a correlation between bias and quality of analysis ... I just don't consider bias to be inherently embedded in ownership. In other words, I see no correlation between having a position and quality of analysis. For example, analysis done the day after buying a stock isn't somehow more biased than analysis from the day before. Perhaps it works differently for the Carl Icahn's of the world who can actually move stocks with their opinions ... I wouldn't know.
    5 Dec 2013, 08:55 PM Reply Like
  • remediios
    , contributor
    Comment (1) | Send Message
    Thank you so much for continuing to post on SA.


    These three particular instrablogs about your approach gives me a lot of insight on investing. I'm truly inspired. I'm a college graduate and I am looking to learn more from you! I don't have much experience but I do believe in value investing. Thank you again!
    20 Feb, 03:31 PM Reply Like
  • DAG1996
    , contributor
    Comments (3066) | Send Message
    Author’s reply » @remediios, Thank you very much for the nice compliment. I actually wrote these Instablogs for relatively new investors and, specifically, the various college-age people in my life. No one attempted to teach me any of this stuff when I was young so it's surprising to me how few of them take the initiative to learn like you are. I hope to write more of these kinds of posts, though it is very hard to find the time.


    Please do note that these first three Instablogs are directed at people who have already addressed an important first question and concluded that self-directed investing in individual stocks is indeed right for them. That is: "Have I already maxed out my contributions to the tax-benefit investment vehicles that are available to me such as a 401(k) or an IRA and have enough left to invest elsewhere?"


    Thanks again for reading and for the nice comment.
    20 Feb, 04:07 PM Reply Like
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