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My Approach To Stock Investing, Part 1

|Includes: Aetna, Inc. (AET), BX, CVX, CWCO, KR, MEG, MWA, RJF, 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 2 and 3 of these ramblings.

1. Due Diligence

"Know what you own, and know why you own it."

Peter Lynch

I typically follow and research a stock for 6-12 months before committing any capital to it (or commenting on it). My due diligence always starts with financial metrics such as PEG ratio, P/E ratio, etc.; but I tend to be most interested in forward-looking metrics and trends much more than past performance. Once I conclude that the financials are acceptable, my resulting research and thesis tends to focus on the company. An analogy to clarify that point could be, if companies were cars, I would consider the performance specifications important, but I would also consider the information that one can glean from an inspection equally important.

Similarly, my experience has consistently been that my best investments most often turn out to be ones where I have particular respect for the guy (or gal) who designed or built the car. A few examples that come to mind are Steve Schwarzman of Blackstone (NYSE:BX), David Dillon of Kroger (NYSE:KR) and Tom James of Raymond James (NYSE:RJF). The latter two have retired from the CEO role and become Chairmen, so the only remaining CEO of those mentioned is Mr. Schwarzman.

In any case, my point is that, as a long-term investor, I tend to focus on companies more so than just stocks. The various financial metrics for each company are readily available on the main Seeking Alpha page for each company, as well as from very many other sources around the interweb, so repeating those metrics isn't really my focus.

2. Rearview Mirror Analysis

"Never look back unless you are planning to go that way."

― Henry David Thoreau

If the cliché of history repeating itself were meant literally, I'd have a pet dinosaur. It's certainly important to understand how a company got to where it is today, so I do spend considerable time learning about each company's provenance. But, when it comes to analyzing company and stock performance, I believe the value of rearview-mirror analysis is limited. Companies, markets and economies change too much and too fast for history to have excessive relevance to future stock prices.

For example, some of my best investments have been turnaround stories that had a hideous chart some years ago, but turned into four or five baggers (BX, CWCO, MWA, MEG, XRM, etc.). So, I do typically look at trailing and historical metrics, but I put far more emphasis on forward-looking metrics. Trailing numbers may be more concrete since they are already reported, but they simply don't tell us much about the future. Similarly, I don't believe in placing excessive focus on a stock's price at any time other than the day(s) that I buy it and the day(s) that I sell it. In my view, obsessing over every daily downtick or basing an investment decision on a stock price from two years ago (or even two months ago) is being a record keeper, not an investor.

On a related note, I very rarely buy stock in any company that has gone public within a year or three. To each his own, but my belief is that the purpose of an IPO is not to make money for retail investors -- it's to make money for the company and the bankers, all of whom are privy to far more and better information than any individual investor. So, my approach to newly public companies is usually to wait for the inevitable price drop anywhere from one day to one year after the IPO, then buy.

3. Portfolio Size

"Bite off more than you can chew and then chew like hell."

Peter Brock

I'm not at all recommending that approach for others, but I must admit, that is indeed what I do. I have holdings in literally dozens of individual stocks, across three separate portfolios. In fact, others often tease that I'm my own mutual fund (for the young'ins, that's an old-school thingy kinda like an ETF). I mention that for a couple different reasons. First, while I don't at all recommend so many stocks for most investors, I disagree with the idea that individual investors must limit their holdings to 5 or 10 stocks. In my view, portfolio size should be a function of the amount of time each unique investor is able and willing to dedicate.

The second reason I mention the expanse of my real-world holdings is to disclose that there are many holdings that aren't included in the actively-managed portfolio I track and refer to on SA. That is by no means an attempt to exaggerate portfolio performance, and is actually just the opposite, since the whole reason the "dormant" portfolios aren't actively managed is that they don't require it. That's because they're remnants from my old "buy & forget" days and haven't been touched in at least ten years. For example, AET and CVX are among the largest and most representative holdings in those other portfolios. As is evident from the differences between the prices of those stocks fifteen to twenty years ago and today, adding such holdings into a current portfolio would greatly distort performance and complicate tracking.

4. Time Horizon

"I'm extraordinarily patient provided I get my own way in the end."

― Margaret Thatcher

I'm primarily a long-term investor in the traditional sense of the term so, to me, "long-term" doesn't mean months or quarters. As such, most stocks I buy and write about are ones that I intend to hold for years -- usually at least 3-5 years, but often 10 years and beyond. However, I believe that successful investors must be able and willing to change their opinions or strategies when the facts or circumstances change. So, I do occasionally decide to sell out of a stock that I previously intended to hold long term, though that happens very rarely anymore. When that does happen, I always update the opinions I've shared. I also trade short-term opportunities so, when I comment on stocks that I intend to hold for only a relatively short time, I make that crystal clear up front.

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 2 and 3 of these ramblings.

Disclosure: The author is long AET, BX, CVX, CWCO, KR, MWA, RJF.