Investing in Individual Stocks

[Donnie]

In light of the recent blog post, I thought it would be interesting to move the debate to the forum. One of the things that frustrated me about the blog post is that there was nothing to react to. Just saying I made money in the market is not something that anyone can debate. Results matter of course, but being too results oriented can blind you to luck or other factors that impacted the results. What can be debated is the logic and thought process behind the decision so that we can all continue to make good decisions with our hard earned money!

In the post and in the comments, no one has really described how they choose to buy or sell a stock. Some comments said, I have nothing to prove, or it's too complicated, or I don't want to give away my secret sauce. That's fine, but I would be interested to hear generally how people look at investing in individual stocks from those who do it / have been successful. Technical analysis? Fundamental analysis? Stock tips from insiders? How have you guys done it and why will it continue to be successful?

As Harry Markowitz said, diversification is the only free lunch. Prove him wrong and maybe you'll get his Nobel Prize!

[Donnie]

I should mention that I have individual stocks in my portfolio as well. I bought Apple, Amazon, Google, Qualcomm, 3D Systems back in 2010 under a vague thesis about investing in technology. After doing it, I realized that proper evaluation of these businesses required much more time and effort than I was willing to give it.

Obviously Amazon, Google, and Apple have done well, and I still hold them beause of the cap gains. I sold Qualcomm and 3D systems at losses and invested the proceeds into diversified funds. Tax loss harvesting is another free lunch!

[ITEngineer]

Donnie wrote:

Tax loss harvesting is another free lunch!

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TLH is definitely not a free lunch. It's a very expensive lunch. Lose up to $3000/year to lower your AGI and even if you are in the 40% Federal tax bracket you are still down $1800. You could have had an $1800 lunch or 18 $100-lunches and saved $1200 and your net worth would have been the same   Seriously - I TLH but I don't like to. Why does it seem that people like to around here? Am I miss-interpreting?

Lets talk Apple. Back in July 2016 it was trading below $95/share. Using Benjamin Graham intrinsic value Formula you have the following. BTW - This formula is well documented all over the internet.

IV = EPS x (8.5 + 2g)

IV = Intrinsic Value
EPS = Earnings Per Share
8.5 = Fair PE for No Growth Company
G = Conservatively estimated growth in EPS for the next 7 to 10 years

Plugging those numbers in and using an ultra conservative 2% earnings growth for Apple I got a share price of $128/share. Buying Apple at $95 (so far) has proven a good purchase.

Whether I'm good at this or not, ask me again in 30 years. But you asked for the process.

[jfoxcpacfp]

Donnie wrote:

Tax loss harvesting is another free lunch!

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In what way?

[ajm184]

That is way too broad a brush Crixus.  Let's take Walmart, #1 in Revenues, yet has an AA+ LT rating and though its debt position is several billion dollars, not exactly an issue when you generate 1+ billion/day in revenue.  Private equity in publicly held companies makes a difference only if you have a large stake (10%+) and have intent to make change/take private.  Bad idea with Walmart as the Walton family effectively owns 50% of the equity.

On the flip side, look at Koch Industries, certainly one of the top 5 privately held companies in terms of revenue in the US.  The parent is well rated at AA+, but if you look at some of its major subsidiary's, Georgia Pacific for example, there ratings are much lower.  The conclusion being, even private companies can act like private equity when it comes to balance sheet management.

As for Donnie's question; answered better in a prior post but here is mine.

a. Have a view that differs from the market.  Making an eps of $1.10 vs $1 is not a view.  Rather, 'the market (i.e. equity analyst's) is viewing Caterpillar's market position incorrectly; I believe that Cat in EMEA will grow alot faster as miner consolidation occurs in Africa's, placing upward demand on larger equipment, that in turn carries higher margins.'

b.  P/E's-  The lower the positive TTM PE the better.   Depending upon company usually like to be within a percentage of a 3 or 5 year TTM low PE.

c.  Dividends- Allows me to lower my dollar cost average if I'm waiting for a number of years.

d. Don't panic, be patient.  Throw D out the window if the company you've invested in is subject to an SEC investigation for 'Accounting Irregularities' (happened to me once, least I sold within a half hour (because I was in front of a bloomberg terminal, yea me!) of the filing and only lost like $2/share and it went pre-pack BK).

e. Know your exit point on the plus side (I've ignored this one too).

f. Throw in the towel price.  The question here is; is the price going down for a fundamental reason, or is everyone getting crushed.  Difficult to differentiate at times.

g. Re-examine A at least quarterly with earning results.

h. stay away from anything with tax payer subsidies (solar power).  Eventually, the government will take away the punch bowl.

i. don't borrow, don't leverage, watch like a hawk if shorting (wish I could have don't this once, would have made like $10/share), don't put all your eggs in one basket.

[ajm184]

Rex wrote:

I gamble a small amount. That’s what I’m doing with a small % of my portfolio. I invest in individual stocks and there is no clear strategy. I buy based on really a feeling similar to when I ask for a card in blackjack. To claim it is anything other than gambling would be BS. I do it for fun. For instance I’ve purchased biohaven after IPO for around 17. That’s done well so far. I also purchased Twitter a few months before the election thinking Trumps use of it would help it. That hasn’t worked out well. I also have some BRK in taxable as a gamble and so I don’t have to think about dividends and taxation. I ride AMD and Apple occasionally. Apple I’ve done well guessing on timing but AMD hasn’t lost me money but gains less than total market returns.

What you find is that individual stock pickers will pretend they have done due diligence and know what’s gonna no to happen and if it doesn’t happen then they have a convenient excuse why that takes the blame.

I’m just going to tell you I gamble a little bc I like to do it.

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Rex- You need to learn to play Blackjack :P .  Used to play $1/hand BJ at the Sahara and $20 would allow me to stay at the table as long as I wanted.  Perhaps another vote for WCI next shinding in Vegas.  Defined outcomes in blackjack versus stock market.

[Donnie]

JFox, it should be an especially free lunch for you given your certainty that the market is going straight up! If the market temporarily declines, you can exchange future capital gains taxes (15-20%) for current income tax deductions (30-40%) up to $3k per year. Free lunch.

[jfoxcpacfp]

Donnie wrote:

JFox, it should be an especially free lunch for you given your certainty that the market is going straight up! If the market temporarily declines, you can exchange future capital gains taxes (15-20%) for current income tax deductions (30-40%) up to $3k per year. Free lunch.

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For some reason, using exaggeration to make a point makes me suspicious. Also broad brush strokes - they kind of make a mess of the artist's canvas. Don't you think that kind of generalization is a bit of a lazy way to answer? If only it were that easy to create and follow a long-term plan, there would be little need for my kind of art.

[Donnie]

jfoxcpacfp wrote:

Donnie wrote:

JFox, it should be an especially free lunch for you given your certainty that the market is going straight up! If the market temporarily declines, you can exchange future capital gains taxes (15-20%) for current income tax deductions (30-40%) up to $3k per year. Free lunch.

Click to expand…

For some reason, using exaggeration to make a point makes me suspicious. Also broad brush strokes – they kind of make a mess of the artist’s canvas. Don’t you think that kind of generalization is a bit of a lazy way to answer? If only it were that easy to create and follow a long-term plan, there would be little need for my kind of art.

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I was just joking!  If you buy a stock at $10k, it goes down to $7k and you sell, it has a $3k loss.  At 30% tax rate, you save $900 in taxes this year.  Assuming you buy back at $7k and it increases back to $10k and you sell at that point, you need to pay $450 in taxes in cap gains.

If you hadn't TLH you wouldn't have to pay cap gains tax, but by doing so, you saved a net of $450 in taxes.  That is a difference of 15% of the $3k you lost.  15% is the difference between cap gains and ordinary income taxes.  If these tax rates are the same, there is no free lunch other than an interest free loan related to getting a current tax deduction that you would subsequently need to pay back to the IRS later in the form of a cap gains tax.

[jfoxcpacfp]

Donnie wrote:

I was just joking!

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Not the first time I have not gotten a joke  Typing makes it difficult.

Unfortunately, I don't believe that TLH is usually a healthy approach to portfolio management. It prioritizes income tax savings over optimal portfolio construction and maintenance, which I call putting the tax tail ahead of the growth horse. Understand it's popular, but just not the way I work.

[Donnie]

I agree that jokes are hard when typing.  I try to put in an "!" to give it away as a joke.

You can combine TLH with portfolio rebalancing.  Generally I think it is worth it to take advantage of tax rate arbitrage by shifting ordinary income to cap gains, but in reality it's not a huge number for a HNW individual.  I just enjoy taking advantage of anything I can to lower my tax bill out of principle!

[StarTrekDoc]

Totally agree - proper planning and strategies would hopefully never see the day for TLH opportunities -- especially for those in a set and forget style investing.

TLH plays a role in those that have a little more active participation in their portfolio and those with their speculation accounts.

 

As to OPs question - Our speculation account is an investment based more on human behavior than any real metrics -- that gut feeling.   That got us some real gems, but also laid some eggs too.  Our most recent egg is stagnant Disney.  It's ahead, but severely underperforming the rest of market over the year.  We thought it had gotten ahead of its ESPN troubles with their movie and parks divisions hitting records---oh well.

OTOH, local fav ILMN has done nicely for us over the same year and we cashed out earlier just in time ahead of its dip.

[Dicast]

When I dabbled in individual stocks I started out swing trading which was too much stress and minimal gain as a poor college student. Then I tried to stick with rapid growth companies that carried minimal debt. The strategy worked for a couple years. Walgreens was about the only one I can recall and I dont think it made up for my later, more risky "gut feelings". I held my losses until I hit the top tax bracket and havent gone back to individual stocks.

I plan to invest in some stocks (10k per year) after we've ended loan repayment. Investing as a hobby is often met with the "get a different hobby" reply but there are many ways to spend lots of money without any guarantee of return. Boats, cars, country club memberships, houses... i was thinking of using my birthday or Christmas as the yearly date of funding to limit the risk of throwing extra money in at random. Of course we may decide to take a 10k yearly vacation instead but if we can accumulate 20k net worth a month anyway I dont see the harm of using 10k once a year.

[Hatton]

I invested in individual stocks for years.  I always also invested in mutual funds and muni bonds to diversify and dampen the risk.  You have to like to read specifically about individual stocks and be familiar with PE, EPS, ROE, etc.  You need some understanding of charts and trend lines.  You have to sell off mistakes quickly and let winners ride (for years).  It can be fun if you have picked winners.  You have to buy with blood in the streets.  The only individual stock I currently own is Apple because the gain is 300k because I bought it in 2008. Let a winner run and I hate taxes.  Now I index because I am 60 years old.

[StarTrekDoc]

Apple, AMZN, and V were my big winners from the same time frame -- hit the eject button on them this spring to 'safer' Total market environments.  Back in 2007, none of these were safe bets by any means and were firmly in our speculation fund.

Like Dicast, we allocate our speculation to 10k buys x1-3 a year and ride with them for awhile.  It's our equivalent of gambling and determines whether we get a nice car; nicer vacation or staycation in awful san diego.