This first post is to lay out my personal views about analysis and investing. There are many other approaches that can work well, too. In other words, I expect some of my readers to have other approaces that work better for them than my methods would.
Future posts will discuss specific investment ideas. I will probably not post the "best" stuff, or at least not until I have had a chance to put on my own positions, but once I have taken a position, I expect that I am better off letting others know my thoughts. They can tell me why I am wrong (which is good for me) or they can put on the same trade (also good for me).
My investing approach is based mainly on fundamental analysis, as distinct from technical analysis, because my experience is more in the fundamentals and because I believe that news from "fundamental" factors drives markets far more than technicals. Earlier in my career I was a sell-side analyst covering the paper and forest products industry and I managed a hedge fund. The fund (actually "separate accounts") was market-neutral, equities only, and narrowly constrained to include only stocks in the paper and forest products and relatred industries (e.g. metal and glass packaging, building materials, timberlands).
Fundamentals versus technicals. I think of a band of trackers in the wilderness of the Old West trying to catch a group horsethieves several days journey ahead. The "technicians" among the trackers look at broken branches, hoof marks in the dirt, recent campfires, and so on, to decide where to go next. The "fundamentalists" in the group think more about where their target might be trying to go. Obviously, both approaches are valuable. In the investing world most players can be categorized as either fundamentalists or technicians, but the most successful have learned how to combine both approaches. It puzzles me that the two groups seem to advocate one or the other approach strongly rather than thinking about how to use them both. The "conventional wisdom," with which I disagree, says to use fundamentals to decide if the stock should be on the long or short side of a portfolio, and to use technicals to decide when to buy or sell. Instead, I try to use the chart to help me better understand the fundamentals. For each past jump in volumes and change in price, I try to find what caused it by reading through news reports, 10Q filings, and so on. As for timing, I don't think TA really claims to be able to predict the direction of the next move. It just tells you how far up or down it might move, if it moves up or down.
Timeframe: A few days to a few months. Intra-day trading works for some, but I am not plugged in to a network of sources that would give me an edge, and I don't really know technical analysis well enough to think I have an edge there either. A time frame beyond a year is good for people who are managing large amouns of money and so cannot move nimbly, but at the moment I am just concerned with managing my small account.
Risk control. The conventional wisdom, and this I agree with, is to cut your losses quickly and early, and let your winners run. Because markets have some persistence, rather than being purely random, this discipline allows you to catch a few stocks that are undergoing long moves. An interesting claim I came across is that it is possible to make money with random entries, provided that a good exit discipline is followed. I like to think of investing as gambling, or a statistical process whereby one tries to make many "bets" where there is a slight statistical edge in your favor. Trying to hit a big home run is a bad idea because you risk getting thrown out of the game after three strikes. More specifically, I like the rule of limiting the maximum loss on any one "bet" to no more than 1% of your equity capital. as your equity rises or falls, this risk measure in dollar terms changes.
Screen-watching can be dangerously addictive. It is tempting to watch stocks tick by tick throughout the day, but I remind myself that my time is usually better spent studying the fundamentals. Decide where you would buy or sell, submit the orders, and go do something else.
Combine a top-down marco approach with a bottom-up company-company-by-company approach. The macro approach tells you what to look for at the company level. The company approach tells you what to look for in the macro picture.
One idea leads to another. If I study a specific company, it will lead me to competitors, suppliers, customers and others that can become ideas too. At the macro level, developments in one economic indicator lead to insights into other indicators.
Trace back to the source documents. One of the great things about the Internet is that now it is usually very easy to obtain the original documents and read them. Possibly the people who filtered the story from the originals missed something that you might interpret differently. Most people just read the news stories and often accept them as the whole truth. With investment situations, things are almost never as they appear on the surface. The stock price reflects the way things appear on the surface. I like to keep peeling back the layers of the onion until the picutre stabilizes to a simple thesis involving a few critical factors. I remember Peter Lynch's test of "can I explain it to my dog in 30 seconds?". In that same spirit, can I explain it on my blog in one paragraph?
Most of the views that one reads or hears are coming from someone who was paid to say it or is repeating someone else's view. True independent thinking is quite rare. I plan to post some tips on how to tell the difference later.
“Analysis by clues” is one of my favorite tools when listening to a company presentation or reading about a company. In poker, it is called a "tell". Body language, dress, facial tics, questions that are
evaded or avoided, and so on. An emotional reaction to a question. Typos in a document that should not
have any. An explanation that does not quite ring true.
“Torture the numbers until they confess” is one of my favorite expressions. Continue taking the
company financials apart and putting them back together until your model really works.
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