Thursday, May 24, 2007

Chapter 1

In chapter 1, Graham makes the distinction clear between an investor and a speculator/trader. An investment operation is one which, upon thorough analysis promises safety of principal and an adequate return. Anything which does not have these 3 elements are speculation.

I realised that Graham keeps talking about the margin of safety principle, with regards to investments.

I believe that it's very important to distinguish whether you are speculating/trading a stock or if you're investing in one. Neither have anything to do with the time period of holding the stock. This is in stark contrast to what many have thought - if you're holding long term, you're investing; short term - you're speculating.

Investing requires a analysis of the business in an attempt to find out the value of the business. Graham keeps emphasizing that the price of the stock goes in tandem with the prospects of the business. The sounder the business, the higher the price. But if you're bought a stock that had good fundamentals but had a high price, the 'promise of safety of principal' is compromised. Therein lies the important lesson in value investing - buy a stock for what it is worth in the future, not at the present moment.

That also means that if I bought a stock that had broken new high, regardless of whether it's fundamentally sound or not, I'm speculating that the stock will, because of the maniac levels of buying, push the stock higher. That's not investment, that's speculation.

I believe that knowing whether you're entering a stock based on speculation or investment makes it easier to exit. Why?

If it's for speculation, I would exit when

1. there is no follow through buying after a breakout (loss)
2. Bad market sentiment (loss)
3. Below my cut loss level, usually defined by 8% loss, or below support level (loss)
4. when price target is reached or going to be reached (gain)

If it's investment (meaning that I buy in at a fraction of its intrinsic value to guarantee safety of principal, usually in a downturn), I would exit when

1. The full value of the stock is realised (that is also the moment when momentum buying starts). You sell when you can, not when you have to. (gain)
2. There's a change in business fundamentals that affected the value of the stock (possibly losses)

Did I miss out anything?

It's disastrous when you mixed up speculating and investing. It's worst when you thought you are investing, when you are in fact speculating (like me). As such, it's better to make sure the stocks you buy are fundamentally sound.

I used to buy stocks at high on speculation that a breakout had happened, but when it didn't went through, I proceeded to hold on in the hopes of a rebound when I should have just cut.

I know a stock, called southern packaging. It's very illiquid, because nobody knows it. The price to book value is around 0.76, according to someone who posted it in the cna forum. I'll keep this stock in view as a case study.

Another stock that my broker recommended me was beyonics. It was below book value per share too. Recently it went to realise the its true value, rising from 0.30 to 0.55. Interesting case study. When I know more, I'll go and calculate all these to verify.