Methodology: A Memo to Me

January 21, 2017

I don’t need to spend as much of my time, on the stock market, as I used to.

I’m getting much better results than I used to, and I understand why that is so. The only thing holding me back from a much better annual monetary result is my reluctance to invest a greater portion of my investment funds in positions that I really believe in.

However, Market Rule number 1 is not to lose capital. Market Rule number 2 is to invest no more than 5% of my investment funds in any one position. Rule 3 is that no one ever went to the poor house taking a smaller profit. When I break any of these rules it is because I assess my chances are much better than even.

Leaving aside my safest investment … SPY. ( only market risk -last year, better than 11% including dividends…no trades ), the basis of my macro approach is to decide to what degree it is safe to invest in stocks.

The present situation, low USA fixed income yields versus USA stock yields (earnings divided by price ), gives the stock market a clear advantage. Example: 2.5% interest on a risk-free 10 year bond versus the earnings yield on equities ( S&P 500 ), roughly 2.5%, BUT, the potential growth of the underlying 500 largest USA Companies included in the S&P 500 Index , tilts the decision in favor of the stock market….SPY. Martin Zweig who called the 500 point plus downdraft in October 1986 and who owned the most expensive apartment in Manhattan ( top two floors of the Hotel Pierre ) stated simply that the centerpiece of his thinking is that in a low interest rate enviornment, stocks tend to go up. And, with increasing interest rates, stocks tend to decline.

In addition , presently , the S&P 500 ( SPY ) was above its 200 day moving average at last month end month end…trend positive. “Let the trend be you friend till the end ”

Reading the investment climate is a huge determinant on how much market risk I’m willing to take on. For instance the post-election market rally has been referred to as the Trump rally But, in a Trump market the wind could shift with just one Tweet . So, you can be sure market players associate Trump’s name with market volatility and uncertainty.

The result is that no matter how beneficial Trump’s economic program promises to be, lots of people think he is unpredictble and that the market has gotten ahead of itself. Everyone is keeping an eye on the exits and no one wants to be caught napping. On the other hand, the present situation does not add up to a euphoric situation which normally signals a top.

The more I read the climate/wind as unpredictable, the more likely I am to keep my money in a passive index fund, SPY, and not in specific stocks.

Anytime I venture into individual stocks, I am saying that conditions are safe enough for me to attempt to outperform SPY. And, that is an unattainable goal for 80% to 90% of professional portfolio managers. Even the great Warren Buffett admits that in most years beating SPY is exceedingly difficult.

My quest to beat SPY is part hubris , part seeking a return that will balance an increasing annual expense budget. ( I retired January 1, 2007 ) and part, a learning exercise which I find enjoyable,… an absorbing game of me versus SPY….a 365 day mental marathon. To me , the stock market is a 65 Chevvy, whose engine I enjoy working on.

The stocks I follow are those that have been winnowed from a stream of interesting names from any written or verbal source for further investigation. Since I don’t have a lot of time, cursory investigation is quick and ruthless. And, the most efficient way for me to come to a fast and ruthless conclusion is the stock chart….Blink. ” What you see is what you get ! ” Thank you Confucius !

Once I select a stock for further evaluation, I investigate other data areas such as the back story underpining its chart, the relationship of free cash flow per share to price per share to determine how quickly my investment will be repaid. I am also interested in earnings growth, but even more important, how much am I paying for that growth ( PEG Ratio ).

Other measures I consider are debt to equity ratio, dividends, share buyback program, debt paydown program, need for cash for R&D and cap ex-investment etc., whether growth has been organic or based on acquisition.

Once I decide I would like to own the stock, the next question is when. So, the name becomes one of the 150 or so stock charts I review each weekend, ( my farm system ! ). Each stock is assigned a weekly score of 1 to 5. A stock rated 5 is a buy, 4, a very small monitoring position, 3 means do nothing, 2 is a sell and 1 means cut from the chart review list if the back story confirms chart action.. Like everything in life, there are exceptions.

I started this blog in August 2010 with the intention of recording my journey and that of my 401K funds through the jungle I refer to as Wall Street. Since I have a degree in Economics and in International Finance, and was trained by Citibank to become a resident overseas bank officer, I wasn’t about to sit myself down at the desk of my bank investment advisor and give them a slice off the top.

What I didn’t have, by design, was a licence to give financial advice for remuneration. What I do have are plenty of associates and friends who I believe can benefit financially ( or at least preserve their capital ) by looking over my shoulder…no charge.. If I have helped at all , a thank you will do.

Richard Maurice Gore

Leave a Reply