The Intelligent Investor Revisited

As the first quarter of 2008 comes to an end, it’ll mark the second consecutive losing quarter for the U.S stock market and as well as my own portfolio. Numerous great writers and investors had suggested individuals need to emerge from a bear market to test the investment principles and their own characters. Regardless the state of the current housing crisis and mortgage turmoil, I can now feel and finally comprehend this echo that I read so many times before.

Since the fundamental principles of my investment strategies are greatly based off Graham’s The Intelligent Investor, I think an evaluation against the book would be a good way to reassess my strategies.

From the very first content in the first chapter, Graham defined investment.

“An investment operation is one which, upon thorough analysis promises safety of principle and an adequate return.”

And I think Buffett said it best in the preface on how to achieve successful investment over a lifetime.

“What’s needed is a sound intellectual framework for making decisions and the ability to keep emotions from corroding that framework.”

From these two key notes that underline the importance of the safety of the principles and the control of emotions, the reflection on my past endeavors shown these two areas will require further improvements.

As a novice investor, looking back at the transactions I made over the past fifteen months, there were some good investments and some bad investments. I am glad the ratio of my good judgments is increasing.

However some judgments, from the selection of the stocks to the timing of the transactions, failed to pass Graham’s teaching on the safety of the principle. To guarantee the safety of the principles is to obtain enough margin of safety at the time of investment. While the intellectual framework and the ability to pick better investments is partly innate and partly a slow process that requires continuing learning, the timing is largely controlled by emotions that unfortunately can be effected by the swing moods of Mr. Market. Practice patience and the courage to act when the market is panicking are good antidotes to emotional influences.

Naturally the question follows is what to wait for? Graham urges to buy when there is a margin of safety and hold preferably indefinite. Over a horizon of twenty years or longer, the market should yield a positive return. After experiencing the up and down of this passing bear market, this is where my belief start to deviate from the traditional buy and hold long.

Buy and hold long should be the method during an upward cycle, where selling stocks with good fundamentals will probably end up at lower prices then the price to buy it back at later time. Different strategies should be practiced at different market cycles.

Regardless of bull or bear market, eventually all will come to an end. Like the bull market that ended last September, the signs of an overheating market were apparent, increasingly high PE ratios with rate of growth that’s unsustainable. Most of my emerging stocks such as ACH, PTR, CEO, YZC, GRMN were approaching over 50% to 90% rate of return for merely three to four month leading to the pinnacle of the last bull run. Buy and hold during this period of unsustainable growth could only mean pay dear when the market undergoes correction.

In order to guarantee the safety of principle, buy and hold should not be the uniform strategy for the ages. Alternatively, it should vary with the general cycles of the market, not the short-term gyrations, but the long-term bullish or bearish cycle that last over five, ten years.

Within a lifetime of investing, I believe large transactions should take place during the climax of each cycle. Large portions of the holdings should be sold or brought depending on whether the current market is excited or distressed, respectively.

Having held through the pinnacle of the bull market last year, I stuck through with the buy and held idiom and missed the chance to sell portion of my holdings. But, with the Dow Jones approaching closely to 12000 and a frantic overselling all across the market, I upped my personal investments this past quarter, a 50% increase from previous quarter, the most I could contribute. These investments should yield a handsome reward once the market starts to recover.

Like mention earlier, in a bullish market, smaller and smaller periodic investments should be made with limited number of selling orders. As the length of the bullish market expands, those purchase order should gradually dimenishes. Of all the cycles occurs in market, the bull cycle should have the lowest number of transactions.

Different strategy should be used during bearish market as we are experiencing right now. Whether it’s a “U” or “L” trend, bearish cycle can last, some “experts” have suggested about an average of 400 days. During this cycle, the trend go through smaller interim cycles with longer wavelength than generally seen in a bullish market. Same selling or purchase price can occur multiple times. Relative short-term patience is needed to wait for the Trough or Apex of the trend. Here I might even consider the reference of the technical analysis. The period of the smaller cycles is at least a month in range. Smaller selling and repurchase transactions can be practiced here following the trend but the holding time should last at least half of the period of the interim cycle. The general day trading is still strongly opposed.

Further, the amount of transaction should be large enough, so that the commission costs do not eat away the short-term profits. I am currently considering this to be less than 1% of the principles. The principles should also be small enough, assuming the fundamentals of the companies still exist, only a small percentage of individual holding should be traded with the trend, say around 30% or less.

The strategy discussed above evolved from my previous investment principle. As such, the underline companies of each transaction are first valued based on the fundamentals of value investing. As oppose to Warren Buffett’s advice in the ability to ignore the daily up and downs of the investments, in a bear market, due diligent is needed as it requires more active participation of the market. Trades and shot-term profits can be made by anticipating the bearish cycle of sinusoid trends.

As always, I will continue to shape my investment principle. This will be an ever evolving process. Current strategy does not reflect future strategy. I am content to have The Intelligent Investors as the foundation to my investment strategy, and optimistically anticipate with each amendment, the results will be shown in more profitable returns.