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What If You’re Wrong?
by Alexander Green, Chairman, Investment U
Investment Director, The Oxford Club
Monday, October 20, 2008: Issue #874
Look at every investment disaster individual investors have endured throughout history and the cause is virtually always the same. They neglected to ask a simple question: What if I’m wrong?
- Take the guy whose retirement account is loaded up with shares of one company, the same one he works for. He exposes himself to a career downturn and an investment disaster at the same time. He forgets to ask, “What if I’m wrong?”
- Or the woman who buys an investment property in a hot market, taking out a mortgage she can barely afford. What if she’s wrong?
- Take the trader who loads up on call options, trades heavily on margin or bets the farm on the bull market in oil continuing. What if he’s wrong?
Of course, every investor can be wrong. We all are occasionally. Successful investing is about taking – and intelligently managing – risk.
We Know The Future Is Unknowable At Investment U
We at Investment U are well aware that to a large extent the future is unknowable. So despite our well laid plans, we always hedge our bets.
That means buying quality, diversifying broadly and running trailing stops behind each of our individual stock positions. Anyone who has done that over the past 12 months is miles ahead of the average investor.
As the old saying goes, “The winner in a bull market is he who makes the most. The winner in a bear market is he who loses the least.”
Although we’re in a bear market now, the time has already come to start looking ahead. Investment legends like Warren Buffett and Mark Mobius know this. (They have the benefit of a well-informed investment perspective.) Your average talking head, apparently, does not.
For instance, there have been six major bear markets over the past 80 years. The average decline in the Dow Jones Industrial Average of the previous five disasters – from peak to trough – was 43%.
That’s just about the low point of the current bear market. Unless we’re about to enter a “Greater Depression,” we’re a lot closer to the bottom than the top.
Scared Investors Are Missing the Easy Investment Opportunities
And there are investment opportunities galore, although most investors are too scared to move on much of anything.
- Many of them are tucked safely away in T-bills, where they can sleep soundly at night. But is the purpose of your investment portfolio to provide for you and your family in retirement or is it to play Brahms’ Lullaby?
- Many of these investors have deluded themselves that they will wait until the coast is clear of any investment disasters and then safely re-enter the market down the road.
In other words, having failed to see the top of the market – like 99.9% of all investors – they are now confident they can pick the bottom.
What if they’re wrong? What if the market is already discounting a severe recession? They run the risk of sitting in cash, collecting a pittance, when the market starts to rally again in earnest.
13 Companies At Bargain Basement Levels – For Starters
Meanwhile, there are plenty of companies out there trading at bargain basement levels. If you don’t have much faith in near-term earnings, try a different tack. Buy a few companies that are loaded with cash.
Which ones? Well, for starters, there is:
- AutoDesk (NASDAQ:ADSK)
- Amdocs (NYSE:DOX)
- Dell (NASDAQ:DELL)
- Expedia (NASDAQ:EXPE)
- Foster Wheeler (NASDAQ:FWLT)
- NCR (NYSE:NCR)
- Cisco Systems (NASDAQ:CSCO)
- BMC Software (NYSE:BMC)
- McDermott International (NYSE:MDR)
- Hewlett-Packard (NYSE:HPQ)
- Intel (NASDAQ:INTC)
- Nike (NYSE:NKE)
What if I’m wrong? What if these cash-rich companies go down in the near future, too?
That’s always a possibility.
Limit Your Downside Risk With Trailing Stops
But if you use our recommended 25% trailing stop, you’re not just buying cheap… you’re strictly limiting your downside risk.
The investor holed up in cash, on the other hand, is earning a meager 2% or so on his money. He may not reach his investment goals. But he sleeps well… and he feels safe.
What if he’s wrong?
Good Investing,
Alex
Today’s Investment U Crib Sheet
Companies with large cash reserves can weather market downturns better than their less-secure competition.
But it can be hard to know if a company’s cash reserves are large enough. For a small firm, $100 million could be five year’s worth of cash, yet barely a day’s worth for a large one.
Experienced investors use a company’s Current Ratio (also known as liquidity ratio, or cash-to-assets ratio) to tell whether or not a company has enough money to meet its short-term financial obligations.
The Current Ratio is: Current Assets/Current Liabilities.
As a rule, companies with Current Ratios higher than 1.5 can meet their short-term obligations. A ratio under 1 would tell you they would be unable to pay if their creditors required immediate payment.
It can also be important to compare a company’s ratio to its competition to see if their ratio is out of line with the industry. Average ratios differ by industry and sector, and what may be high in one, could be low in another.
Knowing what a current ratio is can give you a leg up on the average investor, and help you understand if a company will be able to weather the storm.
To learn how to search for current ratio and to screen stocks like a professional, you’ll find more information in Investment U Issue #842, Deep Value Investments: How to Find Your Portfolio’s Next Superstar.
If you’d like to buy great stocks with large cash reserves, Lou Basenese recently showed us the only investment you can buy at a discount right now. And the best part is, you know exactly what the discount is. Find the full story in Investment U Issue #868, Closed-End Income Funds: Why It’s Time To Buy Them.
- Mergers Heat Up Between Haves, Have-Nots
- When You’re Wrong, You’re Wrong
- New Bull Market? Lock in those Gains…
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Alexander Green is the Investment Director of The Oxford Club. A Wall Street veteran, he has over 20 years experience as a research analyst, investment advisor, financial writer and portfolio manager.
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