But at the end of the 1990s, the government ruled that such contact was illegal and the only way anyone could communicate with executives was through public forums—no more one-on-one insights. After a series of prosecutions by the government, the rule, Regulation FD, or Fair Disclosure, was interpreted to mean that unless the information was released and on the company website, it was not considered legal.
This rule and its interpretation changed everything. It made the whole concept of trying to game short-term movements in stocks almost impossible—not just for “home gamers,” my term for nonprofessional investors, but for hedge fund managers. So the new style of my trust suited the times well.
Third, my charitable trust allows me a rare and brutal look back at why I bought or sold a stock. I am on record about what my thought process was. Which is why what I am about to teach you is the single best set of lessons I have ever come up with. Most people never set down contemporaneously why they do something. If you want to minimize the mistakes you make, you should keep a diary and at that exact moment when you buy or sell, write down why you did it. You will be struck by how many of the same patterns you repeat. The charitable trust forced me to invest like an ordinary person, and that’s given me a lot of insight into the kinds of mistakes that regular investors often make, not the kinds of mistakes that hedge fund managers often make.
It is my sincere hope that you will not have to make those mistakes, not have to take the serious pain that I have had, because I have taken it for you!
With that introduction, let’s explore the twenty most valuable lessons you will ever need for investing—not trading—your personal money. Both Real Money: Sane Investing in an Insane World and Mad Money: Watch TV, Get Rich have more than adequately addressed the best ways to trade. When I wrote the sets of lessons in those books, I still had my head stuck in the world of professional money management and hedge funds, of daily performance checkups, not of sensible long-term investing over a twelve-to eighteen-month horizon.
Here are my lessons from running ActionAlertsPlus.com, my charitable trust:
Twenty New Rules for Investing
1. Don’t invest like a hedge fund manager. You don’t have to worry about the quarter, so don’t play it for the quarter. Free yourself from that mentality. There are so many services and websites and programs devoted to moving quickly and taking advantage of short-term movements and events that it’s almost as if all of the financial services media were set up as if you are or wanted to be a hedge fund manager.
But as I have indicated, such thinking does not allow you to perform over a long period of time—not just because the tax consequences are higher for short-term trading but because the best ideas are the ones you own and continue to do homework on, investments that you’re confident have long-term potential and don’t require minute-by-minute analysis. After all, if you’re reading this book you probably don’t have time during the day or even during the week to trade stocks and constantly monitor them.
That’s one of many habits that cost people so much in 2000. And when I went over my trades from ActionAlertsPlus.com I found that so many of my gains were truncated and much smaller than they could have been because I wanted to show good numbers, quarterly numbers, as if I were under pressure to continue to perform the old way. We are inundated with stocks and tables each month that show who is doing better or worse than someone else. I am sure you fall prey to wondering, “How am I doing?” Take it from someone who has suffered the lumps of being too competitive: It’s a big mistake, especially when it’s all in your head.
Foster Wheeler was one of the best picks that I’ve had in many years, an infrastructure play, meaning it’s a company that engineers and constructs giant projects like petrochemical refineries and power plants, both of which are in incredible demand. Soon after I bought it the stock went down about 10 points, from $50 to $40. (One of the great things about keeping a contemporaneous document is that you can see where you made all of these trades. If the stock went down after you got out, congratulate yourself, but if it went up, you’d better be prepared to explain how you left the gains on the table.) At $40 I bought more. It then dropped to $30 and I bought more still. Slowly it went back to where I bought it and then above to the mid-$50s. As the quarter came, I wanted to record that terrific gain. It didn’t matter that I liked the stock as much as ever. I wanted to be sure I booked a winner.
Though I had sworn that I would run ActionAlertsPlus.com as if no one was looking over my shoulder, I booted it. Subsequently the stock doubled over the next year as my thesis about the stock’s potential played out.
I had fallen victim to hedge-funditis. Had I not cared about the short term so much, I would have held on to a huge gain for at least some of my holdings. While you may not feel as if you are running a hedge fund, the focus on short-term performance has infected pretty much every investor I know. You don’t need to show good days, good months, good quarters, or even good years. You just need to show great wealth over many years. Invest for the long term. Lose the hedge fund mentality.
2. Don’t quit when you get back to even. My ActionAlertsPlus.com Alerts are littered with missives about how I am “battling” individual stocks as they go down to get a better cost basis and then quitting just when I get ahead.
In 2002, I decided that ABB, a Swiss engineering company that was one of the few companies on earth that maintained the ability to build nuclear power plants during the dry spell of construction, was making a comeback. It had been damaged by some serious exposure to asbestos lawsuits. I first bought the stock at $13, but every time an asbestos lawsuit hit the tape, even if it was the good news of a settlement, the stock got hammered back to $11. I was able, after a considerable amount of buying over many months’ time, to get my basis—that is, what the entire position cost me—from $13 to $12 a share.
It was a classic siege and I was conscious of the heroic effort that it took to buy little increments each time it ticked at $11 and change. After five months, the stock finally got back to where I initially bought it. I declared victory, saying I had gotten back to even and then some! I was so proud and relieved that I had outlasted the stock. The fact that I had actually made a dollar despite the bad first buy was icing on the cake. I had won. I rang the register.
A year later, I bumped into a friend who had gotten the first Alert, but didn’t see the second because he was on sabbatical for a year in Switzerland. He wanted to know if it was time to ring the register on ABB. The stock was at $24. He had done much more than get back to even. Oh, and the big orders for nuke plants? The reason I bought it? They finally happened, just as I had predicted. Usually when you get back to even, the stock you own has a lot more upside left. Don’t get out at the ground floor.
3. Never say never when it comes to a takeover. One of the most unnerving parts of investing is missing a takeover that should have been yours after you left the stock because management and everyone else thought that the company couldn’t or wouldn’t be taken over.
Recently, Dow Jones, a company with two classes of stock, one that was meant to keep the company independent and family-run, succumbed to a takeover bid from Rupert Murdoch’s News Corp. Pundits and analysts were adamant that this takeover could never occur, which is why the stock was at $35 before the $60 takeover bid.
It might seem an unusual case, but it isn’t. In reviewing all my bulletins for this book, I was dismayed to see that I had purchased Alcan around $52 because I believed there would be an imminent consolidation of the aluminum business as various mineral concerns were buying up independents. The stock rapidly fell to the $40s, where I bought more, and then dropped down to $39, where I bought even more to bring down my average cost. (Unlike when you are trading, it is perfectly fine to buy a stock that’s down, because when you are investing you are getting a company you like on the cheap.)
When the stock got back to $45, Phelps Dodge, another mineral company, got a very big takeover offer from Freeport-McMoR
an, a gold and copper company. Alcan spiked in sympathy. Immediately, almost all of the analysts who followed the company either downgraded it or pooh-poohed the notion that it could be taken over or would be willing to be taken over. Management gave interviews in the Canadian press about how the company was not a target and had not gotten any inquiries, but it was definitively not for sale.
I read the articles and the analysts’ reports, and even though I liked the fundamentals, I decided to boot the company for a small gain at $47. Less than a year later Alcan got not just one bid, from Alcoa, as part of a big consolidation in the aluminum business, but a second bid, for $101, by Rio Tinto, one of the largest mineral companies in the world. Alcan happily accepted that offer, which neither it nor the analysts thought was possible when the stock was at $47.
My conclusion: never say never about a potential takeover, even when management and the analysts point-blank rule it out. If a company has stock, ultimately that company is for sale. Don’t get scared away just because the Street and the company’s management don’t believe it can be bought.
4. Don’t let the market shake you out of a good long-term thesis. In the spring of 2005 it became amply clear to anyone reading the newspapers or watching TV that we were going to be in a shooting war in Iraq for a very long time. The United States has only one company capable of making all the ammunition needed for a long war: Alliant Techsystems.
After reading about the company, listening to the conference calls, reading analysts’ reports, and noticing that the company had one of the most aggressive buybacks, retiring millions of shares a year off a very small base, I decided to buy some around $67.
It proved to be a prescient buy. The stock vaulted to $75 over the next couple of months. A few months later there was a downturn in the market because of worries of consistent and unrelenting Federal Reserve rate increases. These increases were wholly unrelated to the Iraq War, but I got shaken out and decided to take the quick gain.
Meanwhile the war raged on and so did the need for bullets. Within two years’ time the stock rallied to more than $112 a share. I had let the market shake me out of a perfectly good position with a long-term thesis that, unfortunately for the U.S. soldiers in Iraq, played out. I made 7 easy points; I left 40 just-as-easy points on the table.
You must guard against selling a stock that you own for reasons independent of a market swing. Use the declines to build positions in stocks that don’t depend on market momentum; don’t be shaken out of your good positions. Throughout my investing for AAPlus I have seen this pattern: oil stocks sold because of market volatility that had nothing to do with the increasing price of oil; farm stocks sold even though the farm cycle is separate from the economic cycle; and mineral stocks dumped even though they are more levered to China than to the United States. If you have a good long-term thesis that is independent of the economic cycle, do not let yourself be faked out of what could be some terrific long-term gains.
5. Piggybacking can be a winning strategy if you remember to stay on the pig! If you like an idea suggested by a great stock-picker and you buy a stock, don’t jettison it as long as the champion of the stock still loves it. In the past few years, I have come to love a website that identifies stocks owned by great investors and lets you cross-reference those stocks with those of other holders: www.stockpickr.com. It also allows you to be involved in a community of investors who have posted their own portfolios and given reasons to own the stocks. I find this an incredibly worthwhile way to get started finding a stock.
Not long ago I learned that Rich Pzena, perhaps the greatest value manager of our time, had purchased a big stake in American Physicians Capital. I reached out to Rich—he’s an old friend—to ask him the story. He pointed me to the company’s website, which showed that this malpractice insurance company was beginning to benefit from a tide that had turned against the plaintiffs in lawsuits against doctors. He told me to monitor those lawsuit verdicts through the company’s website and to follow his holdings on the stock to know if anything needed to be done, but that he was in it for as long as his thesis played out. Tracking Rich and others like him is what Stockpickr.com was made for. The stock soon moved up 4 points and I figured, why wait to see if Pzena still owned it when I could take the terrific gain? Not long after I sold, I saw that Pzena had increased his position and become the largest holder of the stock. I didn’t want to buy it back—I should have, but I was too proud (another lesson learned, but something you shouldn’t have a problem with; I was hung up on buying back because every move I make is public). Over the next year I watched it go up and up until it had doubled from where Rich had bought it. I could have piggybacked all the way, but instead I got off despite my desire to mimic this great investor.
If you are in a stock because some great manager likes it and you monitor the story and it doesn’t change and the manager doesn’t sell off some of the holdings, why sell? While a gain is never “costly,” it glares at me that I bought it for one reason, the piggyback, after he had done all the homework for me, and I acted, with my selling, as if I knew more than he did. I didn’t! My belief was in him and his abilities. He never wavered. I did, and I left an outsize gain for him and his investors without me. Stay on the bull that brought you to the party.
6. Try to play with the house’s money. A couple of years ago, Dan Rather decided to do a profile of me for 60 Minutes. I decided I wanted to focus on a stock that would be good anytime the piece ran, because he told me that if it was any good, it would be a candidate to be rerun the following summer. I didn’t want to recommend a stock that would blow up on me.
So I looked at my portfolio and estimated which stock would last the longest, which one I had the most confidence in. I had bought the stock of Anglo American UK (AAUK), a South African mining conglomerate that had said that over the next year it would break itself into parts that were worth more than the whole. I liked the sound of that plan and I liked its long-term nature.
So when Rather’s crew filmed the episode I emphasized that you could own this stock for a long time, scaling out as it went up but ultimately holding on to some stock until you were just playing with the house’s money. In other words, scale out of the stock as it goes higher. I bought 5,000 shares at $26 and my plan was to sell 1,000 shares every few points up until I had recouped my initial investment and was now playing with the house’s money. I didn’t want to be greedy, but I knew that I had the staying power and I knew that it is awfully hard to find another stock that is as good as one that’s winning for you now.
Did I follow my plan? Nah, I got short-term greedy instead of long-term greedy. Anglo American’s stock went up 3 points soon after I bought, and I sold not 1,000 shares, as I should have, but 2,500. It then went up another 3 points and instead of scaling out slowly over time, I sold the other 2,500. My original plan, made before the heat of battle, had been to sell 1,000 shares every few points up and instead I exited the position up about 6 bucks, for a gain of $22,500.
Sure enough, about eight months later CBS reran the program. There I was in full glory talking about how this was one you had to scale out of on the way up. I looked at the stock when the show aired again, and it had almost doubled. Had I followed my plan, I would have booked a $30,000 profit and then let the last 1,000 shares run.
And if I had done that, the house’s money, the last 1,000 shares I held, would have produced the biggest gain of all—$50,000! That’s double the whole gain I took on the position, not including the gains on the other 4,000 shares taken off earlier.
The compounding you get from letting a position run knowing you can’t lose is one of the greatest concepts in investing. But you can’t get to that Promised Land if you don’t even try. Don’t be so quick to sell. You made your plan; stick with it. At least you know you won’t have to be embarrassed by a national TV rerun.
By the way, the stocks I bought with the capital I took out of AAUK did nowhere near as well as that winner. Ouch! Don’t just mind your w
inners, mine them. Scale slowly. Stop selling when you are playing with the house’s money. Remember how hard it is to find winning stocks and don’t be so quick to sell them. You are most likely going to substitute a loser for a winner if you are so quick to sell.
7. Never turn an investment into a trade. In Jim Cramer’s Real Money, I listed the Ten Commandments of Trading that I learned while running my hedge fund. The most important, the first, still rings true every day: “Never turn a trade into an investment.” You bought something for an event; after the event occurs, don’t hold on to it. Sell it either way, take the gain or loss, because you can’t start justifying it as something else.
But I have learned something new from running my charitable trust, something more valuable for those of you who want to stay mad for life: never turn an investment into a trade. In 2004, my youngest daughter asked for an iPod for her tenth birthday. I was stunned. I reminded her that I had bought her an iPod for the holidays. She said that she loved that one, but it was blue and now she wanted a pink one. I said that was ridiculous, her first iPod was fine. She said something that made me stop what I was doing and think hard for a moment: “Dad, it’s like having two pocketbooks or two pieces of jewelry. Just because you have one doesn’t mean you shouldn’t have another. No one would get mad at someone who wanted a second piece of jewelry if you knew that person loved jewelry.”
It hit me like a ton of iPods landing on my head. Of course, it was a fashion accessory! That’s what the kids liked it for. When I went through the research, it was clear that not a single analyst considered it as such. All the saturation figures assumed a point where everyone who was supposed to have an iPod had one already.
I had always liked Apple. I had been paying my kids’ iTunes bills for several years and I had toyed with getting an iPod myself (I now have one with hundreds of songs on it). But I didn’t have a thesis to explain why the iPod would keep growing. I had thought it was just another glorified MP3 player and that many other contenders would eventually get into the market. I had never thought of it as a fashion statement.
Jim Cramer's Stay Mad for Life Page 18