Profit Off This Idiot Investor

Every time you buy or sell stock, you're essentially betting against the person on the other side of the transaction.

The best Wall Street traders know this -- they get fat by eating the lunches of their less-skilled brethren.

When we non-Wall Streeters make trades in our brokerage accounts, we don't have the luxury of knowing the other side of the trade personally. However, we get to participate in a market where thousands of idiots are making bad decisions and bad trades each day.

Join me as I detail two trades one of these idiots made and share how we can take advantage of idiots like this guy today.

The idiot revealed
Before you feel too bad about taking advantage of this idiot, rest assured, he doesn't mind. The idiot is me.

I've made a lot of good stock moves in my day, but I've also made a lot of others that have greatly enriched whoever was on the other side.

The first one I'm going to discuss today happened a few years ago when I failed to take the advice of Motley Fool co-founder Tom Gardner.

The stock I should have sold
In early 2006, I bought shares of online jeweler Blue Nile (Nasdaq: NILE  ) . I was convinced by the recommendations of not one but both of our founding brothers -- first David Gardner in his Rule Breakers newsletter in 2004 and then Tom Gardner in 2005, when he advised on Hidden Gems, our small-cap newsletter.

I was impressed with Blue Nile's push to revolutionize the jewelry industry by educating the public (read: hapless future grooms) on the finer points of finery and then selling them said finery for cheaper prices than their bricks-and-mortar competition. There's certainly some comfort in seeing and touching the merchandise in person, but overall, I saw the jewelry industry in a similar light as I see the used car industry.

I am a believer in the business model of CarMax (NYSE: KMX  ) because it's bringing customer service and transparency to the ugly used car business. And I am a believer in Blue Nile's business model for similar reasons. The jewelry industry is ripe for disruption, and Blue Nile's doing a great job of establishing itself as the pre-eminent first mover.

Great. So why should I have sold it?

Simple. The stock price got ahead of its prospects. As Tom Gardner noted when he recommended selling the shares in the fall 2007, "I'm delighted with every aspect of our Blue Nile experience. It's been a three-bagger for us in a mere two years. However, at $100 per share and a $1.6 billion market cap, Blue Nile now appears quite overvalued to me." He went on to show that Blue Nile would have to grow its profit by 35% a year to make it a buy.

That's aggressive even for a big grower. (To put that in hindsight perspective, when I look at Blue Nile's growth for the past five years, it's less than 2% per year.)

All of that made sense, but I didn't sell. I sold a few years later in 2009 -- at about half the price. In a market that was down 20%, I still made a 70% gain in three and a half years.

But I could have pocketed a gain of more than 200% instead.

Oops.

Yet, as I'll explain later, David Gardner would say that my mistake wasn't selling at a lower price ... the mistake was me selling Blue Nile at all.

The stock I should have kept
On the flip side, I bought shares of Apple (Nasdaq: AAPL  ) during the heart of the financial crisis (September 2008) when its shares had fallen to around $110. The naysayers were talking down Apple because it sold high-end, arguably luxury goods in a crummy economy.

At the time, many folks were tightening budgets and shopping downmarket at places like Wal-Mart (NYSE: WMT  ) and Dollar Tree (Nasdaq: DLTR  ) , as their upcoming quarterly earnings would show. In a prolonged downturn, Wal-Mart and Dollar Tree wouldn't just survive -- they could thrive. It was harder to make that case for Apple.

I was concerned about this as well. But Apple had so much cash and such good products that I was confident it could weather the crisis -- even if it floundered for years.

Of course, that didn't happen. Apple disproved its critics and smashed analysts' earnings estimates and prior-year numbers throughout the financial crisis.

So about a year after I bought, shares were trading at $180 a share, up more than 60%. Happy with my quick gain and worried about valuation, I sold in September 2009.

And now a year and a half later, Apple's stock is almost a double from my sell price.

Double oops.

Damned if I do, damned if I don't
So I lost by not selling. And I lost by selling.

Deciding when to pull the trigger is tough. It's even tougher with higher-growth stocks like Blue Nile and Apple.

One way to deal with this problem is to buy a portfolio of promising, visionary stocks and hold them for the very long term, temporary valuation mispricings be damned. If you choose your companies correctly, the huge winners will more than cancel out the losers.

That's the philosophy of Fool co-founder David Gardner. Recall that both he and his brother Tom had recommended Blue Nile. Unlike Tom, though, he never sold. You and I may say he missed an opportunity to unload shares at $100 a pop, almost 70% higher than today's price. But he'd say we're missing the point. He's sitting on close to a double from his buy-in price, and, if Blue Nile proves itself to be a true Rule Breaker, its growth story is just beginning.

Each of us has our own investing style. While mine differs a bit from David's (and Tom's, too), David's investing philosophy combined with my two bad trades leads to a good investing lesson.

The lesson
The lesson is a simple one but hard to execute. When you've identified a great growth story, be very careful about selling. I clearly underestimated Apple. And even sellers at $100 who never bought back in may ultimately underestimate Blue Nile.

As I look at my portfolio today, I see Intuitive Surgical (Nasdaq: ISRG  ) trading for a rich 35 times trailing earnings and 25 times forward earnings. But I refuse to sell because of the lesson I learned from Apple. Like Blue Nile, perhaps share prices will dip from today. And there's real danger in pricing in too much growth. But in this case, I think Intuitive Surgical has the opportunity to define a megatrend (robotic surgery) -- much like Apple has been doing with smartphones. We'll see if I've properly learned from my investing mistakes.

If you're interested in learning about another company capitalizing on a megatrend, I invite you to take a free copy of our report "The Motley Fool's Top Stock for 2011." You can access it for free by clicking here.

Anand Chokkavelu owns shares of Intuitive Surgical and longs for those sold Apple shares. Blue Nile is a Motley Fool Rule Breakers selection. Apple is a Motley Fool Stock Advisor pick. The Fool has written puts on Apple. The Fool owns shares of Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (24) | Recommend This Article (73)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 01, 2011, at 4:08 PM, TMFUltraLong wrote:

    Anand,

    Good article...I've had plenty of those moments myself. I have to admit though, I saw the title and was really hoping this was about Carl Icahn....

    Cheers,

    Sean (TMFUltraLong)

  • Report this Comment On February 01, 2011, at 4:11 PM, TheDumbMoney wrote:

    Great article. I try never to sell. I find that this eliminates almost exactly half of my investment mistakes. :-) I haven't sold a single share of anything since May 2010, and hope to make it to May 2011, then May 2012, etc. That's not to say I won't sell a loser, if I think it's fundamentally driven. As for selling overvalued stocks, I have found that 100% of the time when I sell a stock that is "over-valued," I end up putting that money into another company that I haven't known as long, and don't know as well, and I'm just as likely to lose money there as on a pull-back in my original holding.

  • Report this Comment On February 01, 2011, at 4:25 PM, griderX wrote:

    As investors...I think we all had the DOH! moment pulling the trigger too early or too late! Since you mentioned ISRG. Did you read up on this news..

    http://www.medgadget.com/archives/2011/01/new_da_vinci_skill...

    Regarding the Skills Simulator: Very cool concept....can you imagine at least one of these machines in every medical/surgical school in the US! This is truly new market for ISRG! There are about 130-160 Medical Schools in the US alone...imagine multiple units in Universities! Perhaps near 1000+ worldwide!

    I'm pretty sure no analyst is factoring this into their numbers...heck I could be wrong and this could be a bust. But I think "robotic surgery certified" will be on every medical students resume in the future. ;)

    Long and Holding ISRG.

  • Report this Comment On February 01, 2011, at 4:39 PM, FoolSolo wrote:

    Have you ever considered using automated trades to take the guess work out of it?

    I've had a couple of recent situations where I found myself sitting on some very outsized profits within days of buying a stock, in the neighborhood of 60-70% in less than a week. As rockets often do, they climb real fast and fall just as quickly, so a week later I was under water.

    Had I followed Elder's advice I would have locked in at those lofty rates, taken my profit, and would have had a chance to buy them back again at the lower prices. Elder's advise is to never let a profit turn into a loss, and it is a lesson I have poorly executed upon.

    I have successfully executed on Elder's advice on other stocks, and I find that TDAmeritrade has a nifty little tool called trade triggers, which allows you to set flexible parameters to submit orders. The triggers are not visible to the market makers so they can't trip them on purpose, as they often do with stop-loss orders.

    I just need to develop the discipline to do it consistently.

  • Report this Comment On February 01, 2011, at 4:51 PM, stuckinamobile wrote:

    Thank goodness!!!! Does this mean you will FINALLY stop blindly pumping NILE?? Please tell me yes.....you were wrong so long and finally admit it so PLEAse sto pumping this over priced overblown, over hyped insider traded, institutional manipulated stock.

  • Report this Comment On February 01, 2011, at 4:56 PM, TMFBomb wrote:

    @stuckinamobile,

    To be clear, the views on Blue Nile are mine only and don't reflect those of David Gardner (or any other Fool analyst), who still has two active recommendations of Blue Nile in his Rule Breakers newsletter.

    -Anand

  • Report this Comment On February 01, 2011, at 5:09 PM, teacher2001 wrote:

    Hi,

    If you feel badly about selling Apple, I feel doubly bad as I listened to Cramer and sold. I bought Apple at 97 and sold at 228 not wanting to be greedy. I am sooooo sorry. I am a real apple believer.

    teacher2001

  • Report this Comment On February 01, 2011, at 7:22 PM, trout41 wrote:

    Sold at $251, never looked back since there are

    other opportunities and one could feel down for a long time but still good idea to review decisions in retrospect to strengthen ones decision making.

  • Report this Comment On February 01, 2011, at 9:04 PM, UMotleyFool wrote:

    i bought at ~85 in mar 09 and sold in april with a 40% gain - bought again in sept, i think, for about 180 and sold a few months later for 200 something. Then again mid 2010 for 250 something and sold before year end for 320 something. i was lucky - you can be lucky too, if you buy apple (calls).

  • Report this Comment On February 01, 2011, at 9:13 PM, Schwaggz wrote:

    You don't lose money taking profits.

  • Report this Comment On February 01, 2011, at 9:15 PM, baldheadeddork wrote:

    To steal a line from the podcast, I think the big macro on this post is that the biggest idiocy can be falling prey to piggishness. If you can routinely pull out 70% gains in three years you're doing really, really well. A 70% gain in a year even gives you a little cushion for those investments that only pull in ten-fifteen percent gain in a year. /sarcasm

    This is something we have to be aware of as we move out of the rebound market we've had in the last two years. The gains from 2009 through today are not normal. If you keep trading like (your favorite stock today) is the Ford or Apple of two years ago you're setting yourself up for a world of hurt.

  • Report this Comment On February 02, 2011, at 12:47 AM, ruffian56s wrote:

    If you are torn between hanging on or taking the big gain there is always the time proven strategy of selling one-half when it doubles and then riding the remainder to where ever. You've got your original investment back and what ever the remaining stock does after that is all profit. I always use this strategy when I think I've found a true rule breaker, like Amazon, Intuitive, etc.

  • Report this Comment On February 02, 2011, at 2:52 AM, tomd728 wrote:

    wowwee now that's a relief !!!!!!!!!!!!!!!

    I was near certain that CelticRiver was the idiot cited and one after the other of his horrible trades

    would be laid out for all to see.Then throw in a bunch of moronic comments.............

    In reading the prelude posts every one makes a salient point but in particular Schwagge and ruffian56s are very easy to get in line with.How could one fault the reasoning therein.

    Just as relevant as "when to sell" is what stop mechanism does one employ when a position is opened ?

    Personally I never lose track of where my sales are currently as I have entered.......sold in the

    same stock as many as 3 times (AAPL).Each time those trades worked as I got more leverage from the profit being invested elsewhere.

    Smart ? Never ! Lucky ? I'll take it every time out.

    Tom

  • Report this Comment On February 02, 2011, at 3:52 AM, Julianoli wrote:

    @ruffian56s

    Exactly, if you ever find yourself stuck in that situation, it's always advisable to secure your principal amount and letting the rest of the money do whatever it is meant to do.

    Too often I hear about people who get greedy and hold on for a month or week too long before selling, sometimes at a loss of principal.

  • Report this Comment On February 02, 2011, at 8:30 AM, BruceHBi wrote:

    Valuable perspectives. However, sometimes looking back at "what could have been" is like second-guessing yourself when you accomplished your objective [a profitable investment]. It can be painful when it shouldn't be.

  • Report this Comment On February 02, 2011, at 11:46 AM, stuckinamobile wrote:

    Anand,

    Thanks for the clarification. I should have figured.....Once on the take.....always on the take. The fool has shamlessly pumped NILE for qite a long time. Throgh missed numbers, declining projections....One of the most outrageous PE's in the NASDAQ and Fool still says NILE is a great company. Insiders do nothing but sell and institutions do nothing but control the bid and ask. GIve me great faith in the Fool and the market overall. Thans for coming clean. Now only if Wall Street would.

  • Report this Comment On February 02, 2011, at 12:15 PM, livinglearning wrote:

    I think about this every time I see NFLX price after I sold for a 25% gain. It's now up 300%. That's why I'm holding PCLN so I don't repeat that mistake.

  • Report this Comment On February 02, 2011, at 4:24 PM, TMFBomb wrote:

    @Schwaggz and baldheadeddork,

    Good points. We'll rarely time entry and exits perfectly and I won't cry too much about taking a profit. Still, I tried to show in this article just how tricky the sell decision can be.

    Fool on,

    Anand

  • Report this Comment On February 02, 2011, at 5:24 PM, personalwm wrote:

    Interesting points.

    I would suggest that derivatives (e.g., options) are more a zero sum game than equities.

    While it is true that shares may be bought and sold due to diametrically opposed views of a company's prospects by the buyer and seller, there are many other reasons to sell shares. You may be rebalancing your portfolio, realizing profits, attaining liquidity, etc.

    It is also extremely difficult to time market or stock movements. In hindsight, it is easy. But at the time you buy, you are convinced of the upside. And at the time of sale, you are convinced it is the right time to divest. Very few investors consistently trade at the best times.

    For more information on investing, please visit www.personalwm.com.

  • Report this Comment On February 02, 2011, at 5:43 PM, HDTVBG wrote:

    Thoughtful piece but you are not an idiot for taking a profit. We've all "sold too soon", I did this just two days ago, reaping thousands in profits on a tiny dotcom I bought at less than 3 cents, held for two years, and sold for more than 11 cents - sweet. But today it is around 25 cents - damn, i couldn't wait two more days after two years ???!!! But who knew? It could easily have been dumped after the pump and I'd have missed my opportunity to ring the register at all. I'll use my profits to find the next home run . . .

  • Report this Comment On February 04, 2011, at 2:16 PM, joeyvk wrote:

    It has been also a decade since I bought AAPL at believe it or not $13 a share ($6.50 a share if you adjust for the split). When the stock hit $45 a share, I sold it all and more than tripled my money. I would like to say "I sold it and never looked back" but I look back at that decision every trading day.

  • Report this Comment On February 04, 2011, at 2:48 PM, mclaugph wrote:

    Anand,

    You made money! Why are you complaining? If you thought the stock was overvalued, you were right to sell. It's up to you to do the analysis and decide.

    I recently read of a Wall Street saying:

    "a bear can make money, and a bull can make money, but a hog never makes money."

    Goes with Buffett's phrase to "be fearful when others are greedy, and be greedy when others are fearful."

  • Report this Comment On February 05, 2011, at 2:16 AM, stevec5792 wrote:

    I do exactly the same thing as ruffian on my non-core positions. It has always worked out. Every time it doubles again, I take some more off the table. Kind of a rebalancing of that one position and it has always worked out for the good.

    And, Anand, ANY profit is good profit. It's not being an idiot to put money in your pocket.

  • Report this Comment On January 22, 2013, at 11:30 AM, MONEYFA wrote:

    ISRG.Pull my money.

    Tomorrow send to me.

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