In Part 1 and Part 2, we applied six tips from the Mike Caro University (MCU) of poker -- as published in poker legend Doyle Brunson's new book Super/System 2 -- to investing. We discussed how every dollar you save is as valuable as every dollar you earn, avoiding over-diversification, making the right decisions, looking ahead, and that investing is about making money rather than earning respect.
The last four tips have a common theme -- what to do when your stock is down. Re-evaluate, and don't chase losers.
MCU Tip No. 3: What you already have invested in the pot doesn't matter.
The lesson: Always look ahead (Part 2).
As we discussed in Part 2, investors are forward-thinking. That means that your decisions going forward are entirely independent of the time and money you have already invested.
When a stock you buy falls, it is time to re-evaluate. If the stock has become more attractively priced compared with its long-term value, then you should at least continue to hold the stock, if not consider buying more. However, if the stock is down but the company's prospects have changed dramatically for the worst, then it is time to consider a sale, regardless of how much you have already invested into the stock and how big a loss you have taken.
MCU Tip No. 9: Never stay in a poker game hoping to get even.
The lesson: If your only consideration for holding onto a stock is to get even, then it is time to sell and move on.
Here's something to consider: Every investor who held onto Enron and WorldCom equity hoping to get their money back went broke on their investment.
Take a step back, and the fact is that many of the investors who bought Cisco (Nasdaq: CSCO), Microsoft (Nasdaq: MSFT), and Intel (Nasdaq: INTC) at the height of the stock market bubble of the late '90s may never recoup their entire investment. The decision those investors should make now is to re-evaluate the prospects for their prospective holdings, while also considering such things as the tax consequences (benefits) of selling in addition to alternative investments.
Cisco, Microsoft, and Intel may very well make viable investments today. But many investors continue to hold onto stocks that they would no longer otherwise buy. And if you have found a better alternative for your money and your only consideration for holding a stock is getting back to break-even, then it is time to sell.
MCU Tip No. 6: Don't treat your bankroll like a tournament buy-in.
The lesson: When you're down, don't play for broke. Be prepared to walk away.
This is the one flaw in reasoning that bugs me the most.
One time not too long ago, I sat down with a buddy in a $10/$20 Limit Hold'em game at the Ameristar (Nasdaq: ASCA) casino in St. Louis. My friend Seth -- who is really more of a pure gambler than a card player -- bought in for $500, which is the current Missouri state limit per two-hour session, but adequate for a $10/$20 game. A couple hours later, he was down $420, leaving $80 in front of him.
And then the atrocious happened.
The under-the-gun player (the player first to act pre-flop in Hold'em) raised pre-flop to $20, and Seth decided to re-raise to $30 in the seat right behind him and play for broke with 10-2 suited spades -- a not-so-good hand unless you're Doyle Brunson (Doyle won back-to-back World Series of Poker titles with 10-2 on the last hand). I should mention that the initial raiser was also the tightest player at the table. So if you're familiar with Hold'em, it's pretty clear that Seth was either way behind a hand like AK or AQ, or absolutely smoked by AA, KK, QQ, JJ, or TT.
I don't even remember the rest of the hand. I just remember Seth going broke and showing down 10-2 suited spades.
"Whatever. I only had $80 left," he says.
But that kind of thinking is extremely expensive. If Seth is an otherwise breakeven player, this flaw alone is enough to make him a long-run loser. You don't get an $80 bonus just for winning $420, so why condemn yourself to losing an extra $80 every time you lose $420?
If you find yourself in this situation, down $420 or 84%, don't put the rest of your money in a situation where the odds are stacked against you. Just walk away with what you have left.
This applies to investing in stocks as well. You made a mistake and overpaid for a stock, and now it's down 50%. But don't play it for broke: As in every example before this, now is the time to re-evaluate.
If the valuation is now favorable -- as I think is the case for LED maker and former TMF Select (now Motley Fool Hidden Gems) selection Cree (Nasdaq: CREE), which was recently down in the low $20s from its December 2004 highs above $40 -- then the stock is worth further consideration for a buy. Stock Advisor selection and undisputed video game king Electronic Arts (Nasdaq: ERTS), back down 28% or so from its highs above $70 since issuing an earnings warning in March, is now a much more reasonable hold.
But if the odds are against you, the odds are against you. And if you're holding a complete dog that is lacking in competitive advantages and is short on prospects, you must be prepared to sell.
MCU Tip No. 10: Don't manufacture a winning streak.
The lesson: Pick your spots and maintain discipline. Wait for that fat pitch.
OK, last tip.
Here's the truth: The only investments that can be made are the opportunities that are available to us at any given point in time. When a stock is overpriced, it is overpriced, and you don't get value out of overpaying for a stock.
That said, there will be times when you are flush with cash, but can't find the right investment opportunity. When this happens, don't look too hard and don't force it. Just wait for your next big opportunity -- the proverbial fat pitch -- and be prepared to hit it hard.
Fool contributor Jeff Hwang owns shares of Ameristar Casinos, Cree, and Electronic Arts.
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