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May 30, 2000

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Subject:  Time For a Change
Author:  heihojin

Well, I've learned a lot the past few months, and I thought I would share some of it with you all.

In March, when the whole biotech sector tanked, I realized that I had made some errors. I proceeded to evaluate each of my decisions over the previous six months (the length of time I had been investing in individual stocks), and I realized that I had made a series of erroneous decisions based on my ignorance of certain, basic principles.

The first principle is that, yes, price matters. Price always matters. My first purchase of CRA was, in retrospect, brilliant - $17 a share, split-adjusted. Of course, even then it was speculative, but it was certainly brilliant compared to later purchases. My subsequent accumulations were all at prices ranging from $101 3/4 to $152, much of which was done on margin.

The second principle relates back to our "risk" thread from a few months ago, in which I took the position that since my original purchase was at $17 a share, I was still only risking $17 a share no matter what the current price was; in other words, "it's not a profit or loss until you sell." I have since realized that this was flawed logic; because I have the option of selling at any given time, the value of the shares can and should be considered as good as cash. In other words, at any given time, I now have the current value of my shares at risk.

The third principle is in regards to the "buy-and-hold" doctrine. The object is to maximize returns. When CRA skyrocketed above $200, the correct question to ask was not whether CRA had been a good investment; the correct question to ask was whether CRA would continue to be a good investment from that point forward. In fact, I should be considering this at any point in time for all of my stocks. When the price increases far faster than cash flow can be reasonably expected to grow, this is a time for re-evaluation. CRA was an extreme example of this. The whole genomics sector had been caught up in a speculative bubble, and my first stock pick had exploded upward. I was so amazed at the upward price movement, and so dedicated to the "buy-and-hold" doctrine, that I never thought to consider how CRA would perform as an investment from that point forward. I was only thinking in terms of how soon I could accumulate more, because the price was going up. Because, after all, the sooner I was fully invested the better - right? ;-)

A related principle has to do with my use of margin. I originally used margin to make my first purchase of HGSI (at a terribly high price) a few days in advance of my biweekly deposit contribution from my paycheck. After thinking about it for a while, I realized that the use of margin could be a strategically sound way to leverage my equity for more profit. The catch is that for it to work, the return on the stock has to be greater than the rate I am paying on my margin. Fortunately, I managed my margin well, and never once came close to a maintenance call. Margin, however, is a double-edged sword, and my use of margin only amplified my valuation errors.

I have since adopted a much more critical eye toward valuation. I have read the posts of the veterans on the AMZN board, as well as read up on the Fool's articles on security valuation. I am certainly not to the point where I can understand DCF, EVA, or any other such valuation models, but I can at least appreciate their usefulness. I am also taking P/E, P/S, P/CF, PEG and YPEG metrics a little more seriously now. I was looking at Philip Morris (MO) at 21 1/2 just a couple of weeks ago, and I would have purchased it had my margin debt been within my comfort zone for accumulation. Now that would have been a good decision.

I have also been reading much of the MI board, specifically with regards to their Relative Strength screens. The data is intriguing, and it has inspired new trains of thought - the least of which is that in the end, the price movement is really all that I as an individual investor am concerned with. Sure, valuation is nice, but if the stock price never budges, I'm still SOL. Positive momentum is good; negative momentum is bad.

In March, JohnRocker's presence on the board increased my interest in shorts. I had recently opened my first short position, AMZN, as an experiment. This was my first attempt at shorting, and done simply because this was an obviously overpriced company that had a high probability of ending up in bankruptcy. Ironically, my AMZN short is now the most profitable position in my portfolio, percentage-wise. As I read JohnRocker's posts on the board, and saw the price of CRA continue to float like a brick, I couldn't help but ask myself: "Why aren't I shorting CRA?"

Having no prior experience on the wrong side of a downtrend, I had no clue prices could drop that fast. Of course, it wasn't downhill every day; there were some dead cat bounces, too, and another speculative surge after Clinton retracted his non-statement. But the whole time, I was losing money and not acknowledging it - partly because I didn't consider it money on the table (until I sold), partly because of my commitment to hold regardless of price, partly because I believed that the price would once again go back up and I would be vindicated in the long run. The first two reasons were logically flawed, and I had no evidence to support the third reason. I just believed that all would be well "in the long run" if things turned out, and if they didn't, then I was only risking what I had paid for the stock.

I made a post some time ago that received quite a few recs. It was entitled, "The REAL Reason I'm Long." Every word of that I believed at the time. I still believe that the understanding of the human genome is ultimately priceless beyond value. I also still believe that CRA has enormous potential to profit from this understanding. Unfortunately, however, I cannot define (or even approximate) what that potential is. And although I still cannot place a value on that potential, I no longer consider that as reason to pay any price for the stock.

So, in terms of absolute value, I've known for some time now that CRA is overpriced. I decided that I wasn't going to accumulate any more unless the price was right. But as long as the market seemed willing to support the current valuation, there was nothing really wrong with holding. This, mind you, was this month, as CRA bounced up and down from the mid-70s to the mid-90s.

Although CRA was still overpriced in my own opinion, I decided to allow market sentiment to determine any points for accumulation, and whether to hold or sell. I decided to wait until CRA was once again just above support in the low 60's to accumulate any more shares.

CRA, however, broke this support yesterday, on a day of average volume.

I am not a technician, but I do know basic things about support and resistance, uptrends and downtrends, moving averages and MACD. I also think these tools are useful in helping to guide decisions based on price activity. One thing I know is that when the stock breaks downward through a support or a trendline, that it's not a good sign. Furthermore, the trend is obviously down. Add to this the Fed's intent on sinking the market further, and CRA's still-overpriced valuation and you have...some very bad near-term signs.

So this morning I had market orders filled to sell my shares of CRA at $56.

I am taking this action based on my outlook for the relatively near term - three months to at least a year. For the long term, this may be a profitable speculative play; but I have re-assessed my risk-to-reward ratio since that post, "The REAL Reason I'm Long." And I can no longer rationally justify holding CRA.

It saddens me, unfortunately. I say "unfortunately" because when it comes to making these sort of decisions, I should not have any emotional attachments to it. Becoming attached to a second-best hand in Poker is by far the most expensive mistake made by all players. But when both my instincts and my reason are screaming "Get OUT!", it's time to get out.

Yes, I may be wrong. The price may jump to $100 tomorrow, and it may never come down. I just don't think that it is likely, and I'm taking action accordingly. Either way, CRA is still overpriced, and has a lot more room to fall. Now, for the long run, CRA may indeed grow into their current valuation. The price may skyrocket again. But because I can't predict the future, I have to have some logical framework with which to conduct my decision-making. I can't justify the current price from a valuation standpoint, and the market has no idea what value CRA will ultimately unlock from the deciphering of the human genome either. So failing valuation, I have allowed the market and price action to make my decision for me in this instance, and yesterday it told me to sell.

So I'm out.


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