My Foolish Investment Concepts

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Post of the Day

By Wax
January 2, 2001

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I don't know if any of you saw Gretchen Morgenson's article in the New York Times yesterday, but if you haven't, it's certainly worth the short amount of time it takes to read it. The article is titled: How Did So Many Get It So Wrong. [N.Y. Times Website, free registration required.]

In a nutshell, the article attempts to highlight the reasons why so many analysts continue to issue favorable ratings for stocks, even when the stock is being crucified by the markets! As Ms. Morgenson notes, the general reason is because the company the analyst works for, is the same company that took the company the analyst is recommending, public.

As a Fool, I don't pay a lot of attention to analyst recommendations, except to complain when they downgrade a stock I own. It's been my feeling for a very long time, that analysts never seem to downgrade a stock in which their company makes a market. Ms. Morgenson seems to have drawn the same conclusion. So what's a poor Fool to do in the face of these seemingly unethical practices? The answer to that is one of personal choice.

Over time, and with a lot of trial and error, I've learned what works best for me. For instance, I pay very close attention to both earnings estimates and earnings growth. Earnings are the principal tool the market uses to determine a fair price for a stock. The stronger the earnings and earnings growth, the more price appreciation in the stock. I always ask myself the same question. Do I want to own a stock that has decreasing earnings estimates and earnings growth, or increasing earnings estimates and earnings growth? Which is better for my personal economy?

Another thing I've learned to watch are trends. Trends as I use them have nothing to do with the moving averages many folks talk about. What I'm looking for using trends, is a series of rising highs and rising lows. In other words, are the highs trending up, and are the lows trending up. I use this information mainly to pick an entry point, not an entry price, when purchasing a stock. I'm really not interested in owning a stock that isn't moving upward, regardless of how much gross profit the company has, or how little debt, or how much cash. Buying a company that has a retreating trend tells me that for some amount of time, I'm going to own a non-performing asset, which is of no interest to me.

I also pay particularly close attention to management. I realized a long time ago that as goes management, so goes the stock price. Lucent is a pretty good example. Management made certain fundamental changes in the way the company did business, deciding to finance sales to customers that had weak financial positions. Doing business this way seemed good for Lucent, and their stock price reflected it. Then the economy went south, and Lucent was left with a number of customers that couldn't pay. Lucent has now issued earnings warnings for the past several quarters running, has replaced their CFO, and ended the year with a stock price of around $13. This is definitely what I call a "don't wanter" stock. All thanks to management!

Of late I've been focusing on Cisco. I think I'm seeing management shifts similar to those made by Lucent. Since my portfolio has a large position in Cisco, I want to be very alert to subtle changes implemented by management that might affect the stock price. While I would hate to close my position in Cisco, I don't want to get caught holding a stock that might take a long while to come back. Thank goodness for stop losses!

As I say, these are just a few of things I do in an attempt to maximize my invested dollars, while at the same time, trying to keep my risk to a minimum.

Many of the things I do are the result of concepts I learned hanging around the Motley Fool. I have refined these concepts to fit my individual investing style.

The most important Foolish concept I have learned is "don't do what I do". Take the ideas and the understanding that is available to you at the Fool, and apply that information to your individual investment goals. Decide just what your personal risk tolerance is and diversify your portfolio accordingly. Think for yourself. Ask lots and lots of questions. Temper what you read on the discussion boards with your own investing beliefs and understandings. Don't get in a hurry to buy or sell a stock until you have had a chance to learn about the company and the management behind the company. Review the company's finances last. In my opinion, they are the least important part when researching a company. These are the things I found to work best for me.

In reading Ms. Morgenson's article, I was reminded of another very important concept. Never pay attention to an analyst's recommendations. They are almost always self-serving because most analysts are not interested in protecting their clients, they are interested in commissions. If you think of a stock analyst as a used car salesman, it should highlight the most basic of financial concepts...buyer beware.