Post of the Day - The BMW Method
Re: Limit Orders & Entry Points?

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By captainccs
January 12, 2007

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The one thing I have learned here, is that the real strong CAGR, on average, comes from buying near that gutter price.


Ain't that the truth! This is the reason why I like doubling down so much. Since short term prices resemble a drunk doing the random walk, you have no idea if today's price is the bottom. If you have made sure you are past the bottom for reasons of safety, well, you can't buy at the bottom, you have to be content to feel safe at the higher price. But if you start buying before the bottom is in, you can buy lower and lower until you hit that coveted bottom.

Now I'm going to reveal to you a secret that has never before been revealed to the investing public. (I always wanted to write copy like they do in those stock market come-on newsletters and this was my chance to do it! hahaha)

Everyone knows that the lower you buy the better your returns will be. What most people don't realize is how much better they really are and that is the secret I'm about to convey to you. A 10% drop in purchase price can add over 50% to your CAGR and a 15% drop can double your personal CAGR.

                              1 year    Yield     Increased
Discount   Price    Target  CAGR   CAGR
  None      10.00    12.00     20.0
   10%       9.00     12.00     33.3      66.5%
   15%       8.50     12.00     41.2     106.0%

And that is not all, the lower purchase price is even more important with slow growth stocks. For a stock that has a lower avg. CAGR your improvement as you get closer to the bottom is even more dramatic.

                     1 year    Yield   Increased
Discount    Price    Target     CAGR      CAGR

  None      10.00     11.00     10.0
   10%       9.00     11.00     22.2     122.0%
   15%       8.50     11.00     29.4     194.0%

Now let's talk a moment about portfolio management. You don't want to have an unbalanced portfolio -- one that does not follow the healthy rules of diversification. I'm going to use our portfolio's NOK purchases as an example. I consider that at 30% of the portfolio we have way too much NOK and, as it has turned out, its CAGR is not all that great. We could have solved two problems with just one sale. Had we sold the first 700 shares at $20 we would have a more reasonable amount of NOK in the portfolio and, since it was purchased at a much lower cost, this portion will yield a lot higher CAGR.

One of my favorite quotes from all my years at the Fool came from Bill Mann (TomG's Hidden Gems right hand man) when he said (paraphrasing) "Almost all of my best-returning investments I bought when the market was pounding on them. I would literally get sick when I pulled the trigger." I have found this to be very true for me, and as far as the churning stomach, that's what Alka-Seltzer is for.

This is where proper due diligence comes in, you have to be able to separate the wheat from the chaff, the investment grade stock from speculation. The BMW Method is very good at this because it insists that only market proven stocks are worth buying. All the BMW Method stocks have earned Main Street's Market Seal of Approval. Just as we can trust the 3M brand of products, we can trust the MMM stock. But this trust has to be backed up with due diligence. Has something changed to make us doubt about the old timer? As an example, we do think that the Internet is disrupting traditional newspaper markets so maybe we should stay away from New York Times and The Washington Post shares no matter how tempting their low RMS.

Let me use Boston Scientific (BSX) as an example to sum up this whole post. I have been watching the company for a long time. It is not the leader in its field, it has lots of competition from JNJ, MDT, St. Jude (STJ) and others. But sooner or later it will become a buying opportunity because some convergence of Main Street and Wall Street market conditions will make it happen. It did: They ran into problem with drug eluting stents, they apparently overpaid for Guidant and, as the share price dropped, security analysts downgraded the stock to STRONG SELL. Now, if this combination does not drive out all weak hands, nothing will. And this is where we come in. The question to ask at that point is simple: "Will Boston Scientific go broke or will they fix their problems?" Despite all the bad news, nowhere does it say that they will go belly up, they will have earnings pressure from the overpriced Guidant and other issues, but, since the market is a discounting machine, all those bad news have been priced into the current price. The great difference between BSX and DRL is that in the case of DRL bankruptcy or buyout, are real possibilities and both are CAGR killers! BSX, on the contrary, is free to revert to mean.

I find IcyWolf's board persona most appropriate for a stock market investor: the hunter. How many of you have watched lions hunting on Discovery Channel? Has it ever occurred to you that the King of the Jungle never gets the head antelope for dinner? The King is quite happy to make a meal out of a sickly, weak and slow antelope. And that is exactly what we do with the BMW Method, we stalk the herd of stocks and we pick off the laggards. Then we settle down to digest them by doubling down.

There is another lesson we can learn from the King of the Jungle, he spends most of his time just lazing around, stretching and enjoying life.

Denny Schlesinger

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