Rules for Investing & Divesting

This post is a little bit complicated to make. I will bring it into the regular flow of the text but it will also be placed on the side as its own page. The rules will also change of time. New will be added and old ones might even be removed if found useless.
Many investors, Warren Buffett especially, is frequently saying that the first rule is not to loose money. The second rule is never to forget the first rule. I would say that this is highly personality based. Do you care more about winning or do you care more about not loosing? I care about not loosing. However I do not see how a rule saying to not to loose money will help me be to make better investments. Maybe later on in life when I am older and wiser I will be able to create fewer rules which will only be the two ones above, since all the others will be so obvious to me, but I am far from that point and need to more strictly regulate myself and my way of acting.

My never list:

1. Never buy stocks in IPOs (initial public offerings) - You will not be able to buy them early enough and you will definitely not be able to sell them soon enough. After the rush is over, if it is a good company, then there will be cheaper moments to buy a part of that company with a higher potential value increase without the risk of being too late in selling the stocks.
2. Never buy stocks during a litigation. The outcome is not clear and especially not how the market will respond to this outcome. There will be moments, once the litigation is over and if the company is good, to buy part of it at a reduced price.
3. Never bet real money on a new or old financial product just to see how it works. There are sufficient ways to be able to test the new products with virtual money and with virtual stock portfolios. Hopefully you will in the meantime learn how the product works AND hopefully the virtual portfolio will go bad. Problem might be that in a bull market every product works out... for some time...
4. Never buy stocks based on what your neighbour, colleague, hairdresser or the stockbroker said. Investigate the company they mentioned and make up your own mind. In a very high percentage these companies are pure speculation.
5. Never speculate but own the companies. Buy their products, try to go the shareholders meeting. If you cannot then at least try to vote (many times easy today due to internet). If there is something you do not like then send a suggestion to the shareholders meeting that you and the rest of the company owners can vote about.
6. Never pay high fees for your financial products. If you invest in an index fund then the maximum cost is 0.5% per year. Every percentage point fee eats up your profit.
7. Never invest more money into a company where the stock is dropping due to poor results. Wait until a good quarter or half year report arrives before even considering a re-investment.
8. Never invest in a company that have not been at least five years on the stock exchange so that they have been forced to file, hopefully, more accurate financial statements.
9. Never invest in companies that have their largest part of business in a country that does not apply to regulations similar to the country that I currently live in.

When it comes to investments I must say that I am thorn in half. I have ended up using several different strategies for buying stocks which then also means that I have several different strategies for when to sell it. For that reason I will only put up some general matters here and then for each and every stock write the reasons for buying and when I will try to sell it. In many cases I try to combine as many of the parameters as possible for getting hopefully better companies in my portfolio.

My rules of Investing:

1. as low P/E as possible unless for when it is a cyclic company having a very good year.
2. as low P/B as possible because, if possible, I want to get 1 euro for 50 cents.
3. Company pushed down due to either temporary bad name or that the specific industrial group is pushed down. This can be due to that they have done bad business or that the industrial group is in the downside/bottom of the cycle.
4. High dividend payment that is not a one-time occasion. This leads to a very easy investment strategy especially in countries where they pay dividends each quarter.
5. Growth companies with high potential. Go to your local shopping mall and see where the people are going. Check out the finances of the company and if it is good then buy it.

My rules of Divesting:

1. A highly simplified version of Benjamin Grahams formula. When the company reaches P/E = 8.5+2*g (g =expected yearly growth in % for the next couple of years) then the company is close to its real value and it is time to consider a sale of the stock.
2. P/B reaches 1. This does not mean that the stock should be sold but now at least the market gives the company the same value as what is in the books. Based on industrial group different P/Bs are widely accepted and an acceptable P/B ratio should be set. Personally I always look at the combination of P/E and P/B which means that once P/B is reached I will look at the P/E before making a sale.
3. When the companies name/industrial group has been re-established on the market then consider a sale.
4. When the dividend payment drops below a %-age then sell it and buy a new high dividend paying stock. The dividend payment %-age varies widely between different countries therefore one must make a fixed value for each owned company bought according to that principle.
5. When people stop going to the store then start to consider to sell the stock.
6. When a company change their fundamentals in a direction that I do not agree with then directly sell the shares. 
7. When the managers are proven or known to be crooks then sell the company. 

What I try to accomplish is a bit of a contrarian strategy. I know that I am not clever enough to find all the advantages/disadvantages that companies might have in their books. Since I am not born in Germany I also do not have the gift of "circle of competence" meaning that I did not grow up with all these companies around me and therefore do not have the built in knowledge of if a company is good or bad and how long they have been either. I therefore must base things on other set of rules. I do however continuously try to improve my knowledge about the German and other companies but I am still far, far away from any native German.

Final rule: If I do not beat DAX in 5 years time then 50% of my portfolio value will be relocated into an index fond. If I also do not beat DAX in 10 years then 75% of my portfolio value will be relocated into an index fund. If I after 15 years still are the big loser then I must accept that and shuffle all of it into a low cost index fund. I will keep my fingers crossed!


Clay said...

Interesting. Personally, I would not get too fixated on the numbers. I am unsure about how accounting works in Europe, but in the US, book values on record are a very questionable figure. P/E ratios are the same way. At the end of the day, every investment is situational. For example, the construction industry in the US went through a major downturn a couple of years ago. Nobody was making money. Sure enough, stock prices for construction companies tanked. However, it would be foolish for anybody to say that we would never build another building, ever. My largest position is in a company that has been treading water for the past few years. Granted, it is "losing my money" right now, but I'm not worried about it, it'll be just fine. Construction is here to stay, people just aren't convinced yet.

I think a refined focus on fundamental analysis would take your investing skills to a new level.

Fredrik von Oberhausen said...

Hi Clay,

Thanks for your feedback!

You are indeed true that the books can very easily be cooked in one or the other direction. Industries and companies that one believe in one should simply step in when they are being traded cheap, which has like you say not always has something to do with P/E. Cyclical companies will frequently make very bad years.

I have in the end several companies in my portfolio that I would never have bought if I would have only looked at the P/E.

My two banks DB and Commerzbank was bought for contrarian reasons without looking on the P/E at all. I have no concerns with them just like you with your construction companies. They will survive, they will make money and they will be good to us!

I have bought a company in Ukraine and I have been buying more with the share price drop due to the war. Nations might not survive but companies will...

When the potash / fertilizer fight started between Uralkali and Belaruskali then I stepped in and bought the German Potash producer K+S since the share price dropped like a stone.

But you are correct. Currently I run a mixture between strategies and maybe I should think about fine tuning it but I am still wet behind the ears and therefore I still try some different strategies to see which one fits me the best.