What's wrong with the 18 Losers vs the 18th Winn

Investment Analysis Clubs Saul’s Investing Discussions
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To simplify, the Gardners’ point of view is that if you buy the same amount of 19 stocks and 18 do poorly, and even go to zero, the one that is a 20-bagger will make up for the losses. Therefore you should never sell your losers. That works in theory, and on paper, but in the real world, if it’s a portfolio with your money in it, it doesn’t work at all.

That’s a pretty radical thing to say, so I’ll make clear why it is so.

First of all, if you don’t sell any of the successful stock on its way to becoming a 20-bagger, it soon becomes 70% or 80% of your entire portfolio, as the losers shrink. Now you have a portfolio with 19 stocks but one is 70% of the entire portfolio. Given that even a stock on its way to a 20-bagger will have ups and downs of 30% or more (which would be scary as hell), and you don’t know this stock is fated to become a 20-bagger anyway (we just know that looking back later), you are not going to sleep nights with one stock at 70% or more of your portfolio and bouncing up and down. Not with your real money in the portfolio. You will probably sell some of it at varying points all the way up, keeping the percentage at a maximum of 20%-25% of your portfolio, or maybe less. And the rising stock will thus never balance all the losers.

Add this to the fact that the ones that go down keep sopping up more and more percent of the total investment as you “double down”, “reduce your average cost”, “buy at better value points”, and generally put in more and more money in at lower and lower prices. For example, on the WPRT board, when the price dropped from $32 to $25 lots of people felt it was a bargain, and bought more, and at $20 “doubled down”, and “doubled down” a second time at $15, etc. It’s hard for people to see a stock they believe in go down to what they think are ridiculous levels without buying more (it’s at $4.15 as I write), especially when it’s misleadingly still labeled a “Buy”. They’ve got this winner that is already up to five times what they paid for it, and another “Buy” that is down to 60% what they originally paid for it. Of course they will sell some of the winner that is making them nervous to buy more of the “bargain” stock.

Unfortunately, if you had 18 stocks that went to zero and one that was a 20-bagger, you probably would have ended up putting much more into each of the ones going down than into the one that went up AND you would have sold a lot of the one going up on the way. It’s natural. I’ve done it myself but try hard not to do it any more. Which is why the Gardners’ hypothesis doesn’t work in real life. It’s the difference between a series of recommendations and a real-life, real-money portfolio. JMO

Saul

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Saul, what you left out of this discussion was the 17 that did better than the 18th winner. They rather change the balance of the whole thing.

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But that also means you could have sold and cut your losses on the losers and added them to any of the 18 winners and been far better off.

Buy & hold is not the same as buy & hope. :slight_smile:

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Thank you for being so logical about this!

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Add this to the fact that the ones that go down keep sopping up more and more percent of the total investment as you “double down”, “reduce your average cost”, “buy at better value points”, and generally put in more and more money in at lower and lower prices.

…but the gardner’s don’t advocate that…

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Add this to the fact that the ones that go down keep sopping up more and more percent of the total investment as you “double down”, “reduce your average cost”, “buy at better value points”, and generally put in more and more money in at lower and lower prices.

…but the gardner’s don’t advocate that…

Hi Huibs. Of course not! I’m talking about what happens in a real-world, real-money portfolio, as opposed to a list of recommendations. I wouldn’t dream of thinking that the Gardners would advocate that. But you can go to any board of a stock that is plummeting and read people saying they are doubling down, or buying more at a better value point.
Saul

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I’m talking about what happens in a real-world, real-money portfolio, as opposed to a list of recommendations. I wouldn’t dream of thinking that the Gardners would advocate that. But you can go to any board of a stock that is plummeting and read people saying they are doubling down, or buying more at a better value point.

…yes, very true, unfortunately…

…I typically buy once, and hold…I don’t recall ever averaging down…

…I do buy up on occasion, normally from exercising short puts…

…after a few years I have a look, and if a company has turned to crud, I’ll sell it and move on…I don’t care about ‘baggers’, and concentrate on the ‘whole’ of my portfolio, rather than each individual part…see the ‘forest for the trees’ approach…

…adding to losers is like putting fertilizer on a dead tree, when it’s much better served on a living tree…and those dead trees can lay there for awhile, I can cut them up later…

…folks should see their portfolios as living, breathing things, that take time to build, there should be no rush, either in or out…

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But you can go to any board of a stock that is plummeting and read people saying they are doubling down, or buying more at a better value point.

I think some of the people that decide to buy at a better value point as a stock price plummets are not using that phrase as originally intended. I may be wrong but I think that is a Tom E phrase or at least popularized by him. My reading of his meaning of a better value point is that a stocks price has continued to rise or trade in a range but over time earnings have gone up even faster than the share price creating a better value point. A declining share price can offer a better value point but the decline is not a result of deteriorating earnings or business fundamentals but short term FUD. A good example of that was Chipotle a few years back. Priced for perfection and a prominent short seller making a public bear case against Chipotle the share price went down significantly, business was still performing well, that provided a better value point. Chipotle has more than doubled since, back to priced for perfection.

If you have a SA subscription he discusses his approach to buying at better value points in a lot more detail in the following thread. It is a long thread so scroll thru for his posts if you do not have time to read the whole thing.

http://discussion.fool.com/1081/tom-e-superstock-addition-316356…

If you have an RB sub here is a link to his page post around the time the price crashed. He pointed out some other short term problems, drought and Europe. His tone, however, is someone very excited about the opportunity.

http://discussion.fool.com/1069/cmg-page-18-30168406.aspx?result…

So I have the next Tom E post on CMG here, RB sub required. Taco Bell was being brought up as a concern back then, there was also some slowing growth. The conclusion is an interesting read as it shows how patient he is waiting for these opportunities.

http://discussion.fool.com/1069/cmg-page-18-30168406.aspx?result…

Maybe I over did it but I am trying to show that he has looked at all the FUD weighing on the stock, reasoned it is short term creating a better value point and he is patient waiting for them. CMG has gone up around 170% since this last post. Other stocks plummet for good reason.

I am sure others have read more of Tom E than I so if I have that wrong please correct me.

1dms - long Tom E, Saul, and a lot of other great writers around these boards.

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Hi Huibs. Of course not! I’m talking about what happens in a real-world, real-money portfolio, as opposed to a list of recommendations. I wouldn’t dream of thinking that the Gardners would advocate that. But you can go to any board of a stock that is plummeting and read people saying they are doubling down, or buying more at a better value point.
Saul

I am sure even if TMF recommends a sell, people will hold and buy if they see the price goes lower. There will be many that bought some of the stocks discussed here that you once bought and exited yet continued to buy as they went lower. I do recall quite a few posts where posters bought AEYE at when it dropped even after you sold it.

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You can’t judge TMF by what Fools do with their recommendations.

Denny Schlesinger

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I don’t subscribe to any of the paid MF services but I do get lots of promotional material in my mail. Today’s caught my attention – twice!

But the truth is that too many investors live in fear of losing.

This got me interested enough to continue reading. I know lots of people who live with that kind of fear. Some people won’t take sales jobs because they prefer a steady income to a potentially larger but unsteady one. I asked for a transfer to sales because I felt I was not paid enough as a technician who did all the work for the sales reps. They wouldn’t give me a raise so I switched.

Then I came to this:

As David wrote in a recent issue of his newsletter service, a whopping 18 of his Stock Advisor recommendations have lost 50% or more of their value. Those 18 picks — “big failures,” in David’s words — must have devastated his total returns, right?

The “18” could’t be a coincidence. That article must have triggered this thread. It turns out that David’s portfolio does not have 19 stocks but over 36 stocks.

This is David’s argument:

“By the same token, let’s look at our 18th-best performer, Hasbro. That April 2003 selection is up … 460%,” David explains. “And this is the key to the mathematics of success: The return of our 18th-best performer on its own equates to wiping out almost half of all those 50%-plus losers. And of course, that’s our 18th best. We have 17 recommendations that tell an even sweeter tale.”

The 18th best can wipe out half the loses of all 18 worst! But this can only happen if you don’t “rebalance” your portfolio. When you rebalance you sell your best performers! Or as Peter Lynch puts it: “You cut your flowers and water your weeds.”

I’ve always held that it is not a good idea to mix and match various investing strategies. For example, stop-loss orders are a trader’s tool that has no place in an investor’s portfolio. You have to evaluate David’s portfolio philosophy holistically, not stock by stock. It has to work in its entirety.

Which brings me to another idea. Investors crunch an awful lot of data giving minute attention to detail. This is the investor’s version of “reductionism” which has worked so well in the hard sciences. But in complex systems like markets you can’t predict the future from present conditions like you can the return of comets or the occurrence of eclipses. To look at investing holistically you have to look at the big picture, at price charts. While certainly not predictive like planetary orbits, there is enough information in prices to swing the odds in one’s favor. And I don’t discard reductionism entirely. Reductionism can discover red flags like excessive debt, a lack of earnings, and stock option abuse that would keep you out of otherwise good looking stocks (good looking charts).

I have a confession to make: last year I allowed one of my stocks to become half my portfolio. This year I’ve cut it back to 40% and I plan to cut it further because growth has slowed. But if growth returns, I will let it grow while taking profits. Like harvesting a fruit tree, you pick the fruit but let the branches grow*.

Denny Schlesinger

  • This is not universally true. For example, they keep avocado trees small enough that they can be hand harvested.
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Danny,

Are you willing to reveal which stock you allowed to become 40% of your portfolio and why? These investing tales are fascinating and can be highly educational.

Thanks,
Vic

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Are you willing to reveal which stock you allowed to become 40% of your portfolio and why? These investing tales are fascinating and can be highly educational.

Vic, let me think about it. Revealing a stock ticker is not enough. I would have to add my reasons and it’s a position that has developed over more than four years. No instant gratification.

Thanks for asking,

Denny Schlesinger