Stock market ups and downs.... How to find the "ups" among the "downs" !

Hi Gordon!

Great story! :)

It really shows something... It shows that even when the market indices are down, not ALL stocks are down. In fact, some go up!

If you know how to pick the right stocks, you don't have to fear. You can invest with security and confidence. That's the way I like to invest....

But first, the shocking news! Then I'll explain how to invest with security and confidence. :)

I was shocked about a week ago to read that out of the top 35 or so market indices world wide, about 28 of them were down over the year for 2000. These indices are the famous American ones -- like the Dow Jones indes, the S&P 500, as well as overseas indices, like the ASX index here in Australia. Most were DOWN over the course of the year!

Why was I shocked? It's because I tend to only look at my own stocks.... and all my stocks were up! I had no idea things were so bad, because I was doing so well. I've made great profits over the last year in my stock market investments....

So, while some others are in turmoil, I'm feeling very secure. I invest based on the fundamentals of a company, and I also try to pick companies which are already undervalued in their price.

Here's one example, to help explain things..... I don't invest very often, but when I do I first do my homework.

My last investment was to buy shares in Resmed (RMD) -- listed on both the NYSE and also on the ASX in Australia. Look it up if you like.

In the FIVE months I've had Resmed shares, they've gone up in price around 48%. You can look it up yourself on one of the various stock market web sites. I'm quite happy about that.... and I STILL think they are undervalued, so I'm holding on to my shares.

In fact, ALL my shares went up (in Resmed, and in the other companies I have shares in). I just mention Resmed because it was my most recent purchase. (It was also my best performer, though the others weren't far behind.)

Here's how I invest with security and confidence, for those who might want to try this approach too....

First, I like to take a long term view. I see purchasing shares as buying a part of a business.

If I bought part of a small business, I probably wouldn't buy it one day, sell it the next, then buy it again. I'd probably hold it for a while, and I treat shares the same way. That's because, buying shares really is buying part of a business.

Secondly, I check to see if the company is making a profit. (You can find this data in their annual financial reports, often bundled in with the annual report.)

If the company isn't making a profit, I immediately reject it. It may mean I miss out on some profits, but I like to look for safety and security in what I buy, so I look for companies which are already making solid profits.

(I didn't buy any internet shares based mostly on this. I saw that most of them weren't making any profits, and that they were speculative buys, so I didn't buy any of them.)

Thirdly, I look at the company's profits for the past 5 to 10 years. What's the trend? Do their profits stay the same? Do they go in a cycle? Or do they keep going up? I look for companies whose profits have a trend of going up EVERY year.

Fourthly, I try to figure out why the company's profits keep going up. Is there a logical reason for it? If so, is it likely to continue? That is, I really try to understand the guts of the business.

Fifthly and finally, I do some calculations, based on the tables you can find in the back of "The Warren Buffett Way" by Robert Hagstrom, Jr. Unfortunately, he doesn't really explain what he's doing there, I had to go through it and figure it out myself.... The point of this step is to see if the company is undervalued or overvalued. If it is significantly undervalued, then I'll consider buying it, but if it is overvalued, I don't.

For example, let me go through it using Resmed as an example.

I did my own analysis of Resmed around six months ago. Here are the conclusions about Resmed which caused me to buy shares in it....

I got Resmed's annual report -- available free from their web site, www.resmed.com . Many listed companies nowadays have their annual reports available online in PDF format.

I checked if Resmed was making a profit, and they were. They passed that test!

Then I looked at their past profits. I calculated at the time that Resmed was INCREASING its profits by an average of about 40% every year. That's a very big increase! Another pass!

Then, I looked more closely at Resmed's business. They are the second largest manufacturer of devices which help with a problem called sleep apnea. That's a medical condition where you stop breathing in the middle of the night, it's often associated with snoring. (Their main competitor is a company called Respironics.)

Anyway, sleep apnea is a problem which could not be treated until very recently, with the invention of these devices. Sleep apnea is a relatively common problem. Because of this, the market for these devices is huge, and that's why they have been selling more and more of their devices every year.

I felt that this was the main source of their increasing profits every year. I think they are still a long way from saturating the market. By my estimates, the market should keep growing for a long time to come, as awareness of these devices increases.

Lastly, I did my financial analysis, to see if Resmed was undervalued. My analysis said it was, so I bought the shares! Although they've gone up in price by about 48% since I bought them, I still believe Resmed shares are significantly undervalued, based on my analysis....

I hope this helps you to also invest with security and confidence too.... :)

Here are the steps again....

1. Take a long term view. Intend to hold your shares for five years or more.

2. Is the company making a profit? If NOT, reject it.

3. Is the company increasing its profits every year? If NOT, find one which is.

4. What is the reason WHY its profits increase every year? Try to understand it. Does it seem likely that the profits will continue to increase?

5. Calculate to see if it is undervalued. If it is significantly undervalued, then buy!

By the way, Steps 4 and 5 are the toughest parts for most people. Almost everyone can do steps 1 to 3.

If you can't do step 4, and don't understand how the business works and why their profits are increasing, then it is probably better to look at businesses you feel that you can understand.

Even if you can just do steps 1 to 4 (without step 5), you'll still probably do alright if you take a long term approach, and hold them long enough, and if you didn't make any big mistakes in your analysis.

But if you're mathematically inclined, you can do step 5 by looking at the tables in the back of "The Warren Buffett Way" and trying to work out what he's doing.

Or alternatively, if you have problems with step 4 or 5, you can invest in my upcoming investment company. :) Gordon recommended that I start one, and I'm going to do it!

Happy investing in 2001, with security and confidence!

Oh yes, and when the market is down, it can be a good time to pick up some bargains.... :)

- Dien Rice

This is really part of step four.... WHY are they increasing their profits every year?

One of the things I look for is a company with some kind of monopoly or strong franchise....

This is an important point for investing with security and confidence.

A company with a monopoly-like position, or a strong brand name, in a product that people really want, is in a very powerful position to control the prices of their products. Otherwise, their profits can be eaten away through price-competition.

So, in general, I prefer to avoid companies which produce commodity-type products (like steel or wool), where it is easy to replace the products from one company, with the products from another.

Instead, I look for monopoly-type positions (such as a monopoly through intellectual property), or strong brands, so it is harder for their profits to be eaten away by the competition.

If this is the case with a company, and if it also passes all the other checks I mentioned before, then I can invest in it with security and confidence!

- Dien Rice

Hi Dien!

I was so thrilled to read your two preceding posts. I am looking into stepping into the investment arena this year and you DEFINITELY gave me some food for thought.

Thank you from the bottom of my heart...and hopefully from an ever growing bank account!

With Purpose and Passion,

JULIE JORDAN SCOTT


Dare to Discover Your Passion, Decide to Live Your Destiny!

Julie, I recommend you read this book if you have not already, it is called Against The Gods, despite the title which may be a little misleading it is a book about investing and the history and pyschology of risk. It is one of the best books I have read about investment. I wish my MBA program made it required reading anyway one basic thrust of the book is that most of the time investment managers with all their technology can't beat the market indexes like the Dow and others on any consistent basis. I think what this means for you from my understanding of the book:

1)Don't pay for management expertise on any long term basis because you could probably have better returns than them, so no front end or back loaded mutual funds, ok? go for no-load mutual funds

2)Most things regress to the mean over time, what it means to you is that after awhile price that are sky high will eventually go down often towards their historical averages and the opposite also things that are very low soon will rise again often toward their historical averages.

One neat tip from the book is some research on mutual funds look for funds that are were down the previous year and are now up in value usually fund managers can ride this momemtum for about 3 years before we see regression to the mean so you can find funds like this ride it for two years, take your cash out then ride another one, let me say in theory that is.

Buy the book, it's great stuff and too techy for all those non present value laplace transform calculus types.




Mike Enlow, high school dropout and ex-private eye now internet guru get his free offer

Also Julie check out the bob brinker radio show, he has been on for years, clear honest investment advice without the hype. He is probably on in your area, in south florida we get saturdays and sundays live, he also has a web site with good info and a newsletter.

Julie my wife got turned to investing by listening to this guy.

Can you tell I think their is a lot of hype?

Hi Julie!

I'm thrilled and pleased as punch that you liked my post! :)

I've been investing in the stock market for about four years now, and I haven't lost money yet on any of my investments.... I expect that one day I probably will make a poor call (it has to happen sooner or later), but I feel that I have a quite safe and successful approach.... It's mostly based on the book, "The Warren Buffett Way."

I had to buy myself a "business dictionary" to learn some of the financial jargon, but I'm glad I did. :)

I take heart from the fact that it does resemble what Warren Buffett does, and he has possibly the best investment record around! :)

Here's why (I believe) it works....

Not everyone who invests, invests in a rational way. This means that often the price of a stock can be driven too high, or too low, due to irrational greed or fears.

The essence of the method I use is to try to identify when a stock is priced too low, given the basics of the company....

However, being able to tell the "worth" of a company depends on certain factors. So, I am really only looking at a small subset of companies, those with profit growth rates that seem to be roughly predictable. Then you can use this data to calculate a "worth" for the company, and get some idea as to whether it is undervalued or not....

Other companies, like those which are not making profits, also have a "worth," but it is much more difficult to tell what this "worth" is since you don't know if they'll be making profits in the future, or what those profits will be. That's basically why I exclude these companies from my analysis....

Anyway, I'm thrilled you enjoyed it! I tend to average I think around a 50% return per year.... (I haven't calculated it recently, but just in the last year I'm easily beating that.)

I *expect* that in the long run I can probably get at least a 30% average return (I'm trying to be conservative in my estimates)....

As a small investor, you have many advantages that the mutual funds don't have.

For example, mutual funds often are required to spread their investments around into thousands of stocks, across a wide range of sectors. I prefer to identify the *extremely* promising companies which are highly undervalued, and put most of my money into a few of these highly promising, highly undervalued companies, with the belief that their "true" value will become apparent in the long run.

I follow Warren Buffett's advice to "put your eggs in one basket, but watch that basket!" Fund managers don't have the luxury of doing this....

Also, as a small investor you can put your money into smaller companies, which are too small for the funds. This means that you have more opportunities open to you....

It's something I enjoy, and I'm pleased with how things have gone so far, in the four years since I started investing.... :)

- Dien

P.S. On a deeper level of economic theory, economics often uses the "efficient market hypothesis." This is essentially the assumption that everyone has equal access to information, and that everyone in the market behaves rationally in their own self-interest.

However, in the stock market, MANY people often don't behave rationally. I believe that the "efficient market hypothesis" is wrong. People behave irrationally -- they often over-react due to greed and fear. (The internet stock market bubble was an example of this, and it follows in the patterns of previous stock market bubbles.) The method I outlined takes advantage of those inefficiencies in the market.

This thought about the falsehood of the "efficient market hypothesis" isn't original to me -- I'm just echoing Warren Buffett's wisdom.... However, it makes sense to me.

If everyone behaved rationally, nobody would ever buy a lottery ticket, or gamble at most casino games, since the odds are that you'll lose your money. But we know what really happens.... People pour their money into lotteries and casinos, even though economically this is irrational behavior....

Hi Garth,

> Can you tell I think their is a lot of hype?

I agree that there's a lot of hype....

Before I started investing, I read very deeply about it for perhaps about a year. During this period, I came across an interesting university textbook about investing. (Unfortunately, I don't remember its name...)

In the textbook, they referred to a university study which was done on various methods of "stock picking." They analyzed most of the well-known techniques, like the Elliot Wave theory, technical analysis, etc., as well as the approach by Benjamin Graham.

(I think the study was done in the mid-1980s if I remember right, so no "Warren Buffett" approach was included, since none of the books about Buffett's approach which we have now had been published yet.)

They applied these approaches to the stock market for a period of a year or two, then checked their results. The results were stunning.

They found that *all* the approaches they tested did no better than throwing darts at a list of company names -- with the EXCEPTION of one method. That exception was Benjamin Graham's approach.

Benjamin Graham's approach is to look at undervalued stocks. Graham was also Warren Buffett's mentor, and Warren Buffett has described his own investment approach as 75% Benjamin Graham, and 25% Philip Fisher.

Anyway, when I read that, I stopped reading about other methods, and focused just on the Benjamin Graham / Warren Buffett approach to investment.

- Dien