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Tuesday, July 24, 2007


Investing - Part 4

On June 23, 1992, I called my broker and put in a buy order for 200 shares of a company he had never heard of, Dell Computer. The order was executed at a price of $15.75. I had read about Dell in Forbes Magazine, an article that described its then unique approach to selling personal computers direct to consumers. The idea of a cheaper clone of an IBM computer, that could be shipped back for repairs if necessary, made a lot of sense to me. I also thought that the approach would work with corporate buyers as well.

Pretty soon I changed employers, and was now in a position to influence the purchase of computers for our company. Though our orders would be small, I was concerned that there was an inherent conflict between my small investment and my job responsibility. Besides, I knew it would be best for my company to make its purchases from Dell and wanted to make that recommendation. Since the stock was up anyway, it seemed that I should sell and remove any taint of conflict. On August 11, 1992, I sold the 200 shares for 22.50, making about a 35% gain net of commissions in the month and a half I owned the stock. I then felt at ease introducing my company to Dell, and within a couple of years, Dells were springing up throughout the Enterprise, but by then, we were hardly unique in that regard.

Since Dell was off the buy list, because of the conflict, I never looked back until some years later, when I realized that a small fortune had gotten away that August. The stock split 2 for 1 six times between October 1995 and March 1999. At its peak in 2000, the stock traded for nearly $60 POST SPLITS! So if I had kept my 200 shares, which would have been 12,800 shares after 6 splits, my initial $3,150 investment would have grown to about $750,000.

Putting aside any other reasons for selling, I realized that I had to do something about the sell decision. I remember being pretty smug about that not insignificant short term gain I made at the time. I think my broker's comment was that "no one ever went broke taking a profit." Thanks, coach. Even if I hadn't sold then, is there any reason to believe I would have kept even a few shares for the bulk of that joyous ride that went on for almost 8 years? And if I had, would I have been able to act once the market broke in 2000? I didn't really think so, looking at things objectively and knowing the emotions I go through on every sell decision.

When the 2000 market break hit, most of my portfolio took the same brutal beating everyone else's did, but I was very lucky since the bulk of my assets were in my former company which was taken over in 1998 at a favorable price, and I had kept a lot of cash going into the market top. Another buyout or two got me through the market break with gains overall, but I realized a few things that I wanted to change:

I needed both a buy discipline and a sell discipline, but especially the latter; I had to take the emotion out of my trading decisions.
I needed to pay attention to the risk in the portfolio; diversification was not enough. I had to force myself to buy some stocks with sound balance sheets to go along with the growth issues I had bought during the tech run-up.
I needed to unwind all my option positions, and stop all option transactions, both hedges and speculative bets.
I needed to figure out a way to keep the portfolio changing while still emphasizing a long-term strategy. That meant more frequent but smaller transactions and required the use of a discount broker.
I needed to incorporate my newly found appreciation for carrying a cash balance as the ultimate hedge against down markets.

So the formula was born and evolved to meet these objectives. In short, it is a mechanical black box that allows for my stock selection ability to come to the fore while recognizing my inherent weaknesses as a trader. Most of all it is logical in its formulation to meet the above objectives while driving a tendency to buy low and sell high, which is the goal of every investor. You can review it to see how it meets these objectives by going back to part 3 of this series.

As in most exercises, serendipity plays a big part in the success or failure we achieve, more than most of us care to admit about our successes. There are so many tales analogous to the Dell story I could relate that illustrate good trades and bad, good fortune and bad, and perhaps in some other post, I might include one or two. I'd rather discuss them in person over a vodka martini. These stories are not unlike the "big fish that got away" or the "time I made a hole-in- one," etc. Usually dull for everyone but the narrator.

One more thing about serendipity - we all know that Branch Rickey famously said "Luck is the residue of design." So the final goal of the formula is to put luck in my corner more often than not. We are getting a good test this week, but over my investing years, I would say luck has been more favorable than not.

There will be one more post in this series where I answer readers questions already received and try to anticipate others that readers may have. Then it will be back to more important things: politics, international conspiracies, popular culture, martinis, education, health insurance, wine, sports, golf, poker and oh yes, did I say martinis?


Today, I bought 700 shares of Sirius Satellite Radio (SIRI) for 3.19, clearly a "0 buy" as the smallest position in the portfolio (before today). Before anyone even gets to send me an e-mail to ask how this dog can possibly still be on the buy/hold list, the answer is that it will be as long as Mel is in charge, and I do think the merger with XM will be approved, removing the cost pressure because of the current competition for talent.

Remember, redwavemusings is not an investment advisor, neither is its author, and you should not assume that the securities mentioned here would be suitable for you (or anyone else, for that matter).

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