Monday, September 2, 2013

Looking For The Sure Thing

There is no sure thing in the stock market, but there is a way to invest with a margin of safety.

A sure thing is something that is going to happen no matter what. One sure thing is that five years is going to pass regardless of what we do with our lives.

If we know X company will likely be bigger, stronger and more profitable five years from now, then we should own shares in it and let time work for us.

The surest and safest form of investing is picking a company that owns a near-monopoly market share in its industry, has a strong balance sheet and is trading at a discount to its true worth. The company's earnings must continuously grow over time. The company must have the ability to raise prices. The stock must not be overvalued on a fundamental basis compared to its peers. And the downside risks must be minimal and manageable. Very few stocks meet all this criteria. 

I'm not a market timer. However, extreme levels of fear or greed will give opportunities for investors. Panic-driven selling in 2008 and 2009 gave me a lot of opportunities. With stocks trading at or near historic highs in 2013, investors are wise to be patient and wait for an opportunity. I believe it is better to do one good deal in a year than to do 12 marginal deals that lead to losses.

I am not a day trader. Day trading is a fool's game. It takes a lot of skill to trade with any success at all. I've met several traders who lost money trading stocks. 

By the time retail investors hear about a stock, it's often too late, the stock has already run up. The retail investor will buy the stock at a high, watch it fall 7%, panic and sell out.

I favor buy-and-hold long-term investing. 

I never short stocks. Shorting stocks is much riskier than what I am willing to take on for myself. A person who shorts a stock at a price of 150 must deliver the stock at a future price; what if the stock goes to 220? That person takes a huge loss of $70 per share to acquire and deliver the stock. Never short a stock that is growing sales and earnings at double-digit growth rates. If you have to short a stock, short a bad company getting worse. 

If I truly believe a company is going to execute its business plan, reach and exceed sales and earnings goals, and reward shareholders along the way, then I am going to hold onto that stock. When stocks reach new highs, I rarely sell. I accept that there will be downturns and try to buy more on the dips.

I never borrow money to buy stocks. What if my investment thesis is wrong? I would hate to owe money on a trade that went south. 

I know several successful investors who made decent stock investments many years ago, held onto those stocks through thick and thin and today those stocks are worth quite a bit of money. The key to their success? Low trading. They held on and added to their positions over time.

There is no sure thing, but I know these techniques work for the Careful, Patient and Thoughtful Investor. I used these techniques to acquire Union Pacific Corp. (NYSE: UNP).

The Railroad Play

In September 2011, CNN and other news outlets published stories saying a "double-dip recession is imminent."

Economically sensitive stocks such as transportation stocks fell 10% to 15% on such news. But I checked stats with the Association of American Railroads that showed U.S. rail traffic growing at about 1.1% week ended Sept. 24, 2011, compared with traffic in the same week the year before.

The economy isn't going backwards if railroads are hauling more freight, I thought. Union Pacific was trading at the time around 12 forward P/E, but was growing earnings at a double-digit pace annually. The company has a domineering position in transportation. It would be virtually impossible to create a competing railroad through the same geographies as Union Pacific.  The company's financials were solid and it could afford to pay and even raise its dividend. So I loaded up Union Pacific at $85 and $88 declaring this a "Conviction Buy."

Shortly thereafter, fears of a double dip recession receded. Transportation stocks went back up.

It's rare that I feel a "conviction buy" about any stock, but UNP was a fantastic investment and remains a hold today.

The Bottom Line

The patient and thoughtful investor watches and waits for the right opportunity. He focuses on executing one good deal at a time. This may take  months of patient observation, reading and analysis. The investor knows  he may be wrong, but invests with a margin of safety, just in case his original thesis doesn't work.

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