Investment Catastrophe or Hidden Opportunity?
My Bauman Daily article from August 11 got a lot of positive comments (including one from my boss, which is always nice.)
I wrote about what we call “handholding.” It’s one of the key elements in the job description of an investment writer like myself. It’s not enough to recommend investments. We must guide our subscribers through their ups and downs.
I talked about how to approach a big pullback in a stock position. The bottom line: If the industry and the company have a strong future full of tailwinds, don’t sell.
Today, I decided to continue the theme by addressing another difficult part of an investment writer’s job: the model portfolio.
A model portfolio lists all the current and closed positions in an investment service like The Bauman Letter, Profit Switch and Flashpoint Fortunes (or the exciting new service that “Mr. Bullseye” Clint Lee is about to launch that lets you see a countdown before a stock slingshots upward).
This gives subscribers a view of the service’s track record.
But in a trading environment like 2021, model portfolios can be misleading … especially when they obscure the potential for much better gains.
A Tale of 2 Time Frames
Below are two charts drawn from my Profit Switch model portfolio.
The first shows a disappointing drawdown. It’s a technology company in one of the hottest sectors out there. But thanks to fears of Federal Reserve interest rate hikes, it’s taking a beating, like most of its peers:
Here’s another chart from Profit Switch. If you entered this position in May, you’d be up over 50% right now. You might even have taken some nice profits when the stock broke through to 70% gains from your entry price:
Here’s the thing: These charts show the same stock.
In the Red: Catastrophe or Opportunity?
The natural human tendency when looking at a model portfolio position that’s deeply in the red is to think “stay away!”
That’s when the smart part of “smart and tough” comes into play.
In my earlier article, I recommended that you ask three questions after a big pullback in a stock:
- Does the company’s end market have a bright future?
- Is the company taking advantage of that future, as shown by its performance?
- Are there any external or internal factors that threaten this company?
If the answers are yes, yes and no, I said, then you shouldn’t sell the stock. Doing that puts you on the wrong side of Warren Buffett’s description of the stock market as “a mechanism for transferring wealth from the impatient to the patient.”
But what if you’ve just joined an investment service? That’s when it’s even more important to ask those questions.
Recently a subscriber wrote in to say he’d bought the company in those charts above in mid-May. He took 70% gains on the position twice and continues to hold one-third of his original shares. He’s up 50% on those.
He did that because he carefully considered what I had to say about this company in my weekly webinars. In them:
- I admitted that I had mistimed our entry. I overestimated the sustainability of the stock’s run-up in December last year.
- I emphasized the big increase in the company’s total addressable market even amidst the pandemic. Sales of its product category are skyrocketing all over the world.
- I pointed out the company’s rapidly growing unit sales and revenues. I showed how some of its competitors were falling behind, opening the pathway to even greater future profits.
In effect, those webinars answered the three questions I wrote about last week. Based on that, the subscriber made a great deal of money in short order.
The Golden Rules of Investing
Of course, that may be cold comfort if you bought the stock when I first recommended it.
But if you had followed some simple rules of investing … and thought carefully about my webinar advice … you could have turned what initially looked like a sow’s ear into a silk purse.
Let’s say you doubled your position in the stock at its low in mid-March. You added the same number of shares again in the mid-May dip.
Today, even though the stock is steeply off its initial buy price, you’d be up 20%.
If you didn’t do that, on the other hand … if you invested your entire intended allocation to the stock on Day 1 … you’d be in the red.
That’s why I and all my other colleagues here at Banyan Hill advise you to follow three simple rules:
- Never invest more than you can afford to lose in any one position.
- Set a target allocation for each position. Invest bit by bit. Time those investments for pullbacks if the bull thesis for the stock is intact. That way you lower your average cost basis.
- Let your head rule your heart. Stay well-informed. Read our handholding notes. Watch our weekly videos or read the transcripts.
In other words, don’t base your decisions on the inevitable emotional reaction to the sight of red in the model portfolio.
If the bull thesis for a stock is intact, you can easily turn that red into black in your own portfolio by following the rules above.
Unfortunately, we can’t add buy-the-dip positions to our model portfolios. In times like these, when the market has pulled back waiting for external market developments to unfold, our model portfolios can be highly misleading.
In fact, over-focusing on the model portfolio can obscure excellent gains for you … gains that depend entirely on using your head … and taking advantage of the steady stream of information we send you about our stock picks!