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Value Investment Institute


JEast
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Very good article titled 'What happened to my Margin of Safety?" that goes into what some of us have surely experienced in buying deep value stocks.  Mainly the theme that the stock tanks after you buy it and then you question your analysis and you get paralyzed into neither buying more or selling your position.

 

http://www.valueinstitute.org/viewarticle.asp?idIssue=1&idStory=120

 

Cheers

JEast

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Already posted here earlier this week but thanks anyway. ;)

 

Like someone said before, he would have done great if he bought more. I personally don't mind buying more aggressively as long as the fundamentals don't change but I have noticed that generally I'm way too early. When I buy a stock and it drops another 10% I get all excited, only to see it drop another 20%+.

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Already posted here earlier this week but thanks anyway. ;)

 

Like someone said before, he would have done great if he bought more. I personally don't mind buying more aggressively as long as the fundamentals don't change but I have noticed that generally I'm way too early. When I buy a stock and it drops another 10% I get all excited, only to see it drop another 20%+.

People say this often, but are you sure it's not some form of selection bias perhaps from loss aversion? I have half a dozen of quite small positions in my portfolio that never grew bigger because they ran up a lot before I had the time to buy more (or sucked my thumb). Even so, the ones I recall most vividly and beat myself up about are the ones that fell a lot after I bought much of them (why did I not buy more at lower prices alternatively why did I not stress margin of safety more).

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Why not be more selective.  Let's say you have the opportunity to put 4% of your capital into ten bargain stocks that appear to have a margin of safety.  Why not pass on all of these untill a few of them drop much more. Then you might be able to buy a couple at a much greater discount if they are unimpaired.  Then load up on those two.  I think this will give better results than buying the group at a higher average price.

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Why not be more selective.  Let's say you have the opportunity to put 4% of your capital into ten bargain stocks that appear to have a margin of safety.  Why not pass on all of these untill a few of them drop much more. Then you might be able to buy a couple at a much greater discount if they are unimpaired.  Then load up on those two.  I think this will give better results than buying the group at a higher average price.

 

Why not?  Because as investors all know stocks only go down after you buy them.  Ones you sit on the sidelines waiting to go down only go up…

 

In all seriousness I've changed my approach some.  I used to build full positions right away only to see the price drop.  Now I'll start smaller and build in with a drop.  Sometimes it never drops and I'm kicking myself for not buying bigger to start.  There's always regret.

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It's interesting that a number of posts relating to this story mention or hint that if only the author of the article had bought more stock after it had fallen he would have made out a huge winner.

 

Well I thought I'd offer my perspective on the Readymix story.  I'm the "fellow member of the Value Investment Institute" mentioned at the beginning of the article.  I was invested in Readymix over the same period as the author of the article.  I should stress at the outset that these are my views and not necessarily the author’s.

 

In my view, the outcome of this investment -- I got my money back, plus a little -- was pretty much irrelevant.  More important was -- and this only came with hindsight -- that my ability to understand / analyse Readymix and the industry within which it operated was limited.  It made me think about how well investors typically understand their investments, that the lack of knowledge only tends to come to light when the investment goes wrong (i.e. when investments go up we are blissfully unaware of our deficiencies).

 

Let me highlight some of the issues as they pertained to Readymix:

 

--  There was (is) massive over-capacity in the Irish cement market.  Operators are not willing to cut capacity because of the high fixed cost nature of the business as well as the full loss of carbon credits that would result from cutting capacity below 50% capacity utilisation.  Moreover, the cement operators in Ireland are vertically integrated, so they dumped cement into their block operations, meaning Readymix couldn't compete on price.  Furthermore, one of the cement operators has been in administration for the last few years and reportedly was extending credit to downstream companies (Readymix competitors) of questionable viability, in an effort to keep the business looking sweet for a sale.

 

--  Illegal quarrying for aggregates is also a big problem in Ireland and the authorities appear to turn a blind eye to this.  This puts compliant operators, such as Readymix, at a price / competitive disadvantage.

 

--  Another reported issue was the fact that sole traders frequently closed operations, leaving their debts behind them, only to reopen the following week in the name of a brother / wife / son etc.

 

In these ways, capacity didn't exit the industry as one might have expected.  This led to sustained losses and the racking up of debt, provided by the parent, Cemex.  Towards the end of 2011, when the share price was at its lows, it was not obvious at all that the company would survive.  It was perhaps years away from becoming profitable.  It was reliant on debt financing from its parent and it wasn't clear that the debt agreement was watertight.  A concern was that Cemex might have been able to put the company into administration, cherry-pick the best assets and leave equity holders with nothing.  This also meant that when eventual Cemex bid came, shareholders were not in a good negotiating position to push for a higher price.

 

Of course, these details I've highlighted above are unique to Readymix, but I believe the 'story' is a recurrent theme.  I got suckered in by a 'cheap' valuation and a nice narrative about depressed profitability.  For me, the wrong take-away from the Readymix example is not "I should have bought more after it fell", but rather "I got lucky in the end and should never have invested in this stock".

 

I read this morning in the Bloomberg article on Ted Weschler that he spends 500 hours analysing an investment.  That’s probably the real answer…..

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