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The Year That Was - 2012

Chandan Dubey

Chandan Dubey

97 followers
This year was cathartic for me (and my portfolio).

I began the year with a portfolio which has -20% in cash, i.e. I had debt which was 20% of my net asset value. My portfolio was also quite bloated with more than 40 different stocks. Most of the positions were smaller than $1000.

On top of that, most of my bigger positions, i.e. Credit Suisse (CS) (24% of NAV), Bank of America (BAC) (12% of NAV), Hewlett-Packard (HPQ) (10% of NAV) and Best Buy (BBY) (10% of NAV), were a result of dollar cost averaging without understanding the business fundamentals. The amount of research was negligible in comparison to my belief in myself.

In Alexander Pope’s words, “A little knowledge is a dangerous thing.” The books I read in preparation were, "Stocks for the Long Run" by Jeremy Siegel, "The Little Book That Beats the Market" by Joel Greenblatt and "Contrarian Investment Strategies" by David Dreman. All three of these books are terrible in their own way. They are great for making a case for buying equities but are useless for anything else. I can write an article each on why these books are extraordinarily bad as a way to learn investing for individual investors and still have things left to say. So, I will make a few criticism and move on.

All three in their own way give a formula on how to invest with minimum effort and reasonable upside. In particular, they ask you to buy a basket of stocks based on some easy-to-verify conditions. For example, Greenblatt espouses his "Magic Formula" which basically involves buying a basket of well-diversified (say 30) stocks with low price-to-earning ratios and high return on capital.

Similarly, Dreman recommends buying a basket of stocks with low price-to-sales or low price-to-book ratio, i.e. companies that are unloved. Siegel goes farthest by suggesting that you buy a basket of stocks randomly (a monkey throwing darts can pick them up for you)! Or maybe just buy an index and be done with it.

Each of my major positions (Best Buy, Hewlett-Packard, Credit Suisse, Bank of America) was contrarian, and Best Buy and Hewlett-Packard had single-digit P/Es with ROIC greater than 15%. Furthermore, the 40 stocks I bought were all contrarian and with low P/Es and good balance sheets.

One of my major criticisms of the formula-based investing is that it separates you from understanding the business. The magic formula investing (and contrarian investing) may lead you to buy companies which are becoming obsolete, and you are looking at them from the rose-tinted lenses of the past. You can look at the screener run today (above $50 million market cap, 30 stocks). The result is shown below. Some of the stocks that appear are: Herbalife (HLF), Apollo Group (APOL) and Gamestop (GME). I would not touch these stocks even with a six-foot-long pole. I do not know about most of the companies below, so I reserve judgement on them.

MeLzFDYGL7sblAXLSp7xVddmSUVv8-MXzgXtyprL

A second criticism is that the gist of their argument is this: Here is a formula and it has worked amazingly well in the past. Use this formula to look for new companies and they will give you good results. If you do not see the logical jump, here it is: Something that has worked in the past may not work in the future.

In any case, I sold most of my positions this year. I hold 16 companies and more or less the same amount of equities in absolute dollar terms as the beginning of the year. This means that on an average my positions are more than twice as big. Also, I know a lot about the companies I am holding and can sleep at night even when the stock market is tanking. In fact, I look forward to drops as a way to add to my positions. For example, I am hoping that Intel (INTC) and Teva (TEVA) will continue to fall so that I will be able to buy them cheaper. Nearly 30% of my net asset value is in cash, waiting to be deployed when a market weakness offers opportunity.

Even with this underlying change in the way I invest, i.e. taking a loss of $5000 on Credit Suisse, $700 on Best Buy and a lot more, I have managed to achieve a return of 11.8% as opposed to 13.6% for the S&P 500 (SPY).

About the author:

Chandan Dubey
I invest because I want to be free by the time I reach 40 years of age i.e., 2025. My investment style is to find a small number of bets with large margins of safety. I pay a lot of attention to management and their incentive. Ideally, I like to buy owner operator businesses. I am fortunate to have a strong inclination towards studying. I aid my financial understanding by extensive reading in psychology, economic, social sciences etc.

Rating: 4.1/5 (17 votes)

Comments

batbeer2
Batbeer2 premium member - 1 year ago
Thanks for an article worth reading.

Here's a thought.

If you really understood 12 publicly traded businesses while ignoring the rest, do you think you could get satisfactory returns and sleep well too?

For me, 2012 was all about about understanding three stocks better. Yes, I probably worked on more than a dozen stocks but that too just helped me understand my favorites a bit better. For those particular stocks, the guy selling to me (or buying from me) has probably done less homework. That's a nice feeling but it is also a simple fact.

It's like buying used cars. If you're familiar with a certain type of car, you know what it's worth, which parts are expensive and how it should handle if it's in good nick. You also know what to look for to see if it's been well maintained and by whom. If someone out there is trying to offload a dud, you're not going to be the buyer.... simple.

It's a whole different ballgame if you're looking to buy your first say.... Saab or Porsche.

Just random thoughts.
cdubey
Cdubey premium member - 1 year ago
I want to get it down to 10. The problem is that each stock in my portfolio seems to be ok on an individual basis. I did not want to sell too fast because I was at a risk of overestimating my stock picking abilities. With time though the number will come down. In the new year i.e., 2013 I will try to pare down the number to 10.
superguru
Superguru - 1 year ago
Few things I learned,

1) Be very careful in doing deep value investing in Technology companies. Changing technology trends can kill even the tech companies with pristine balance sheets and companies like HPQ do not even have good balance sheet. IMO for profit education is another area going major technological and regulatory disruption. May be companies like WPO and APOL can buy their way through it, may be not.

2) Do deep value investing in companies which have moat and/or real physical assets which have liquidation values. (Having a inventory of palm pilots or HP tablets which no one wants to buy does not count as real physical assets with liquidation values)
cdubey
Cdubey premium member - 1 year ago
@Superguru: Thanks for sharing. First hand lessons tend to stick.

I hope I don't have to learn these first hand with HP.
graemew
Graemew - 1 year ago


Thanks for your article Chandan,

In 2011 I experimented with doing my own research on a large number of small cap companies...based in different markets, and then I bought into about 10 of those I considered the best (In addition to the existing stocks in my portfolio). The results were variable....in a few cases I made some substantial gains, but in a few I made some big losses. And I realised that I didn't know as much as I thought I did. I then decided on a new approach. The new approach is to mainly follow other top investors that have excellent track records. Each quarter when the updated portfolios of these gurus are made public i check what they have been doing and search for stocks that might meet my criteria in terms of value, risk, diversification and sustainable competitive advantage. And occasionally I decide to follow them. This approach has the advantage that you know the stock you are buying has been analysed and approved by one of the world's foremost investors...so your risk is greatly reduced. And I also learned that it is not necessary to try to compete with or to try to outperform an index or other investors. The aim should be to achieve a fair return at the lowest risk possible.
cdubey
Cdubey premium member - 1 year ago
@Graemew: Excellent approach. Additionally if you hold a few stocks then you should do well. Buying too many is going to mimic the S&P with very high probability.

In fact, this is why gurufocus is a very nice idea. You get to choose from stuff which has already been chosen, so to say.
beltrancaceres
Beltrancaceres - 1 year ago
keep up the good work and the posts. I guess, learning the hard way is the best....
unixninja
Unixninja premium member - 1 year ago
I know I am a little late (I just became an official member this year), but thanks for posting your experience over the last year. Many people stand to benefit from what you have written.

One thing I have learned over the past few years of investing is that there actually is a secret to investing! The secret to investing is that there is no secret. While this may sound stupid and/or obvious it is important to remember. Too many people fall into the trap of trying to find a "magic formula" or one size fits all ratio(s) that will tell them what to buy, when to sell, etc.

Once you give up on the idea of a finding an easy method to investing and start looking for value at low prices you have a much better chance of finding success.

If you haven't already done so (And I am assuming anyone using this site has already done this), I would highly recommend reading all of the free annual shareholder letters that Warren Buffet has published on the Berkshire website. Many people read through them with the expectation of finding his "secret" and come away very disappointed. If you look at them from the perspective of what "things" does Warren find valuable for different types of businesses and why you will find much value. His skill with asking the right questions when valuing a business is extremely important and these annual letters give quite a lot of insight into his thinking process.

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