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Waiting Out the Storm - Practicing Patience

January 29, 2013 | About:
The Science of Hitting

The Science of Hitting

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If you’re like me, you’ve probably heard just about enough when it comes to Apple (AAPL). With the media milking this ongoing story for all it’s worth, it’s safe to say that this stock has become the primary focus of the financial community. As you may have noticed in many of those discussions (articles, TV debates, etc.), the tone has gotten decidedly heated; those who put themselves in the “I Don’t Know” camp (of which I am a member) appear to be wildly outnumbered by the two extremes. The daily conversation is becoming increasingly irrelevant: It looks like steadfast beliefs and a hefty dose of emotionally-charged rhetoric far outweigh the concern for cold hard facts; this is a situation that lends itself to serious behavioral biases – most notably confirmation bias, where one seeks out information that further affirms their current beliefs while disregarded as (for lack of a better word) “hooey” all evidence to the contrary.

As noted above, I’m solidly in the “I Don’t Know” camp. Others surely know much more than I do – but there’s also a crowd that simply can’t handle the potential regret of missing on Apple once again. For those people, Warren Buffett’s words should provide some much needed advice: “Investing is not a game where the guy with the 160 IQ beats the guy with the 130 IQ. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing… The most important quality for an investor is temperament, not intellect. You need a temperament that neither derives great pleasure from being with the crowd or against the crowd.”

As always, you don’t have to do anything. You can sit quietly and twiddle your thumbs, waiting for the next pitch to come across the plate. This sounds so simple – yet the aversion of regret chews people up inside (“I’ve completely missed Apple’s run up over the last decade – I won’t miss this chance to get in.”). Patience is much easier to talk about than to practice.

Value investing, by its very nature, is closely tied to market (security) timing – while the intrinsic value piece of the equation is relatively stable, the market valuation is often jumping sporadically from one day to the next; often, this leaves us focusing on the wrong side of the equation. This is inadequate – if you can’t even calculate a broad estimate of intrinsic value, you should move on.

From my perspective, intelligent capital allocation is best kept in check with two tools: an investment journal and a buy list. Once a security has been analyzed, you should set a price at which you would be willing to make the holding a sizable piece of your portfolio, regardless of how far off the current price may be (I recently added a buy target of $55 for a company trading around $85).

This approach, by its design, has two critical buffers – first, it requires that you have at least analyzed a company before you consider purchasing it (if it’s not on the list, no matter how cheap it may be, you cannot act without thorough analysis). Second, you will think twice before adding a name and a buy price if you are set on staying true to your word and buying regardless of the noise around the company or in the market as a whole if your target level is breached (assuming the fundamentals are unchanged, as noted in your original write-up and updated in your journal over time).

Emotions can stymie intelligent decision making; avoiding the stranglehold all together is optimal. Often, as with Apple, companies come under great fire when they reach a level where value investors might be interested. You should do your research outside of the storm – or consider waiting for brighter days ahead – to avoid the behavioral biases that we’re all susceptible to.

About the author:

The Science of Hitting
I'm a value investor, with a focus on patience; I look to buy great companies that are suffering from short term issues, and hope to load up when these opportunities present themselves. As this would suggest, I run a fairly concentrated portfolio by most standards, usually with 8-10 names; from the perspective of a businessman rather than a market participant / stock trader, I believe this is more than sufficient diversification.

I hope to own a collection of great businesses; to ever sell one, I would demand a substantial premium to the average market valuation due to what I believe are the understated benefits to the long term investor of superior fundamentals and time on intrinsic value. I don't have a target when I purchase a stock; my goal is to replicate the underlying returns of the business in question - which if I've done my job properly, should be very attractive over many years.

Rating: 4.3/5 (36 votes)

Comments

ansgarjohn
Ansgarjohn - 1 year ago
You wrote "Value investing, by its very nature, is closely tied to market (security) timing –" ???

According to Bestinver : "Attempting to predict market behavior (timing) is a complicated task that requires a great deal of dedication; even then, forecasts rarely prove accurate. Accordingly we prefer to seek out solid and undervalued companies, as they will certainly outperform the market regardless of its performance."

"Value Investing means taking advantage of short-term fluctuations in share prices to invest in the long term.

It is based on acquiring stocks below what Benjamin Graham defined as the Intrinsic Value: this is the value an informed buyer will offer for 100% of a company in a peer-to-peer negotiation. Warren Buffett, a disciple of Graham’s and possibly the best investor ever, has always applied Value Investing criteria to his investments, seeking out comprehensible businesses with favourable long-term prospects, managed by honest, competent people and, most importantly, which are available at an attractive price. An attractive share price is one that is at a discount to its Intrinsic Value. The difference between both is what Graham called the Margin of Safety. "

If you can buy with a margin of safety today, you can buy, but you can't time the market imho.

The Science of Hitting
The Science of Hitting premium member - 1 year ago
Ansgarjohn,

I don't mean market timing in the sense of "I think we've got 20% upside in the S&P this year" - I mean that you must - after determining the intrinsic value piece of the equation - purchase a stake only once the market value piece of the equation is well below the denominator. A better term would be security timing - as you note, taking advantage of short fluctuations, ASSUMING YOU KNOW THE INTRINSIC VALUE PORTION. That's the critical distinction between value investing and market timing/guessing in my view. Thanks for the comment!
ansgarjohn
Ansgarjohn - 1 year ago
Thanks for your response. It sounds like you're describing "Margin of Safety" or not, when you say "well below the denominator"?

Have you seen this? http://aswathdamodaran.blogspot.nl/2013/01/are-you-value-investor-apple-test.html

What would your estimate of Aapl intrinsic value be today?

Mine is 15 x $45 EPS = $675 , Margin of Safety: $675 Intrinsic value/$458 Market price= 47%

The Science of Hitting
The Science of Hitting premium member - 1 year ago
Ansgarjohn,

That's exactly what I'm describing - I'm simply pointing to the fact that this must be timed to some extent, meaning the price portion of the equation often requires a good bit of patience; market timing was probably not the right choice of words to get my point across.

I saw Aswath's post, and honestly didn't think too much of it; without seeing raw data, that's to be expected. As always, others may see something I'm missing - personally, I will not commit capital at this level. I feel no need to own or short Apple, and will simply avoid it unless I have a very good reason to act in either manner. Thanks again!

SeaBud
SeaBud premium member - 1 year ago
This has been discussed extensively, but sustaining the level of Apple's earnings is the issue. One equation cannot define a margin of safety and stating that Apple will continue earning $X/share is a projection that many now question.

Like Science, I cannot predict whether they can or cannot, but you can be certain that they are in a highly competitive marketplace that shifts constantly in terms of the favored hardware and ecosystem. I have written this before, but repeat my summary here: I will not buy or short Apple (though thought about the short at $700). They are an incredibly strong brand and company but they face competition from Samsung (best mass electronic manufacturer in the world), microsoft (largest software maker in the world), Nokia/Rimm (both know how to make phones VERY well and are pushing hard) and the carriers that hate subsidizing Apple's massive earnings. Top it off with the fact that most of the ROW (non-US) is not enamored with Apple and is less able and willing to pay the Apple premium, and I tend to fall on the "no margin of safety in apple" camp.
mvpeach
Mvpeach - 1 year ago
APPLE STOCK: A BUYING OPPORTUNITY. WHY? Anyone owning APPLE products and who has also visited an APPLE store knows this company is vibrant especially with the younger generation. The company is flush with cash and pays a nice dividend. I say this is a real buying opportunity.
batbeer2
Batbeer2 premium member - 1 year ago
>> Mine is 15 x $45 EPS = $675 , Margin of Safety: $675 Intrinsic value/$458 Market price= 47%

OK, but why not go looking for a stock trading at a margin of safety of say.... 75% ?
brodsky
Brodsky - 1 year ago
With Apple or any other company for that matter, one needs to define margin of safety first, otherwise you all wobbling around. It is easy to short Apple today because as you're looking for information, as The Science of Hitting mentioned, you're going to find something that will prove your point or form one. Given that all recent information on Apple is negative, chances are that you going to form a very negative opinion therefore avoid and/or short the stock.

Now, how close is your thinking to reality? no one know. That's why folks like The Science of Hitting is in the "i don't know" club.

LwC
LwC - 1 year ago
Ansgarjohn,

In your example, wouldn't the Margin of Safety (MOS) estimate be: 675 IV minus 458 mkt price equals 217 discount to estimated IV; and then 217 divided by 675 IV equals MOS of .32 or 32%?

Alternatively: 458 mkt price divided by 675 IV equals .68; and 1 minus .68 equals .32 or MOS of 32%.

IMO an estimated 47% MOS would be : .47 times 675 IV equals 317 discount to IV; and 675 minus 317 equals 358; so the required mkt price for a MOS of 47% would be 358. (alternatively: 675 times .53 equals 358.)

BeFullyInformed
BeFullyInformed - 1 year ago
Often with a stock like Apple Stock, it is worthwhile thinking about safety and return in the same vein. To that end consider selling into the leap puts at a valuation point that you find compelling both from an entry-level and possibly a longer-term investment level. Perhaps you think $440.00 would be a nice entry point based on the past 12 months of the stock, By selling the January 2014 put strike you can earn $45.00 from the put premium, which returns 10% for the year and should the stock fall and you are assigned, your cost basis is $395.00. This is a simple strategy just to indicate there are many alternatives when it comes to accepting risk in an investment. I have many of these types of trades on my website at fullyinformed.com

Teddi Knight

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