Roy the Contrarian
Invest Like a Pro
How Doubling Down Works
---
Last month (May 24 to be exact), I wrote about a method to find
stocks that will likely decline a minimal amount during stock
market corrections. I concluded that
CVS Caremark (
CVS
)
and
Walt Disney Company (
DIS
)
would not decline significantly during future stock market
declines. You can read my analysis
here.
Since I started writing the
Cabot Benjamin Graham Value Letter
nine years ago, I've instructed my subscribers to double down
whenever a high-quality stock declined 10% or more. For those of
you who are bold and are looking for a proven method to beat the
stock market whether the market is declining or advancing, my
"contrarian" approach might make a lot of sense.
I realize that you may be a growth investor and are seeking
appreciation without taking unnecessary risks. If you have found a
method that made money consistently during the past several years,
you should continue to focus on what works for you.
But you also might consider diversifying your approach to diminish
your risk and at the same time increase your profits. And if your
approach only works part of the time and occasionally leads to
mini-disasters at inopportune times, then please hear me out.
I'm a value investor-I buy when I think a stock is undervalued and
sell when a stock is overvalued. I don't trade based on price
charts, and I don't try to time the stock market. I stay fully
invested in stocks and bonds all of the time.
We all make mistakes in the stock market. We buy a "can't miss"
stock only to watch it decline immediately after purchase. Or we
buy a stock, and an unforeseen political crisis somewhere in the
world sends the stock market skidding. What should you do when your
stock(s) drop 10% or more?
As many growth-oriented Cabot editors have written, stop-loss
orders make sense for growth stocks, momentum stocks, and higher
risk stocks. However, when investing in low-risk, undervalued
stocks, I strongly suggest a much different method.
Whenever one of your favorite stocks, which you really, really want
to hold for the long haul, declines by 10%, try doubling down.
However, if your favorite stock is volatile and swings wildly from
time to time, then I advise doubling down only when and if your
stock falls 20%.
What do I mean by "doubling down?"
Let me give you a few examples, but before I do, let me give you an
example of how my system works.
---
I write the
Cabot Benjamin Graham Value Letter
and the secret to my success is finding high-quality stocks at
bargain prices. I do this by evaluating 1,000 companies to
determine those that have lots of cash with little debt, have
produced steady sales and earnings growth during the past decade,
and whose stock prices are clearly less than they should be.
If you pay attention to the numbers, and you hold patiently, you
will reap great profits!
In May 2009, I recommended that my subscribers buy
Cash America (
CSH
)
, writing...
"Cash America International owns and operates pawn and
check-cashing facilities in 1,004 locations in 21 states… The
company's business tends to flourish during periods of economic
weakness. My forecast for a sharp economic downturn followed by a
very slow recovery will provide adequate opportunities for Cash
America during the next several years. I expect revenue and EPS
growth to accelerate during the next 12 months. EPS will likely
increase 16%.
"CSH shares have declined 50% during the past year, which is
unwarranted because the company will prosper during the current
economic malaise. CSH shares are undervalued at 9.0 times latest
12-month earnings per share (
EPS
). I believe CSH shares will recover to my Minimum Sell Price
within one to three years. CSH's balance sheet is strong with loan
losses at low levels. BUY."
At the time, CSH was trading at 23.70.
And two-and-a-half years later, I recommended that my subscribers
sell CSH, writing...
"Cash America (
CSH
) reached its Minimum Sell Price of 62.29 today and should now be
sold. During the past three years, the company has racked up
impressive sales and earnings gains, which have driven CSH's stock
price to new all-time highs.
"Future sales and earnings prospects continue to look rosy, but
there are a few clouds on the horizon. Large U.S. banks are
beginning to offer short-term loans to potential borrowers who
might otherwise use CSH's loan services. Also, state governments
have passed new laws to limit the fees and interest rates on cash
advances and short-term loans.
"Cash America's stock price has risen a whopping 160% since we
first recommended the stock in the May 2009 Cabot Benjamin Graham
Value Letter, compared to an increase of 33% for the Standard &
Poor's 500 Index during the same period. I advise SELLING now."
By investing in CSH when I suggested, my subscribers did almost
five times better than conservative investors holding the S&P
500.
Furthermore, four months later, CSH was trading at 42, down 33%,
proving my valuations, based on Benjamin Graham's analyses, were
spot-on.
You don't need to worry about details, because I do all the work
and present the results, telling you in plain English what to buy
and why. For every stock, I give you specific Maximum Buy Prices,
as well as Minimum Sell Prices (i.e., target prices), and I update
my buy and sell prices in every issue.
My system is simple: Buy high-quality stocks when they are
undervalued, and sell when the stocks become overvalued. Buy low
and sell high-it doesn't get any simpler!
---
Ok, now back to doubling down during stock market declines.
As an example, let's say you bought 100 shares of
Deere & Co. (
DE
)
at my recommended Maximum Buy Price of 77.61 last month. DE then
fell 10% to 69.85 on June 4, whereupon I would have advised that
you buy another 100 shares at the lower price. Now you own 200 DE
shares. The objective is to take advantage of lower stock prices
when they occur.
I would then advise placing a sell limit order at your original
purchase price of 77.61 for 100 shares of DE, or one-half of your
holding. In this example, DE reached your sell price of 77.61 on
June 19 and your 100 shares were sold, lowering your cost basis by
10%. This technique can work wonders if you are bold and are
willing to go against traditional investing systems.
In my May 2012
Cabot Benjamin Graham Value Letter
, I featured four high-quality companies which I thought would
produce solid profits for investors during the next one to three
years. My four buy recommendations were C
elgene (CELG), Deere (
DE
), DIRECTV (DTV)
and
Dollar General (DG).
The stock market tumble in May dragged three of the recommendations
down 10% or more. If you used the doubling down system, you would
have doubled your investment in Celgene, Deere and DIRECTV, which
lost 10% after they were purchased.
As of today, Deere has climbed back beyond its original purchase
price of 77.61, but Celgene and DIRECTV have not quite reached
their original buy prices. Dollar General did not fall 10% since
its purchase and is now 13% higher than its May 1 purchase price.
The doubling down methodology produced a profit of 3.9% compared to
a decline of 5.3% for the Standard & Poor's 500 index from May
1 through June 27.
Of course, these are just a few recent examples, but they show
that, declining stock markets present a difficult challenge, you
can make money when the stock market is declining, which will
dramatically boost your long-term investment results.
I will continue to recommend buying Celgene, Deere, DIRECTV and
Dollar General, as well as a number of other undervalued,
high-quality companies in my Cabot Benjamin Graham Value Letter. My
next issue, coming soon, will include a special feature on
Undervalued Canadian Companies. I hope you won't miss it!
Sincerely,
J. Royden Ward
Editor of
Cabot Benjamin Graham Value Letter