Thursday, February 17, 2011

Value Investing

In the little spare time I have, I have recently begun reading "The Big Short" by renowned author Michael Lewis. The book details the background of the financial crisis of 2008-2009, including little known facts such as the players involved and the messed up nature of the motives. Lewis provided as good of a explanation as can be found on what sub-prime mortgages and credit-default swap are -- and how it was manipulated by major financial corporations for a gain. I am pretty appalled at the fact that intelligent people would be so carried away by the greed.

One character from the book (thus far) stands out: Mike Burry. I believe the guy is still around -- he is a self-professed value investor who foresaw the crash of the housing market and bet heavily against it through his hedge fund Scion Capital. Prior to betting on credit-default swaps, Burry had consistently beat the S&P500 index through "value investing".

Value investing is picking particular stocks/securities that are seemingly undervalued by the market -- in other words, what Warren Buffett does. The key is being able to show great patience and not just look for short-term gains. The investor has to analyze the cash flow projections of companies and understand not only its product line, but also the industry as well.

I discuss value investing because it is pretty much what I am attempting to do -- only I am not so patient sometimes. I started buying stocks in May 2009, when the stock market was slowly recovering from its bottoming out two months prior. I essentially put all my equity into a number of companies:
  • Nvidia, Citigroup, Ford, GE
A couple of months in, I decided to sell Nvidia and Citigroup and instead acquire some of AIG, some of Wells Fargo, and some of AMD. The reasoning are as follows:
  • Selling Nvidia -- I originally bought the shares on the hype of its Tegra chips, which promised to revolutionize computing. The only problem at the time was, these chips were not due to be on the market for at least a couple of years. Nvidia stock actually doubled over the past couple of months. But at the time, it showed minimal changes and looked like they would be quashed by...
  • ...Buying AMD -- I am a geek and so like to read news about computing technologies. I was determined to hold onto a tech stock and AMD looked good at the time. Sure they were in debt and were dwarfed by Intel in the market, but I think they had great potential.
  • Buying AIG -- purchased these shares purely on the fact that its price had jumped 2-fold that day. I realized that it (acquired for $20/share) had potential to go even higher, especially since it was worth more than $600 per share not two years earlier.
  • Selling Citigroup -- pretty much a trade for Wells Fargo stocks. Wells Fargo looked better since it had much lower debt.
  • Buying Wells Fargo -- strictly as a means of diversification. Bank stocks were performing great back then and I had high hopes they would continue. Wells Fargo had also just absorbed my bank, Wachovia. Unfortunately, this stock languished for about a year and I ended up liquidating it for little profit.
I think it was back in November 2009 when I made my second adjustment or, as-you-will, series of trades. I ended up selling AMD for its lack of performance; sold a portion of AIG when it peaked around $60. I believe my holdings at the time were: AIG, GE, F, Wells, and AMD. These stocks I would hold until about a year later.

Last October, I made my third adjustment that essentially diversified my holdings even more. Ended up selling AMD, Wells, AIG, and a minor portion of GE in favor of buying AOL, AXP:
  • Buying AOL -- I had been trying to get a job with AOL the months prior and in the process learned a substantial amount about the company. It looked like it was bouncing back and was a major player in the online advertising market. Google may the the king of search, but AOL controlled a significance market share of display advertising through its subsidiary Also, there were rumors the company would be acquiring Yahoo!. I ended up liquidating these shares for a minor loss for the lack of performance and the passing of the acquisition rumors.
  • Buying AXP -- its price had dropped significantly that day on news of an antitrust ruling against the company, Visa, and Mastercard. It had solid cashflow, paid okay dividends, and thus seemed undervalued. This stock performed okay but not great.
About two months later (November 2010?) I ended up consolidating my positions by selling off everything except for GE and Ford. I used the proceeds generated to acquire more Ford and reacquiring AMD. The former because it looked promising in the long run (and a friend shared similar thoughts) and the latter due to its release of the Fusion chips. We shall see.

One of my struggles has been the lack of capital, without which I cannot create economies of scale. Even with the low transaction cost of $5, it is hard to generate any substantial gains/profits without relying exclusively on major stock price increases. The latter is difficult to comeby and more difficult to identify (the stocks about to explode). In other words, I could generate a good profit if able to purchase 2000 shares of a company instead of 200...

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