In this article I would like to answer the questions most often asked by subscribers and visitors.
Even though I try to answer all the questions I receive myself, and manage to do so 90% of the time, it is not always possible. I use articles like this one to answer questions that are asked often and the ones you may also have in mind.
If you have any questions, please do not hesitate to send them to me by going to the Contact Me page on my website.
On to the questions.
When or how do you decide to sell investments?
That is a very good question, and a very difficult one to answer.
When I did some research on selling a few years ago I found thousand of books written on buying investments but I could only find three on selling.
However having a strategy for selling is just as important as one for buying.
For me there are usually three reasons I sell a share:
- When a company is fully valued,
- When I find a better investment and I already have 30 names in my portfolio (in order to be able to follow most names in my portfolio are hardly ever have more than 30 positions)
- When a stock has fallen below my stop-loss limit
I used to sell investments when I thought they were fully valued however after tracking stock price movements after selling I changed my strategy.
I realised I sold investments too early and ended up losing out on further substantial gains. I started following a strict trailing stop-loss strategy.
After classifying an investment as fully valued and move into a separate part of my portfolio where I follow a strict trailing stop-loss strategy, which, depending on the volatility of the share price, varies between 15 and 25%.
Should the share price decline more than 15 or 25% from its highest point the position is sold.
How has your investment process developed over time?
As long-time readers know, my investment process started from using technical analysis without success, moving to broker recommendations which were also was not successful.
My investment returns really started improving when it dawned on me that there were successful investors and I could improve my investment returns by studying what they have done.
This process of discovery and learning lead me to an 84 page book written by an unknown South African mathematics professor called Winning on the JSE.
This book, for the first time introduced me to a structured investment process where you work through a list of checklist items in order to determine if the investment is worth buying and to ensure that no important item is left out.
After that I went on to read books on Warren Buffett, Benjamin Graham, John Neff, Joel Greenblatt and too many others to mention.
Until today I have not stopped reading. I will basically read anything written by somebody that has a proven track record of investment success.
Over time through learning, reading and applying my knowledge I develop my own investment process with which I feel comfortable and have shown extraordinary good results.
I continuously seek to improve my investment process by reading academic studies that have shown substantial investment gains over long periods of testing.
I do my own testing and then after proven success I incorporate what I’ve learned in my investment process.
You can read more about how to develop a successful investment process in my article titled. The best investors have this… Do you?
What I forgot to mention is that the formulation of an investment process is an ongoing process whereby I incorporate new information all the time, re-evaluate existing processes, select the best and use that in my investment decision-making.
What broker do you recommend?
This is a very difficult question to answer even though I’ve thought about it a lot.
Probably the most important consideration before selecting any broker is to make sure that your funds and investments are kept completely separate from the assets and liabilities of the broker or bank. In most countries this is required by law but it is always worth double checking.
This means that should the broker go bankrupt your money will immediately be available to you to transfer to another institution.
Be especially careful when you leverage your portfolio as all securities and cash in your account may be used as security for the loan and the position, of your assets being completely separate from the broker or bank, may thus be lost. Read the fine print on the loan documentation and also general terms of business very carefully.
Because of my background and my confidence in selecting investments I do not make use of a full service broker (that also offers research) but use a discount broker where I can enter all orders through the Internet.
At the moment I use two brokers in Germany. The one is called Comdirect 80% owned by Commerzbank the largest retail bank in Germany and the other is called MaxBlue the online broker owned by Deutsche Bank.
I only opened the MaxBlue account recently, but so far am very am satisfied with their service and transaction costs.
I would recommend always having two banks or brokers through which you invest, as you never know when one of them has a change of strategy or no longer fills your needs.
Having two brokers mean that you can quickly transfer your funds to the other and continue with your investment activities saving you the trouble of looking for a new broker when you may be pressed for time.
How do you track your performance?
I used to track my performance on an individual investment basis but during 2007 and 2008, when my portfolio had high amounts of cash it became very difficult to track the overall performance.
What I then started doing is tracking my investment performance like an investment fund does. This means that you value your cash and securities in your investment account on a daily basis.
This makes it easy to track your performance even if you add and withdraw cash from your investment account often.
To start value your portfolio and add the cash you have available to invest. Divide this value by a number to give you a value of around 100.
For example if you have a portfolio with the value of Euro 100,000 divided it by 1000 to give you a value of Euro 100.
The 1000 you divided by is the number of units you have invested in your portfolio.
On a daily basis thereafter you then value your portfolio add that to the cash in your account and divide by the number of units (1000 in the above example). This number gives you a value per unit that you can use to track your performance or compare to an index.
Should you add or withdraw cash from your account reduce or increase the number of units with the amount added or withdrawn. For example if your unit value is Euro 90 and you have 1000 units in your portfolio and you want to withdraw Euro 900. You thus remove 10 units (Euro 900 divided by Euro 90 = 10 units) and subtract the Euro 900 from your investment cash account.
After deducting the cash from your account the unit price should remain unchanged at Euro 90 but you will only have 990 units.
I hope this is understandable, after reading it I am not sure if I explained it well, but if you try it in a spreadsheet you will see it sounds more difficult than it is.
Where can I find investment ideas?
I read a lot of blogs, magazines and newspapers and anything else that looks interesting. This used to be a large source of investment ideas to investigate further but over time I’ve started moving more and more to using investment screens.
Through my investment process I know exactly what type of companies I am looking for and at what valuation I start getting interested.
I then use a screening tool I developed called Quant Investing (www.quant-investing.com) to get a shortlist of companies that complies with my criteria which I then research further.
I use this as my main source of ideas but that doesn’t mean I won’t look at company suggested by other investors I respect or if I read an interesting article in the Financial Times or Fortune magazine
You can find more information on stock screeners in my article The single best way to get investment ideas.
What do you do if the bottom drops out of a stock (the stock price declines sharply)?
This is a very timely question because it happened to me the other day.
In March 2010 I invested in a company called Invocas in the UK and a few days ago they announced that management wants to delist the company and because the company does not have sufficient cash resources they won’t be making an offer to minority shareholders.
In order to delist they need approval of 75% of this shareholders and just through the votes of management they already have 70%.
On the day of the announcement the shares dropped over 60% leaving me with a company valued as follows:
- Price to earnings ratio of 1.1
- Earnings before interest and tax is to enterprise value of 575%
- Price to book value of 11%
- Price to sales ratio on 0.2
The company was clearly extremely undervalued and I had to decide if I wanted to be a shareholder in unlisted company holding physical share certificates or sell out at a 60% loss.
As the company was so extremely undervalued I decided to buy more and take my chances with the delisting. The company was just so undervalued that it would have been a shame for me not to be invested.
But that doesn’t really help you in making a decision regarding an investment that decline substantially.
What is important is to determine the reason for the price decrease. If it is because of a profit warning, determine how attractive the valuation of the company is at this price level and make your decisions based on this valuation.
In most of the cases I have found that it’s best to sell after the company has issued a profit warning as there is never just one cockroach in the kitchen.
But it may be worthwhile to wait a day or two after most of the sellers out of the market as you may then get a slightly better price.
My situation described above is little different because the company was already substantially undervalued before the 60% drop in price caused by the delisting.
I will have to wait and see as there may still be a long road ahead with me holding an unlisted investment and it may have been better to sell right after the delisting announcement.
I will let you know how things turn out.
That doesn’t really clearly answer your question but in most cases I would say it’s best to limit your losses and sell as soon as possible after bad news and move on to other attractively priced investments.
I’m a big believer in limiting the downside and letting the upside take care of itself.