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Using the Value Stock Buy List Program Productively - Dealing with S & P Downgrades AND Averaging Down |
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Submitted by Steve Selengut
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If you didn't have questions, the "Selection
Universe" itself, and the refined and filtered "Value
Stock Watchlist" would be just another stock picking
gadget, easy to slip into like a well worn pair of loafers. This is
not your ordinary list of hyped up "story" stocks. It is
the result of applying a time tested set of selection rules, concepts,
and experiences, to a pre-selected group of securities that are of a
known level of quality i. e., Investment Grade
only. Here's a fairly comprehensive
Question and Answer [more accurately, a
Question & Discussion] list that should
help you to use the Value Stock Buy List Program productively. Remember,
the program is designed to follow the investment process defined and explained
in "The Brainwashing of the American Investor". The
more times you read it, the better your performance will be. Steve
Selengut has been kind enough to answer some questions about his
methodology. Here are my questions (and some that he has fielded
directly). with his responses. (If
you have additional questions, please send them to: brainwashed@optonline.net.)
Dealing with S & P
Downgrades:
When a stock is downgraded S & P, how long
thereafter do you stay away from it?
- That's really a function of how low it
goes. I'll get out ASAP if it goes below "B+", taking even a
minor profit or loss as soon as I'm aware of the change. Then, if it's
a larger loss, I'll consider it a candidate for "ATH" loss
taking, but some judgment is certainly required. For example, when IBM
went to "B" status years ago and Dupont did the same more
recently, I held out for those small profits. With a less well known
or widely held issue, say good bye as quickly as possible.
- Downgrades between the "A" categories are not
as significant to me, dependent again on my familiarity and experience
with the company as a trading vehicle. I don't give up too
easily on issues that I've had good experience with, and even though
the overall trading objective can be somewhere between four and seven
months, you will always have situations that you wind up holding on to
for much longer periods. There won't be many, and it's perfectly
acceptable to take a smaller profit or even a small loss on a
seriously long holding.
- A downgrade to B+ should raise a cautionary
flag, but it's nothing to be too afraid of, unless your overall
portfolio seems to lean in the B+ direction. I've made a lot of money
over the years at this end of the Quality spectrum and such a
downgrade may just turn out to be an excellent buying opportunity.
Keep in mind that we are looking at the bigger and stronger companies
in the first place and that many of these become more attractive as
takeover candidates at lower prices.
How often have you found that the S & P
rating was totally wrong?
- Within the "Brainwashing" book
methodology, there are management controls (checks and balances) that
warn of problems at the companies we invest in. Specifically, a cut in
or elimination of the dividend, and an S & P downgrade of the
stock below investment grade. Rarely is there a situation where
serious trouble won't come to our attention in time through one of
these mechanisms.
- I can think of only three glaring instances
over the years where an Investment Grade Rating held up to the very
end: Ames, Enron, and Friedman's. But, and key to the overall methodology,
major individual portfolio disasters were avoided because of
individual security % of portfolio diversification rules that must
never be violated and which must always [absolutely always] be
calculated using The Working Capital Model.
- Also, in each instance, profits had been
made on the security more than once prior to the disaster.
The "Buy
More" Decision (Averaging Down):
Should the opportunity to add to an existing holding (25% to 30% below
original cost) be considered before adding a "new" opportunity
to the portfolio?
- Generally, I won't buy more of an existing
holding if I have an adequate supply of new opportunities to choose
from. Stocks that go down this much on news or because they are in a
weak sector (the drug companies, for example) don't seem to bounce
back as quickly as the newbies.
- I also won't consider buying more of a
stock that has been downgraded to "B" or lower. These
become candidates for the "ATH" decision.
Assuming that the "fundamentals" haven't
deteriorated, and that the current buy list isn't wonderful, is the
"30% down from cost basis" a hard number or a guideline?
-
I stick to the 30%
faithfully, although I do consider it a guideline rather than a strict
rule. As your experience grows you'll be able to judge better, but
there is nothing wrong with doing nothing. Buying should always be
done slowly.
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