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Be Wary of High Debt Levels Question What do you mean when you say to avoid debt-laden securities? Answer Your longer version of this question, which I have summarised above, seemed to be looking for some decision rules in terms of absolute and universal numbers. I am sorry, but this is not the way to address this issue. Debt is a marker of financial risk. Financial risk is basically the ability of the company to meet debt service payments and debt repayments on time, even in difficult times. If a business is in a cyclical industry (one whose revenue and profits rises and falls with the level of economic activity), then it has more financial risk with a given debt to equity ratio than a company in a non-cyclical industry. The other aspect is that if a company finds itself in trouble for a while, a high debt to equity ratio is a marker of more risk than a low debt to equity ratio. If debt is low, there is borrowing capacity unused in a difficult time, but if the debt level is already high, there is no fall-back borrowing capacity. So, the first step is to look at the debt to equity ratio. The lower it is the better in financial risk terms. Certainly it is also a safety valve in hard times. Then you have to assess it against its competitors as discussed above. It should also be noted that I said securities, not shares in my talk. There are quite a range of securities you can buy these days. A trust and a company are different beasts. You need to know that and what the implications are. Also, there are stapled securities, which are a trust unit plus a share. This is a different animal again. I personally avoid these securities and confine myself mainly to companies, because they have more growth potential from retained earnings. Trusts can not retain earnings because of the way the tax law works. There are many more wrinkles to these securities, about which I am not an expert, so I cannot comment in detail. I follow Warren Buffett’s dictum of not investing in businesses that I do not totally understand. I Can’t Always Follow You Comment I have looked at your portfolio in relation to their charts. The buys, mostly I can see, but a lot of the sells I can't work out. Response I publish my portfolio on my web site for only one reason. This is so that anyone reading my work in the Australian Financial Review or AFR Smart Investor magazine is aware of what I do or do not hold myself. This is required by law if I am commenting on stocks. Putting my portfolio on my web site overcomes a problem of just tacking a notice on the end of the article or column, in that my position may have changed by the time you read the article or column. I would hope that my buys are explicable in terms of my method as explained in my books The Aggressive Investor and Hot Stocks. If not, I am not following my investment plan. I am therefore not surprised that you worked most of them out OK. Sells are a little more complicated to follow at times. The ones that hit a sell stop level, or gave one of my three sell signals, should also be fairly easy to work out. However on top of this, there are other considerations. The most important one relates to my market exposure strategy. At times I make decisions to vary my market exposure. The general rules for this strategy are set out in my book The Aggressive Investor. However, what is unstated is what I might be thinking. My current position is fairly much discussed in detail in my book Hot Stocks. At other times I may make some other moves, which are driven by my personal situation. I might need to sell something to pay a tax bill. I may need to liquidate some investments to shift some assets from one tax-driven structure to another. And so on. These things will probably remain hidden from your thinking. I am sorry about that, but I can not legally give a running commentary on my actions in the market without crossing the line on not being able to give a view about the market without an adviser’s licence. The best I can offer is that if you ask me I will answer if I am legally able to do so at the time. I know this may sound like an evasion, but it is not. I simply cannot take the risk of breaking this important law which is aimed at investor protection, even if it is rather heavy-handed. In this respect, I dare not answer your questions with any reference to the stocks you mention that you hold, because that could easily be seen as expressing a view about them. Where Should My Stop-Loss Be? Question The real problem I am having is trying work out where to set a stop-loss for skyrocketing stocks where there has been little sign of a plateau or minor downturn. Answer With the greatest respect, I would like to suggest that you are tackling the problem the wrong way. Let me answer your question in two ways. First, if a stock rises so far without any correction that you are uncomfortable with your sell stop, I think the best approach is not to try to tighten up your sell stop somehow. That could be inviting a normal market movement to take you out of a good investment. I think that your sell stop should be always where the logic of your investment plan says it should be. Then, if you find that the result is that too large a percentage of your capital is then at risk, the logical course is to sell your position down to a size where less of your capital is at risk. Say you started with a risk of 2% of your capital and the stop is now 4% of your capital away. It makes sense to me for you to halve the position. Remember that you can always rebuild it again later when the logic of your plan allows a closer sell stop. The other way, and in many respects the better way, to answer your question is by reference to my investment plan as set out in my book The Aggressive Investor. The way I set my sell stop is only one of my three sell signals. My sell stop may be a long way away after a strong rise. That is part of the dictum to let your profits run. However, if the rise runs out of steam and the whole trend fails, I find that I am likely to get one of my other two sell signals well above the sell stop level. I think that the answer to your question is a combination of these two approaches. Wait for a sell signal, but if you cannot stand the pain, sell down to a level of risk you can tolerate. Resist the temptation to tighten the stop in a way that is contrary to your established and tested investment plan. Where the Money Is Comment In a mining boom, just like the 19th century gold rush, it wasn't only the miners who made money, but the people selling the picks and shovels so companies which supply the resources companies have produced fantastic returns. Response I agree entirely. I had to delete the codes of the companies you listed to avoid breaking the law. If you peruse my portfolio and the companies I have held in the last year you will see that I have followed that general approach with great success. Another Scam Question I had a phone call from (name withheld) about their amazing grey box that automatically browses 1200 stocks picking the best 10 stocks each day using no less than 250 indicators. It’s yours to keep for life, gives an average 18% per month and you can obtain your data feed from any source you like. They also sell a professional version that returns 30% per month. They say they are only selling 250 licences Australia wide and there is only a couple left. I also received their glossy brochure with a lot of glossy pictures but little else about what you are actually getting for your money. They are asking $8,500 and the professional version costs $30,000. Should I hang out for the steak knives or put the brochure in the bin where it belongs with all the other too good to be true scams? Answer This is an all too familiar marketing story and sounds like any one of several similar scams over the last ten years or so. Bin it. If you have friends or clients who you think would like to receive the newsletter, please email it on to them and invite them to subscribe by going to the Newsletters page on www.bwts.com.au and clicking on the relevant link. My only proviso is that the newsletter be sent in full and unchanged. My email newsletter list contains only your name and email address, which information is not used for any other purpose than to send out email newsletters. Past issues of the email newsletter are available for downloading from my web site www.bwts.com.au. Newsletters will generally be posted to the web site when the following issue is sent out, about a month later, so my email list is the fastest way to get to see them. Subscribe by going to the Newsletters page on www.bwts.com.au and clicking on the relevant link. |
