Go to Jeff Salisbury LWGate Home Page.From: "Katherine Malm" <kmalm@earthlink.net>
Subject: [CANSLIM] Due Diligence
Date: Wed, 30 Jan 2002 11:11:05 -0600
Previous Article (by Date): Re: [CANSLIM] Candidate List: ETsPVWwSNC 1/29/02 "Katherine Malm"
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Hi all,
One of the parts of my investment discipline that I feel very strongly =
about is the due diligence step. I call this "making a case for the =
stock" or "the 2 minute elevator speech." Gerald Loeb calls it "having a =
single ruling reason." Wise advise from a gentleman that's known for his =
successful career. Here's a terrific article on the subject that I'm =
placing in the front of my CANSLIM binder in the section marked "sell =
rules.":
- --Katherine
Investment Ideas Have Expiration Dates=20
28-Jan-02 11:50 ET=20
=20
[BRIEFING.COM - Robert V. Green] You probably wouldn't drink milk =
in your refrigerator that is a month past the expiration date. Why are =
you still holding on to the stock whose investment idea has expired?=20
Stock Purchase Premises
We believe strongly that when you buy a stock, you should have an =
investment premise.=20
A premise is an reasoned explanation or idea for why the stock =
price for your chosen investment will rise. This includes ideas such as:
a.. Revenue and earnings will grow because the company has great =
distribution in an expanding market.=20
b.. The company will be acquired because it fits well with XYZ's =
stated expansion plans.=20
c.. The company will continue its strong demonstrated increase =
in its net profit and gross margin percentages, thereby earning an =
increased market multiple.=20
d.. The company's market multiples are low in comparison with =
comparable companies, and will eventually reach parity.=20
e.. The historical stock price chart indicates a coming change =
in the stock price.=20
f.. A new product introduction will generate a new stream of =
revenue and earnings that are not yet factored into the price.=20
g.. The company is the sole provider of a product, demand for =
which will increase.=20
These are examples of the conclusion of an investment premise. A =
fully developed premise includes a financial projection and assumed =
market multiples in the future that predict the future stock price.=20
(For the moment, we will ignore the problem of buying a stock =
without an investment premise. This far too common practice deserves its =
own separate treatment.)
Even the best researched and thought out investment premises do =
not always come true. How you address your investment at this moment is =
a key element of investment success.=20
Sell When It Does Not Work Out
An investment premise imposes a discipline upon the buying =
decision.=20
It also can be a key element of the sell decision.=20
When it becomes clear that an investment premise is wrong, you =
have only two choices:=20
1.. Sell.=20
2.. Develop a new premise.=20
Failure to take either of these two paths means that "hope" is now =
the premise on which your money is invested. While "hope" is a great =
motivator in our emotional lives, it is a very poor reason to make an =
investment.=20
When you learn or decide that your investment premise is wrong, =
and you cannot develop a new investment premise, you must sell, even if =
it means a loss. Failure to take losses at this point only subjects your =
money to "uncalculated risks." If you have no reason for why the stock =
price will rise, you have no understanding of what is driving the stock. =
As an extreme example, consider Exodus Communications. The =
investment premise behind many owners of the stock in 1999 and 2000 was =
that the world-wide boom in web site build-outs would lead to an =
increased customer base for Exodus with strong revenue growth and =
earnings growth. This was actually a very reasoned and rational =
investment premise at the time.=20
However, this investment premise was destroyed in April of 2001, =
when Exodus reported sequential revenue declines were coming. At that =
point, the price of the stock was $9. Investors who had bought on the =
growth premise were faced with large losses. The stock had traded above =
$50 just six months prior and $100 one year earlier. [Katherine's =
note--technical sell rules got you out of this stock *long* before the =
fundamental slowdown kicked in. If you missed the technical sell rules, =
the lone fundamental rule of slowing earnings/revenue would have saved =
you.]
But anyone who sold EXDS at a loss in April 2001 because the =
growth premise had been disproved, saved the additional $9 a share they =
would have lost if they continued to hold the stock.=20
"Avoiding investment loss" is the same as "making money." When you =
sell at a loss because your investment premise has not worked out, you =
often save yourself from further losses. [Katherine's note--another =
CANSLIM sell rule, cut your losses short and move on]
Expiration Dates
Investment premises have expiration dates.=20
If you have strong investment discipline, you can sell when you =
know your investment premise is wrong. But what if time elapses and =
there is no conclusive evidence that the premise is either right or =
wrong? What then? [Katherine's note--think this is an investing =
discipline that transcends all styles]
You should decide, in advance, how long you can wait for the =
premise upon which you based your investment decision to develop. =
Patience may be a virtue, but investment patience that is not backed up =
by progress eventually becomes "hope" and not a true premise.=20
Business progress towards a business goal is called "traction." If =
your premise is based upon a company's business fundamentals you need to =
look for traction in the earnings reports. Failure to produce traction =
is often a contradiction of a growth premise, even if the company's =
stock price does not move. You should decide how long it "should take" =
for the business to truly live up to the promise of your premise. If =
traction doesn't occur in the timeframe you expected, start considering =
selling.=20
This is the reason that growth stock prices decline so drastically =
upon poor earnings reports. Disciplined professionals dump the stock =
when their premise is disproved by poor results. The refuse to hold the =
stock, even if the losses are severe. [Katherine's note--another =
important sell rule...inexplicable gaps down near earnings dates and/or =
gaps down on earnings news.....get out of the way. Another sell =
rule--tails near the top on high volume indicate institutional =
selling...pay attention and make sure you have big ears when the market =
speaks.]
If your investment premise is based upon technical analysis, =
expiration dates are even easier to define. Most TA approaches forecast =
chart moves within a timeframe. When it turns out that the expected turn =
did not happen within the timeframe expected, your investment premise =
has expired! [Katherine's note--another sell rule...if a stock breaks =
out and has not follow-thru within a reasonable timeframe, move on]
New Premises
When the milk in your refrigerator expires, you pour it out and =
get a new gallon. The same practice should apply to investment premises. =
[Katherine's note--another CANSLIM principle, dump the losers, pyramid =
into the winners. If your sell rules kick in and there is nothing of =
quality setting up to buy, you wait in near-cash. If you are more =
aggressive you can practice "upside-down CANSLIM" and go short.]
It is extremely distasteful to take a deep drink of sour milk =
unknowingly. Equally unpleasant is holding a stock long after the reason =
you bought it has been explicitly disproved through contradiction, or =
implicitly disproved through the absence of traction. Only you can =
decide how long your investment premise should last, but without an =
expiration date, you may well find that your investments have curdled =
while you weren't looking.=20
Comments may be emailed to the author, Robert V. Green, at =
rvgreen@briefing.com=20
=20
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<DIV><FONT color=3D#0000ff>Hi all,</FONT></DIV>
<DIV><FONT color=3D#0000ff></FONT> </DIV>
<DIV><FONT color=3D#0000ff>One of the parts of my investment discipline =
that I=20
feel very strongly about is the due diligence step. I call this "making =
a case=20
for the stock" or "the 2 minute elevator speech." Gerald Loeb calls it =
"having a=20
single ruling reason." Wise advise from a gentleman that's known for his =
successful career. Here's a terrific article on the subject that I'm =
placing in=20
the front of my CANSLIM binder in the section marked "sell =
rules.":</FONT></DIV>
<DIV><FONT color=3D#0000ff></FONT> </DIV>
<DIV><FONT color=3D#0000ff>--Katherine</FONT></DIV>
<DIV> </DIV>
<DIV>
<TABLE cellSpacing=3D0 cellPadding=3D4 width=3D"100%">
<TBODY>
<TR>
<TD class=3Dheader><FONT size=3D4><STRONG>Investment Ideas Have =
Expiration=20
Dates</STRONG></FONT></TD></TR>
<TR>
<TD><FONT class=3Ddate>28-Jan-02 11:50 ET</FONT></TD></TR>
<TR>
<TD height=3D8></TD></TR>
<TR>
<TD>
<P>[BRIEFING.COM - Robert V. Green] You probably wouldn't drink =
milk in=20
your refrigerator that is a month past the expiration date. Why =
are you=20
still holding on to the stock whose investment idea has expired? =
</P>
<H3>Stock Purchase Premises</H3>
<P>We believe strongly that when you buy a stock, you should have =
<I>an=20
investment premise. </I></P>
<P>A premise is an reasoned explanation or idea for why the stock =
price=20
for your chosen investment will rise. This includes ideas such =
as:</P>
<UL>
<LI>Revenue and earnings will grow because the company has great =
distribution in an expanding market.=20
<LI>The company will be acquired because it fits well with XYZ's =
stated=20
expansion plans.=20
<LI>The company will continue its strong demonstrated increase =
in its=20
net profit and gross margin percentages, thereby earning an =
increased=20
market multiple.=20
<LI>The company's market multiples are low in comparison with =
comparable=20
companies, and will eventually reach parity.=20
<LI>The historical stock price chart indicates a coming change =
in the=20
stock price.=20
<LI>A new product introduction will generate a new stream of =
revenue and=20
earnings that are not yet factored into the price.=20
<LI>The company is the sole provider of a product, demand for =
which will=20
increase. </LI></UL>
<P>These are examples of the conclusion of an investment premise. =
A fully=20
developed premise includes a financial projection and assumed =
market=20
multiples in the future that predict the future stock price. </P>
<P>(For the moment, we will ignore the problem of buying a stock=20
<I>without</I> an investment premise. This far too common practice =
deserves its own separate treatment.)</P>
<P>Even the best researched and thought out investment premises do =
not=20
always come true. How you address your investment at this moment =
is a key=20
element of investment success. </P>
<H3>Sell When It Does Not Work Out</H3>
<P>An investment premise imposes a discipline upon the buying =
decision.=20
</P>
<P>It also can be a key element of the sell decision. </P>
<P>When it becomes clear that an investment premise is =
<I>wrong,</I> you=20
have only two choices: </P>
<OL>
<LI>Sell.=20
<LI>Develop a new premise. </LI></OL>
<P>Failure to take either of these two paths means that "hope" is =
now the=20
premise on which your money is invested. While "hope" is a great =
motivator=20
in our emotional lives, it is a very poor reason to make an =
investment.=20
</P>
<P>When you learn or decide that your investment premise is wrong, =
and you=20
cannot develop a new investment premise, you must sell, <I>even if =
it=20
means a loss. </I>Failure to take losses at this point only =
subjects your=20
money to "uncalculated risks." If you have no reason for why the =
stock=20
price will rise, you have no understanding of what is driving the =
stock.=20
</P>
<P>As an extreme example, consider Exodus Communications. The =
investment=20
premise behind many owners of the stock in 1999 and 2000 was that =
the=20
world-wide boom in web site build-outs would lead to an increased =
customer=20
base for Exodus with strong revenue growth and earnings growth. =
This was=20
actually a very reasoned and rational investment premise at the =
time. </P>
<P>However, this investment premise was <I>destroyed</I> in April =
of 2001,=20
when Exodus reported sequential revenue declines were coming. At =
that=20
point, the price of the stock was $9. Investors who had bought on =
the=20
growth premise were faced with large losses. The stock had traded =
above=20
$50 just six months prior and $100 one year earlier. <FONT=20
color=3D#0000ff>[Katherine's note--technical sell rules got you =
out of this=20
stock *long* before the fundamental slowdown kicked in. If you =
missed the=20
technical sell rules, the lone fundamental rule of slowing=20
earnings/revenue would have saved you.]</FONT></P>
<P>But anyone who sold EXDS at a loss in April 2001 because the =
growth=20
premise had been disproved, <I>saved the additional $9 a share =
</I>they=20
would have lost if they continued to hold the stock. </P>
<P>"Avoiding investment loss" is the same as "making money." When =
you sell=20
at a loss because your investment premise has not worked out, you =
often=20
save yourself from further losses. <FONT =
color=3D#0000ff>[Katherine's=20
note--another CANSLIM sell rule, cut your losses short and move=20
on]</FONT></P>
<H3>Expiration Dates</H3>
<P>Investment premises have expiration dates. </P>
<P>If you have strong investment discipline, you can sell when you =
know=20
your investment premise is wrong. But what if time elapses and =
there is no=20
conclusive evidence that the premise is either right or wrong? =
What then?=20
<FONT color=3D#0000ff>[Katherine's note--think this is an =
investing=20
discipline that transcends all styles]</FONT></P>
<P>You should decide, in advance, how long you can wait for the =
premise=20
upon which you based your investment decision to develop. Patience =
may be=20
a virtue, but investment patience that is not backed up by =
progress=20
eventually becomes "hope" and not a true premise. </P>
<P>Business progress towards a business goal is called "traction." =
If your=20
premise is based upon a company's business fundamentals you need =
to look=20
for traction in the earnings reports. Failure to produce traction =
is often=20
a contradiction of a growth premise, even if the company's stock =
price=20
does not move. You should decide how long it "should take" for the =
business to truly live up to the promise of your premise. If =
traction=20
doesn't occur <I>in the timeframe you expected,</I> start =
considering=20
selling. </P>
<P>This is the reason that growth stock prices decline so =
drastically upon=20
poor earnings reports. Disciplined professionals <I>dump</I> the =
stock=20
when their premise is disproved by poor results. The refuse to =
hold the=20
stock, even if the losses are severe. <FONT =
color=3D#0000ff>[Katherine's=20
note--another important sell rule...inexplicable gaps down near =
earnings=20
dates and/or gaps down on earnings news.....get out of the way. =
Another=20
sell rule--tails near the top on high volume indicate =
institutional=20
selling...pay attention and make sure you have big ears when the =
market=20
speaks.]</FONT></P>
<P>If your investment premise is based upon technical analysis, =
expiration=20
dates are even easier to define. Most TA approaches forecast chart =
moves=20
within a timeframe. When it turns out that the expected turn did =
not=20
happen within the timeframe expected, <EM>your investment premise =
has=20
expired! </EM><FONT color=3D#0000ff>[Katherine's note--another =
sell=20
rule...if a stock breaks out and has not follow-thru within a =
reasonable=20
timeframe, move on]</FONT></P>
<H3>New Premises</H3>
<P>When the milk in your refrigerator expires, you pour it out and =
get a=20
new gallon. The same practice should apply to investment premises. =
<FONT=20
color=3D#0000ff>[Katherine's note--another CANSLIM principle, dump =
the=20
losers, pyramid into the winners. If your sell rules kick in and =
there is=20
nothing of quality setting up to buy, you wait in near-cash. =
If you=20
are more aggressive you can practice "upside-down CANSLIM" and go=20
short.]</FONT></P>
<P>It is extremely distasteful to take a deep drink of sour milk=20
unknowingly. Equally unpleasant is holding a stock long after the =
reason=20
you bought it has been explicitly disproved through contradiction, =
or=20
implicitly disproved through the absence of traction. Only you can =
decide=20
how long your investment premise should last, but without an =
expiration=20
date, you may well find that your investments have curdled while =
you=20
weren't looking. </P>
<P>Comments may be emailed to the author, Robert V. Green, at <A=20
href=3D"mailto:rvgreen@briefing.com">rvgreen@briefing.com</A> =
<!--(V) (RVG)--></P><!-- =
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