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Saturday, January 19, 2008

FSK's Stock Investing Philosophy

If you desire a counter-economic investment, gold or silver coins or bars do nicely. Remember: If you want to invest in gold or silver, make sure you have physical metal in your possession. I haven't bought any physical metal yet, but I've heard that Apmex is the most reputable online dealer. A price comparison of a few dealers also shows Apmex to have the best prices.

Even though the US dollar is crashing, I don't feel urgency to buy gold or silver. The rate of increase in the stock market will approximately match the decline in the value of the dollar. Stock investments will be safe until the agorist economy is mature, at which point the current economic system will completely collapse.

I never realized how clueless most people were about investing. Even though I am convinced that the current economic system is invalid and destined for collapse, it isn't going to go away anytime soon. In the short-term, stocks are the best inflation hedge. If you pick wisely, you can even outperform inflation by a few percent. Overall, I've made an annualized return over 25% since I started picking individual stocks in 2000.

Buy companies whose products you know and like. For example, I chose to invest in an airline based on which airline provided the best customer service.

Only invest in companies you understand. I understand software and technology, so I'm good at picking tech companies. I'm not a doctor or biologist, so I stay away from drug companies. At work, other people said that HP computers were better than Dell computers, so I bought some HPQ. At one job, it was the first time I'd ever worked on an HP computer instead of a Dell computer.

Suppose you interview at a corporation, feel you were treated well, but were not offered a job. That becomes an investment opportunity; that's how I choose which financial companies to invest in. If you interview at a corporation, and you leave the interview thinking "I can't believe their heads are that far up their ***es", then you know to not buy that stock.

Valuation counts. You should compare P/E ratios of several companies. Sometimes companies have special events that inflate or deflate their reported earnings, so you should look at the current year, previous year, and predictions for the future year. Corporate earnings will naturally grow with inflation. As inflation occurs, corporations will have higher prices for supplies, higher prices for sales, and the same target profit rate. Inflation affects every large corporation.

Buy the stock as if you were buying the entire company. Look at market capitalization. Compare corporations' market capitalization. Compare several different corporations as if you were buying the entire corporation.

For example, when I wrote this, MSFT had a market capitalization of $300B and GOOG had a market capitalization of $200B. Is Google really worth 2/3 as much as Microsoft? MSFT has two monopolies (OS and Office) that have withstood the test of time. (In computer-time, 20 years is like forever.) Every large corporation has a ton of custom software written for MSFT's OS, which cannot be easily ported to other platforms. MSFT has a history of ruthlessly knocking out competitors, and you know that GOOG is firmly in the cross-hairs of MSFT. Google has no lock-in for its customers, whereas MSFT is an expert at getting lock-in. I can effortless switch search engines, if necessary. If I needed to abandon Blogger, I would.

Google is a great company. Is it worth 2/3 as much as Microsoft? You've got to be kidding me.

Consider another example. When I wrote this, KO had a market capitalization of $140B. KO had a P/E ratio half that of GOOG. KO has withstood the test of time. I would even go as far to say that Coca-Cola has a good chance of surviving past the collapse of the red market. Is Google worth twice as much as Coca-Cola on an earnings basis, and 40% more on a market capitalization basis?

By this analysis, I would be forced to conclude that Google's stock is overpriced. Google is a great company with great products. It's overpriced as an investment.

If I had enough cash around to buy an entire corporation, I'd buy Coca-Cola first, Microsoft second, and Google last, among those three corporations I analyzed.

Dollar cost average. Suppose you've analyzed a stock and conclude it's a good investment. You buy some. It goes down 20%. If there was no news released that affects your analysis, buy more! Spread out your purchases at least a few months apart, so you don't keep buying a stock that's rapidly tanking. Also, if you're willing to invest $n in a stock, invest in $n/2 or $n/3 increments. This way, you can buy more if the stock goes down after you buy. If the stock goes up after you buy, great! Take the remaining $n/2 and pick a new stock.

For every time there's a stock like ENE that crashes all the way to zero, there are stocks that go down and recover. If your original analysis of the stock is unchanged, it makes sense to buy again after a decrease.

Similarly, if a stock runs up a lot, you should consider selling. However, selling means you have to pay capital gains taxes. This means that your new investment has to be 25% better than your old investment, for it to make sense to sell. Some stocks I bought went up so much that I had to sell some for diversification purposes. (Everyone should have that problem!)

It helps to read sites like The Motley Fool, which encourage individual independent thinking about investing. It was independent thinking about investing that led me to discover things like the Discounted Cashflow Paradox and realize the fundamental structural flaw in the current economic system.

As a more advanced strategy, you can buy call options. When you buy a call option, you are actually making a bet that there WILL be inflation. A call option includes a loan element, because you don't have to pay the strike until expiration. That loan is priced at the Fed Funds Rate, which is a bargain. Individuals can't normally borrow at the Fed Funds Rate. If I want to buy stock on margin, I have to pay 8%. Options are an opportunity to profit from inflation. The details are a subject of a future post, because the full argument in favor of buying call options is really complicated; it's related to the fundamental structural flaw in the monetary system. Call options are a loophole that allow the average investor to borrow at the same rate as hedge funds and banks, provided they use the proceeds to buy a stock.

Don't use stop loss orders! Using stop-loss orders is really counter-productive. Market makers get to know if there's a large stop-loss order on the book. If they see a large stop-loss order, they will try to move the stock down, electing the stop order, and the market maker will buy from the stop-loss order. The result is that the person who placed the stop-loss order winds up selling at the ABSOLUTE bottom.

Stocks are the best investment strategy for now. You should take advantage of this massive government subsidy as best you can. As the end of the current economic system approaches, it would pay to start making counter-economic investments.

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