Is this a viable lifelong strategy? And A New Definition For Risk

Today someone close to me asked if this is a viable lifelong strategy and it has left me feeling a little bit deflated. Not because I don’t believe that I can make it but more so because it feels like your goal/lifelong dream is being questioned.

Now, I am not under any delusion as to how hard it will be to generate a living from the market, nor how long it will take for the companies I invest in to reach their full potential. I also don’t want to lie and say that if one of my stocks goes up ten times I’ll be a multi-millionaire, because that is simply not the case. To turn this goal into a reality I really need one ten bagger from which I can then enter another couple of stocks with three to four times what I put in my first few (OBJ, MHM & KGL). This is the value of compounding and each successive win means I have more capital to put into my next stock.

Right now the risks are the greatest because I already have three stocks and only room for maybe one or two more. From those five companies one or maybe two will fail but the gains from the others should more than offset those losses. If this occurs then I will have a larger capital base and my future portfolio could probably accommodate up to six stocks, with a bit of cash for short term opportunities and a cash buffer to protect against more than 50% of the portfolio crashing to zero (i.e. ensure I have money to come back in the event of a worst case scenario).

Finally I don’t necessarily classify my portfolio as “high risk” because if you have conducted the research and understand the fundamentals of the company then it should be “known risk”. High risk to me sounds like some useful catchphrase from which people can justify poor investment decisions. Why would anyone invest is something that is “high risk” unless they are gambling. It is a non-sense saying made to satisfy the demands of the ignorant. I apologise if I have used the words “high risk” in relation to my stocks in the past, but it was probably to make sure people understood what I was taking about in a general sense. From now on I will use my new phrase (not sure if it’s been used in investment terminology before or along these lines) but I propose the following definition:

“known risk in relation to a stock (or portfolio of stocks) that are anticipated to generate a high rate of return refers to the ability of an investor to understand the fundamental components of the company, the industry in which they operate and other external factors which may affect their future performance. Taking all these factors into consideration the investor calculates a future share price or market capitalisation that is likely to be five to ten times that of the company’s current value.

If the share price then falls by a considerable margin this is not an unpredicted event, but one of the considerations accepted by the investor when making their investment decision. I.e. The Investor chose to invest based on the likely return, but with knowledge that the return was conditional on a set of targets or objectives.

Known risk should not be used when referring to any investment that involves “hit and hope” exploration, companies with poor management or no/limited future of financial performance or security. These should be classed as poor investment decisions. I.e. there is no risk because they will only ever go one way, down”

I didn’t Listen to My Own Advice

This is pretty embarrassing to admit after banging on about the importance of doing your own research and the forming your own opinion, however I have recently fallen into the trap myself.

I have been following a stock, Northern Star Resources (ASX: NST), for a while now and was considering taking a position. In my opinion it is a well-run company, that has managed to turn an unwanted mine into a good little cash cow. That said there are a number of risks that I have to consider including the fact that the mine life of their Paulsens project is unknown and their Ashburton Project is pretty much 100% refractory ore, which makes the recovery of gold harder.

Anyway, as I was saying, I was considering taking a position in the company but my research indicated that future growth could only be achieved through an increase in the gold price, a sustainable mine life at Paulsens or further acquisitions. I discussed my research with another poster and it was only now that I can see that I placed too much emphasis on that discussion. My opinion was swayed and I decided to cease researching the stock. At the time it was trading around 58 – 60 cents (which is where it is currently at), however a couple of weeks back it dropped to the low 40’s which would have been a prime buying opportunity had I kept on top of the game.

Furthermore NST has made some recent announcements which are very significant for their Paulsens project, with the potential to alter my valuation. In my mind as long as Paulsens continues to pump out the gold this company is going to be in a very strong position. So I have admitted my mistake and maybe I have missed the opportunity, but I am going to pull up my notes and do some further research. Who knows it may be part of the portfolio shortly, it may not.

As always please do your own research and consult a licenced financial advisor before making any investment decision.

The Benefits of "Do Your Own Research"

I admit it is hard to block out all the noise that we hear on a daily basis, media commentators, youtube videos, forum posters, blogs, everyone seems to be shouting some message and it always those who are the most controversial (whether bullish or bearish) who get the most air time.

When I was younger I used to get caught up in this, not because I didn’t do my own research but because I was second guessing myself or looking for confirmation from an external source. However, the fact remains that these “talking heads” do not necessarily know more than you do. They do not have a crystal ball. And if you apply yourself and spend the time to research a particular company or industry you too can become an “expert” in that field. When you are confident in your knowledge and ability you will not seek this external validation, your investment decisions will be clearer and you will sleep better at night.

So why am I writing this post today? Well for two reasons. Firstly I read two rubbish articles on the Sydney Morning Herald and News.com.au website today claiming that property prices were going to boom from now until 2013. Both articles referred to a BIS Shrapnel report, a report which I happen to have. Both of these articles correctly stating that BIS are anticipating growth up until 2013, however they then say that growth is expected to slow. This is incorrect. On page iii of the executive summary it says:

“However, the magnitude of price rises will be constrained by the spectre of rising interest rates, which are forecast to eventually peak and bring about a downturn in the market in 2013/2014”

A downturn is completely different to the “slowdown” that the major news sites claim will take place. A downturn implies prices will go down! A slowdown implies price growth will slow! Two completely different things! Any way the reason why I post this is to highlight that you must go to the source of the information to understand the true picture. Don’t just listen to the “talking heads” whether they are on the net or in a paper (and that includes me).

The second incident that led me to write this was some recent comments made by a “well respected poster” on a couple of forums. Now this person is intelligent and certainly understands the industry in question very well. As a result they do appear to hold “sway” over a number of posters who hang onto their every word. This same poster for whatever reason turned bearish and mentioned that they would be dumping shares in a particular company (yet the volume so far suggests otherwise). As a result of these statements a number of other posters suddenly got nervous and I thought I would take this as an opportunity to say that just because someone says something doesn’t mean they will actually do it. For all we know the person may be a net buyer and/or change their mind very quickly. Furthermore if you allowing your investment decisions and frame of mind to be swayed by someone else then it highlights a lack of belief in your own ability and research.

In summary, don’t look for confirmation from others, do your own research and you will be much better off for it.

Explorer to Producer and Why Your Timing is Important

The other week I replied to a post about a resource stock and its share price. My response was in regard to the life stages of a company as it moves from explorer to producer and the affect this can have on the capital structure. I received some positive feedback on the post so I thought I would share part of it with you again today. It is very simplified but I think it details the overall process well.

As a resource company moves from explorer to producer the share price normally re-rates in a number of ways.

If the company starts out as an explorer the share price will be largely tied to their exploration potential and any discoveries they make. The share price will normally jump in price if they announce good drilling results and a “potential” discovery.

Following this spike in the share price will typically fall. At this stage the stock is basically controlled by traders and after they have traded the run up they will move out of the stock and look for their next target.

Time then passes and if we assume that the discovery is good further drilling takes place as the company proceeds to put together a JORC estimate. Obviously it is normally two steps forward, one step back but for the sake of this example and simplicity let’s assume they have discovered something worthwhile. The share price is then likely to jump again once the JORC estimate is finally put together and people will start applying an in ground value to the resource.

The share price then drops back as traders leave it again and longer term holders realise that it takes a significant amount of capital to develop a mine. There is also other risks associated with mining approvals and licences, etc.

Assuming all is well the company will then proceed to the preliminary feasibility stage to run some basic numbers on the project. If we assume this comes back positive then the share price is likely to rise again as the first box towards developing a mine has been ticked.

As per usual it will then drop back as it is dumped by traders again and longer term investors wait for the bankable feasibility study which is required before the formal decision to proceed with the mine can be made.

Once this is released it confirms that a mine can be profitably developed and the share price may run again off this news. However, following this the share price may retrace again because the mine development costs will be high and existing shareholders face the threat of dilution (as the company may issue additional shares to raise funds).

The share price may then run and re-trace every now and then based on the issuing of mining licences, securing of finance and successful capital raisings. During this time the shareholder base is also likely to change with more investors coming on board and positioning themselves for when the company starts producing.

Finally once the mine is in production there will be a re-rate in the share price because they will have finally achieved what they wanted (i.e. a mine that is operating). The real re-rating will however come in 3, 6 or 9 months when the company proves that not only can they run a mine but that they can meet their production targets, revenue and profitability forecast.

Now that is obviously a simplistic breakdown of the process and it may take a resource company many, many attempts at exploration before they are in a position to define a resource. However we can see from the above that the reason why it can run and re-trace so much is because in the early days it is largely traders who push the price up and down. Also as an explorer the company will probably have a market capitalisation of between $20 and $50 million. To develop a mine will cost many times their market capitalisation and as a result new shares will be issued diluting existing holders. Obviously some people will sell in anticipation of this which can also have downward pressure on the price.

I would also like to add that in regard to my investment approach I primarily look for companies that have a good chance of moving into production, low/no debt and preferably a cash in the bank to minimise the potential of a capital raising. In summary if you are a long term investor it is about buying at the right stage of the company’s life to minimise the potential of adverse effects and the burning of time while you wait for the company to move to the status of producer.

Know What You Invest In

I have never read a book about Warren Buffet or his investing approach but one of the most important things I believe he has said is “never invest in a business you don’t understand”.

Just today I have been reading some blogs and posts on a couple of stocks and it amazes me at the amount of “long term investors” (note I am not talking about traders, you are free to buy and sell whatever you want) who say that they hold a stock but clearly don’t understand the business or industry itself. Many of these people may have purchased the stocking “thinking” they know about it, but the majority opening admit that they “just think it has potential but don’t really understand what the company does”

This is probably even more evident in the bio-tech space where every company thinks they are onto the next big thing and it is easy to get caught up in the “hype” generated by the company. However, if you are going to invest in this end of the market please take the time to do the research and understand the company you are about to invest in. It is also important to understand that many of these companies will require significant capital contributions throughout their life and the hype in their technology is required to maintain shareholders belief while they tap them for more money.

I will not sit here and pretend that it is possible to know everything, but at least do the research, understand the company and its potential and run some calculations on its future earnings/profitability. As you will know from reading my blog I only hold two stocks, I have however researched many more than this. Some of these stocks I was originally very positive about and definitely thought I was going to buy. However by taking the time to research the stock, the industry and its potential I cut many by the way side.

If you are one of those investors who do not currently understand the companies you are invested in, stop and take the time to do some research. It is better late than never.