Friday, August 13, 2010

Your Investment's Time Horizon


I was recently asked by my friend, Mario (hi, Mario), how my True Religion stock was doing.  I told him that it was down to $22 ($20.94 now, at time of writing).  He knew that I started buying when the stock was $29.  He did not say much, but I can guess what he was thinking.  He was probably saying in his head, "So, Felix, you have your own investing blog and claim to know a few things about stocks, why has your stock dropped more than 24% since you started buying?  Why should I listen to you?"

Patience: Gift of the Holy Spirit
My answer to Mario is that God was gracious enough to grant me one of the twelve gifts of the Holy Spirit: patience...well, at least when I'm investing.  The reason why the title of this blog is "The Catholic Investor" and not "The Catholic Trader" is the fact that I have a long time horizon.  Define long?  It is difficult to say, but it would be in the order of magnitude of years and definitely not weeks or months.  Of course, this gives me a nice excuse of telling you, just wait...and by the time a few years have gone by, you would likely have forgotten about what we talked about!  Hopefully, you would not hold this cynical view!  This is also a reason why I have published my trades starting this year.

A long time horizon is the foundation of fundamental analysis.  The jist of fundamental analysis is that the stock of a company has an intrinsic value, that is sometimes independent of the price of its stock.  Even though True Religion may be priced at $20.94 per share right now, we posit that the value of stock is much higher than that.  The market is driven by emotion and stock prices can fluctuate immensely for an extended period of time.  We need to exercise the strategy that is so well known and obvious, but seldom executed well, "Buy low, sell high."

A Good Guess
Despite how some claim that stock price movement is entirely random (hint: this is absolutely false), stock prices exhibit many identifiable characteristics.  Amongst these is the rate of ascend and descend.  What I mean is that a stock rises and drops roughly at the same rate that it has always done so, within a certain range. If we look at Google's (Ticker: GOOG) stock chart for the past 5 years, we can see that during an uptrend, the stock doubles roughly every 1-2 years.  Even during the cataclysmic market meltdown in 2008, the descend is just slightly faster (on a logarithmic scale), at about 50% decrease in a bit less than a year.


Right now, GOOG is at about $490.  I happen to think that the intrinsic value of the company is around $1000-1100 (using my Rule #1 spreadsheet).  Let's just say it's roughly double from where we are today.  So, looking at the previous behaviour of the stock, we can guess it would take no less than a year to reach that point, if today was the start of an uptrend.  We are currently in a correction and frankly, I don't know when this correction will be over (there are some hints of it though).  Let's give the market another year to bounce up and down without going anywhere.  That brings us to at least 2 years out.  And since we've seen a spectacular rise in the stock since December of 2008, we can guess that the next leg up would not be as dramatic.  In conclusion, I would expect my time horizon for my Google stock to be 2-5 years.

A Moving Horizon
Let's look at our crystal ball: we are now 4 years into the future.  Google has found a way to massively monetize Android, which now has 50% of the mobile phone market share.  Youtube has turned into a money printing press.  People are starting to adopt cloud computing and Chrome OS has 20% market share.  Google TV turns out to be revolutionary in the way we watch TV.  The stock is now at $1100 as we had calculated.  What now?  At this point, we re-run our initial analysis to see what the intrinsic value of the company is.  If  the stock is fair or overvalued, find a good opportunity to sell it.  If it is still undervalued, it would be wise to hold the stock and buy more when the stock price dips.  

With the latter case, your time horizon may continue to grow.  You bought the stock in 2010.  Now, in 2014, your stock is still undervalued and you expect it to reach fair value in, say, 2017.  Your time horizon has just increased to 7 years.  I suggest re-running your analysis every quarter to fine tune your portfolio.

What Have You Done About Your Loses?
So, I'm in the red in True Religion, because I bought at the wrong time.  However, the perfect timing of the market is almost impossible.  I do not know of any investor that can accurately predict a stock's bottom over an extended amount of time.  However, a lot of good investors are out there.  What do they do?  A fund manager, who controls billions of dollars in assets, cannot enter into a position all at once without pushing up the stock price.  What he/she does is buy shares over weeks or even months.  This is what I try to do as well.  Since I can never figure out when the real bottom of a stock is, I determine an entry price for the stock I want to own.  For True Religion, it was in the $30s.  Therefore, I started buying when it was $29.  As it dropped, I did not panic, I did not dump the stock, I did not have a stop-loss order in place...I simply bought more!  It was because I knew the stock was worth way more than $29.  The lower it is, the better for it is for me.  After I have exhausted my capital (which I have not), I just sit and watch the stock rise back to its fair value and cash out.

As I said, that may be years into the future, but if my analysis is correct, I will reap great rewards!  You, too, can benefit in this way...so, pray, and pray hard for the gift of patience!