Operational Questions & Answers - Part 2

There are Investment Grade Securities that generate very little trading volume. Are they included in the Selection Universe?

• No, they are purposely excluded if they average less than 5,000 shares per day, because the trading methodology really does require liquidity in Common Stocks. Some newspapers include only the x,xxx most active issues in their listings, and this may be an inconvenience for travelers without Internet access.
• On the other hand, many investors will have CEFs (Closed End Funds) in the Fixed Income portion of their portfolios, and these trade in much smaller volumes. When selling, this needs to be taken into consideration because, believe it or not, even small traders can affect market prices. It's not unusual for me to trade positions a few hundred shares at a time, based on the supply and demand numbers.

Dealing with S & P Downgrades:

When a stock is downgraded S & P, how long thereafter do you stay away from it?

• That's really a function of how low it goes. I'll get out ASAP if it goes below B+, taking even a minor profit or loss as soon as I'm aware of the change. Then, if it's a larger loss, I'll consider it a candidate for ATH loss taking, but some judgment is certainly required. For example, when IBM went to B status years ago and Dupont did the same more recently, I held out for those small profits. With a less well known or widely held issue, say good bye as quickly as possible.
• Downgrades between the A gradations are not as significant to me, dependent again on my familiarity and experience with the company as a trading vehicle. I don't give up too easily on issues that I've had good experience with, and even though the overall trading objective can be somewhere between four and seven months, you will always have situations that you wind up holding on to for much longer periods. There won't be many, and it's perfectly acceptable to take a smaller profit or even a small loss on a seriously long holding.
• A downgrade to B+ should raise a cautionary flag, but it's nothing to be too afraid of, unless your overall portfolio seems to lean in the B+ direction. I've made a lot of money over the years at this end of the Quality spectrum and such a downgrade may just turn out to be an excellent buying opportunity. Keep in mind that we are looking at the bigger and stronger companies in the first place and that many of these become more attractive as takeover candidates at lower prices.

How often have you found that the S & P rating was totally wrong?

• Within the Brainwashing book methodology, there are management controls (checks and balances) that warn of problems at the companies we invest in. Specifically, a cut in or elimination of the dividend, and an S & P downgrade of the stock below investment grade. Rarely is there a situation where serious trouble won't come to our attention in time through one of these mechanisms.
• I can think of only three glaring instances over the years where an Investment Grade Rating held up to the very end: Ames, Enron, and Friedman's. But, and key to the overall methodology, major individual portfolio disasters were avoided because of individual security % of portfolio diversification rules that must never be violated and which must always [absolutely always] be calculated using The Working Capital Model.
• Also, in each instance, profits had been made on the security more than once prior to the disaster.

The "Buy More" Decision (Averaging Down):

Should the opportunity to add to an existing holding (stick with 30% below original cost) be considered before adding a new opportunity to the portfolio?

• Generally, I won't buy more of an existing holding if I have an adequate supply of new opportunities to choose from. Stocks that go down this much on news or because they are in a weak sector (the drug companies, for example) don't seem to bounce back as quickly as the newbies.
• I also won't consider buying more of a stock that has been downgraded to "B" or lower. These become candidates for the ATH decision.
• Absolutely do not buy more of a stock that falls below $10.00 per share, even if a high S & P Rating is maintained.

Assuming that the fundamentals haven't deteriorated, and that the current buy list isn't wonderful, is the 30% down from cost basis a hard number or a guideline?

• I stick to the 30% faithfully. Although I do consider it a guideline rather than a strict rule, pushing it higher is probably a safer strategy than moving it lower. As your experience grows you'll be able to judge better, but there is nothing wrong with doing nothing.

• Buying should always be done slowly... no matter how impatient you are becoming. When "Smart Cash" rises month after month, the correction is coming! The correction is coming!

The "ATH" Decision:

What is the ATH decision, and what is it used for?

• Most of the investment world worships the bottom line market value of portfolios, and such a focus (without an understanding of too many things to mention here) causes a book full of problems. Within the Working Capital Model method of portfolio management, market value is compared with net deposits to determine if and when a portfolio is at an All Time High Profit Level.

• When it is clear that an ATH has been achieved, the portfolio should be looked at carefully to cull the worst performer, at whatever the realized capital loss happens to be. Issues that have fallen below investment grade must be eliminated eventually, and this is the least painful time to do so.

• Be careful not to get carried away with this process. Examine weakness in fundamentals, not in market price, and if you have a choice between more than one loser, pick the one that loses the least capital... it will give you more to work with than the others.

• Major losers (although quite rare) need to be dealt with or your Working Capital Totals will become unrealistic. Again, when the portfolio value is at an ATH, in spite of that holding, it is the right time to bite the bullet.

• Oh yeah, an ATH Profit Level may or may not also be an ATH Market Value... you folla?

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