John is having a wild ride on Gamestop (GME) and is asking for a bit of help:
"Hello Phil Town, I WANT to believe in this system and as someone with not a financial bone in my body, I am beginning to worry about retirement now in my early 40’s with little (~$20,000) in the way of retirement savings. I read Rule #1, some sections repeatedly, to insure that I’m following all of the criteria. I did the research and came up with about 8 businesses out of the 80+ that I researched, that fit the guidelines for a wonderful business. I did a few simulated buys, none of which returned much of anything, but at least they didn’t go completely awry. Currently, although this may be premature (perhaps it will still turn around although I’ve got Sell signals on two of the tools), I am now ‘taking a bath’ with Gamestop (GME) waiting for it to give me the third Sell signal (see attached). It appears to be doing the same thing that a simulated buy did with Walgreen’s (WAG). If I had bought in on that one after getting a Buy signal from all three tools, I would have lost money by the time the Sell signals came in (see attached). It headed down the day following the Buy signals and GME appears to be doing the same.
I’m using the tools from two different sites (Trade King & Yahoo Finance), looking at them over 1, 3, and 6 month periods (in case the period length makes a difference), and watching the Buy and Sell signals but I don’t seem to be getting consistent results in terms of keeping me safe from losses. I’m using your recommended numbers (14,5 for SS; 8, 17, 9 for MACD; 10 for MA) for the tools. I’ve looked at the history of most of my “wonderful businesses” and looked at how they did with respect to the tools, but I often see the Sell signals come in too late to avoid losses. I would really appreciate any feedback/examples you can provide on using the tools because I see some positive comments about this system, which makes me wonder what I’m doing wrong. I want to believe I can make this work but I’m quickly losing confidence in my ability to execute this system with positive results. I realize that it’s not your responsibility if people are unable to execute properly but I feel like I’m following all of the guidelines/criteria “to a T” and I’m at a loss as to why this isn’t working"
Phil Town's Response:
The issue seems to be that as soon as it gets three green arrows and he gets in, it goes down like a brick. The problem is obvious: The problem is that whenever John buys a stock it goes down. The solution for the rest of us is to short everything John buys. (John may be posting his future trades on this site for a fee. Stay tuned.)
Or John is making a mistake.
Let's take a look at option 2. The first clue is that John's email doesn't say a word about the single most important thing we have to know to be able to buy a company at all - never mind the arrows. You have to know what the value of the business is. If you don't know the value of the thing you're buying, you are flying a jet in the dark without any instruments. You are lucky if you don't crash.
Take a look at GME's long term financials. If you don't know how, read my new book, Payback Time, (and don't invest until you do) or read my first book, Rule #1 - which John says he read. Except for the part about figuring out the value. I took a quick look at GME. Analysts projections are at 13%, TTM EPS at $2.35, MARR at 15%. All we have to do is figure out a reasonable PE, or multiple of earnings that the business will sell for. A Rule #1 PE is 2X the growth rate or 26 in this case. That's not a bad number but its higher than the last years high PE and that worries me a bit. I'd rather not get up there that high. Looking at the high and low PEs over time suggests 21 for a PE and I'm good with that. It isn't low and it isn't too high either. That puts the value at $44 and our MOS at $22. And let's look at the payback time - the time it takes to get our money back if we owned the whole business and kept the earnings. At a $22 MOS, we get a payback time of 6 years (for the how-to, read Payback Time). That's quite good. In other words, if GME goes as we think it will and we bought the whole business, we'd theoretically get our money back in 6 years and then own the thing forever with no risk. 6 years is about what a good private business goes for these days and public businesses usually cost twice as much as private investments. So this is a good deal if we think the business is wonderful.
At $22 its a good deal. IF its wonderful.
Did you notice what price John was buying in at? Looks to me like he was hitting it at $36 the first time and $20 the second time. So the first investment at $36 was buying in within 20% of the full retail value of the business. We don't do that ever because what happened to John happens all the time. As the stock begins to approach the retail value, the Big Guys dump it. They can do the math, too, you know. And if the Big Guys dump it, it goes only one way: down.
The second investment was much better. Hitting it below the MOS. Good start. It went up a tad and then slid down. But notice that the stock is in a long term negative trend that started two years ago. And he's using the 10MA to get in. He should be using the 10 MA to get out, not in. In a long down trend, we'd prefer not to invest but if you're going to, go in slow and get out fast, not the other way around. As I said in my book, this sort of thing can kill you - the death of a thousand cuts.
The real question from a technical point of view (since he must like the current price of $19) is not about the red arrows green arrows - its about whether this price drop has found a floor. I write about that in my new book Payback Time for just this sort of problem. He wants to buy because its cheap (assuming he understands the business) but it could keep going down. He should wait for a floor and then buy.
But an even better strategy is what I call Stockpiling. Find the floor (and it might be around $18 or so) and as the price comes off the floor, buy and then hope the price goes down some more. This strategy is awesome. Basically you buy and hope the stock goes down, not up, because you are intent on accumulating (or stockpiling) as big a position as your recurring cash flow allows over time. Today John buys at $20 and holds. Tomorrow he buys more at $18 and keeps holding. And then he hopes he can get a bunch more at $15 in the future. He's going to buy and hold whenever he can get a great price. One day the price will move all the way up to the value and he will more than double his money.
I love Stockpiling for you guys for this market. Its the best way to load up the truck and it takes care of a lot of the issues that come with trading in a down market. But hear this: You must know that GME is a wonderful, durable business that is going to be around for a long, long time. You must know the industry (MEANING), their protection against competition (MOAT) and you must trust their CEO (MANAGEMENT). Do not buy anything you aren't sure about when it comes to those three things. And then, please, don't buy it when it isn't avaliable below its retail value.
And remember this: Postive thinking is a bad idea for a Rule #1 investor. We don't guess, we don't hope, we don't pray. Just use your head and follow Rule #1.
Now go play,
