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Stock pick Strategy & Money Management   

7/24/2004

The market is very tough recently. The highflying Tech stocks and Penny stocks have been hit especially hard. So what is strategy for the Blast Investor Model Portfolio to control risk and to achieve goal of  index-beating performance?

Disciplined Value Investment Method

Blast Investor Model Portfolio is built upon the same long term value investment philosophy, which is a proven investment method  championed by Benjamin Graham and Warren Buffett .  Value Investors such as Warren Buffett and Benjamin Graham achieved astonishing performance even in the severe bear market of 1930's and 1970's.  The same value investment philosophy also made me huge investment profit during post internet bubble bear market.

The main difference between a market-timing trading method (such as Technical Analysis or momentum trading) and value investment method is:

•   market-timing traders are make money by  predicting trend  (up or down) in short term.  The key here is mood or trend of stock.
  
•   value investors make money by looking for bargain price mainly while ignoring most of up or down of market noises. 
  

By ignoring most of market noises, value investors avoid emotional mistake of greed and fear in the market and put discipline into investment.  Simply by  investing into good solid value stocks for the long term, the index-beating performance will be rewarded to skillful value investors.

Skillful Money Management

In addition to conservative stock picking, correct money management skill is also needed to control risk and to out-perform in the long run. By providing real-time trade alert service, Blast Investor Real-time Plus newsletter not only provide independent stock picking research, but also deliver my money management method to you in real-time basis.

Diversification - risk control

Minimum of 5 stocks diversification is needed for protection from disaster.   2004 Year to date performance of the Blast Investor Model Portfolio speaks for the importance of diversification. Due to diversification of the portfolio, the Blast Investor  Model Portfolio still beat index decently for 1st half of 2004 even though SOHU NTES performed poorly this year.

I want to also emphasize here that  Blast Investor Model Portfolio does not intend to invest into more than 10-15 stocks.  Over-diversification can lead to poorer performance. Over-diversification is something mutual fund do to provide excuse for poorer performance.  I  control risk by avoiding high-priced stocks and  by implementing extensive due-diligence in stock picking rather than by over-diversifying into mediocre stocks.

Prudent use of leverage

Blast Investor Model Portfolio utilize leverage very cautiously. Leverage is very useful method to enhance fund performance. Leverage is also very common in hedge fund world. However, Leverage is also a double-edged sword. Lots of individual investors' accounts got wiped out due to misuse of margin debt during the bubble period. 

The safety of leverage  not only depend on the degree of leverage but also lie on the safety of holdings.  Benjamin Graham once said: "Sometimes it is quite safe to load bond under margin  for certain special arbitrage opportunity while in comparison it is very risky to invest into a batch of penny stocks without any leverage."

Right portfolio asset allocation for each stocks

The Blast Investor Model Portfolio holdings can be grouped into 2 types of stocks:

1. 80% of holding -  value stocks. These group of stocks either trade below liquidation value/ private acquisition value or  have price to true earning ratio (true PE) at or below 15.  This group include  NRG, CHK, WLL, LIBHA, NEN, HRB, ADGO.
   
2. 20% of holding -  Buffett-type growth stocks. These are growth stocks that have consumer-monopoly charactistics and relative high PE ratio and high PB  ratio.  They typically have higher barriers to entry and they have pricing power. SOHU NTES belong to this group. 
   

Majority of the Blast Investor Model Portfolio holdings fit into 1st group of value stocks.  Value stocks are much safer in a tough bear market. Over the past 100 years, severe bear market bottomed when the average index PE was around 10.  Value stocks have such low valuation in that their price already factored in a bear market valuation.  Any improvement of earnings or market sentiment will move value stock price higher although the waiting time for investors may be quite long.

Buffett-type growth stocks are riskier in that they do not factor in a bear market valuation. They typically trade at higher PB or higher PE than value stocks.  If market truly gets ugly, these group of stocks can further go down to the level of value stocks valuation.  The Blast Investor Model Portfolio limit growth stock risks by limiting the asset allocation into these group of stocks.  For example, if SOHU NTES PE goes to low teens or  SOHU NTES prices  further cut in half,  the Blast Investor model portfolio would only suffer around 12%. The fact that only 20% of total portfolio is in these growth stocks group would protect Blast Investor Model Portfolio very well in a truly ugly bear market. 

There are many stocks that qualify as Buffett-type growth stocks such as Coke, EBAY, YHOO, Washington Post,  INTUIT, etc. However, Buffett-type growth stocks as cheap as SOHU NTES are rare in US stock market. Even with the risk associated with growth stocks, It is still well worth the pain to hold them for the long term for their potential huge reward.

I avoid all other type of growth stocks. Most business can not maintain 25% plus per year earning growth for the long run. For that matter, most growth stocks do not deserve a PE larger than 25. Especially,  I would avoid most of the growth stock darlings such as high-flying tech stocks in semi, telecoms equipment, biotech  etc. industry.  Technology providers usually are in commodity business where there is no pricing power and prone to competition. They are  not suitable for conservative long term investment.  I would rather invest into a simple dull business instead where I can understand the business easily.

Conclusion

WIth all the above measures in place, I am ready to make money for the Blast Investor Model Portfolio  in the year ahead while waiting patiently in this tough market enviroment.

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Blast Investor Model Portfolio Update

(as of 7/23/2004)

Blast Model Portfolio - Performance