Tom Gardner's
Take
by Tom Gardner
(TomGardner)
William J. O'Neil started Investor's Business Daily (IBD). He wrote
How
to Make Money in Stocks. Both of these make him nothing less than a champion
of the small investor. He has brought quantification and basic investment
education to investors and clubs across the country. His CANSLIM model is
beloved by many, and at least most of it should be.
I'm mainly attracted to a handful of O'Neil's investment strategies -- Following
quarterly earnings diligently, screening out companies that aren't showing
rapid growth, focusing on industry leaders, and studying new product developments
(particularly in technology). Upon these principles are great investment
portfolios built.
Where I take issue with O'Neil is on his coverage of market valuation (the
M in CANSLIM) and his promotion of tight stop losses. Let me take 'em one
at a time:
1) M(arket Direction)
O'Neil writes that the best way to determine the direction of the market
is to follow and understand every day what the general market averages are
doing.
O'Neil believes that general market direction will ultimately determine whether
an investor wins or loses in the marketplace. Obviously, The Motley Fool
has driven down its flag into a different land, proposing as we do that most
of the time general market direction is up, from year to year, and that investors
stand to benefit from putting their moneys behind those "most of the times"
in the marketplace. And not worrying much at all about market direction.
David Gardner wrote what seemed a daring idea in our year-end recap for 1996
(12/31/96: A New Year's Letter from
the Gardners). As he relayed that three out of four market years this
century have seen positive gains, he wrote:
The market will probably go up -- again. (in 1997)
On this principle, we challenge the idea that investors -- not speaking of
traders here -- need to worry much at all about market direction.
2) Stop Losses (p.91)
The second place I take issue with O'Neil is in his proposal that investors
limit their losses to nothing more than 7 to 8%. I can't imagine placing
stops that tight for any portfolio with assets under $300 million. Even there,
I think active trading of large positions and numerous positions is
disadvantageous to shareholders come tax time.
Tight stop-loss investors in Microsoft over the past ten years would have
bought and sold the stock dozens of times, paying stiff commissions along
the way and dealing away a lot of loot in capital-gains taxes. Their
counterparts, who bought and held Microsoft, paid no commissions, are still
waiting to pay Uncle Sam, and have generated extraordinary, compounding returns.
Had they, instead, traded in and out and paid cap-gains taxes each year --
blammo -- the returns would have been dramatically diminished.
At The Fool, we're not supporters of stop-losses. For small investors, they
will generate substantial commission fees and heavy taxes. For large investors,
for mutual funds, preaching your stop loss positions is like showing your
hand in bridge before the bidding. It's a knight flaunting the chink in his
armor. It's a general showing the enemy his troop formations days before
the battle. It's the football coach handing the opposing team playbooks before
the big game.
Other institutions will try to trip the stops, as they are evident on many
trading desks, and are thus trippable. The big bad world of
underperforming mutual funds is an extremely competitive one. If I know your
stops are 8% below your purchases, I can send you into a series of tailspins,
can I not?
More importantly here, I think that when a small investor cuts losses at
7-8%, he is letting the market dictate his investment approach. Our belief
is that investors should engage the marketplace on their own terms, from
their toes, not their heels.
Much as I love Mr. O'Neil's work, and what he's done for small investors
everywhere, I take issue with his devotion to market prediction and
his support of stop losses. IBD is wonderful, though.
Hey, when's all that data coming to the online world!?
Fool on,
Tom Gardner
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