Rule #1 Finance Blog

With Investor Phil Town

The Trend Is Your Friend

I posted the following as a Comment under the Chico’s post, but it’s important enough that I wanted to repost it here, where you’ll all be sure to see it.

Wow, you guys are learning fast!  Laura, I’m glad to hear that you just used a small amount to test.  Good job.  It’s really important to get the hang of this without getting burned.

That said, you are all correct that I should have gotten the bear trap stuff in the book.  My bad.  It’s a great point that I’ll reiterate here.

There is an old saying that “The trend is your friend.”  This saying has been abused horribly by day traders, but it applies well to what we do with Rule #1.

If a business’s stock price is getting hammered for long periods of time, it is really important to either have total faith in your superior understanding of the business (and this is of course what Warren Buffett has) or stand back until the stock price finds a floor.

There is no guarantee about a floor in the price, but there are a couple of signals.  The most important one I’ll mention here:  The volume starts to go up and the price goes up with it, or at least doesn’t continue to go down. 

And that makes sense, doesn’t it? If people are selling more stock and the price isn’t going down, somebody big believes in that price quite a lot… enough to put their money where their faith is.

But my preferred way of dealing with a major price crash is to review the first three M’s: Meaning, Moat and Management.  Is something changing on one or more of the three?

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So Laura, you did a fine job of extrapolating a long-term growth rate for CHS from their history of the four growth rates, and I know their ROIC is going good at 23% and holding pretty steady long term. So sure, you should use the 25% you came up with and the historical PE.  Exactly right.

(I just dropped it to 18% to see if we still had a big MOS even at a lower growth rate and we do.  More confidence for us that we have room in the price almost no matter what.)

So here is your homework that I’ll post when I get it:

What is going on that is causing the big guys to be so skeptical about the future?

Has something major changed in the first three M’s that should make us suspect the MOS is not all that great?  Or is this just a classic big guy panic bailout on short term issues and therefore a great opportunity for us to get ready to buy the heck out of CHS?

Now go play!

Phil Town

Phil Town is an investment advisor, hedge fund manager, 3x NY Times Best-Selling Author, ex-Grand Canyon river guide, and former Lieutenant in the US Army Special Forces. He and his wife, Melissa, share a passion for horses, polo, and eventing. Phil’s goal is to help you learn how to invest and achieve financial independence.