The Prudent Investor

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From the Editor - April 06

The commentary below is from our monthly newsletter and is provided here as a convenient reference for our readers.

Sticking to Your Discipline

One of the very hardest things about managing your own investments is adhering to your investment discipline at all times. As James P. O'Shaughnessy showed in his informative book What Works on Wall Street, almost any of the myriad of well-known investment strategies will work over time. That is, the strategies will work if strictly adhered to, come hell or high water. O’Shaughnessy also showed that no investment strategy works all the time—e.g., sometimes value investing is in style, and sometimes growth investing.

Other studies have documented that the “average” investor earns far less than the overall market return as measured by a standard index like the S&P 500 (of course, all of our readers are well above average). Why? Most likely, among other things, they are not sticking to their investment discipline (we are granting them the gracious assumption that they even have an investment discipline to try to stick to). Rather, they are “chasing returns,” a common temptation that we all experience.

At The Prudent Investor, we try hard to adhere to our discipline of stock selection, including when to buy or sell a given stock. It isn’t easy. This month, for example, we say goodbye to a longtime favorite in our portfolio, Giant Industries (symbol GI). GI has been in our newsletter portfolio from the very beginning, back when it was $26.50/share. We say goodbye at a price of $69.54, for a nice gain of about 165% in 15 months or so. But why sell now? By most accounts, it is still an excellent stock to hold. It is relatively cheap (forward PE of only 8.6), it is in a sector that we want to maintain a strong focus in (energy), and management seems to be doing things right, giving hope that the good times will continue.

So why sell now? In short, to stick to our discipline. We make our decision for three reasons: 1) The stock no longer has any meaningful insider buying (a reason we purchased it in the beginning); 2) earnings estimates for this year are slipping a bit more than we might prefer; and 3) we found another stock in the energy sector that we like more. Reason three may be the most important of all actually. When keeping one stock in your portfolio, even a good one, you have to remember there is always an “opportunity cost” in doing so. By keeping GI, we would be prevented from purchasing Hercules Offshore (symbol HERO), which looks more closely aligned with our investment discipline. HERO 1) has more attractive insider purchases (at the IPO last year, which is somewhat uncommon), 2) has earnings estimates that are increasing, rather strongly in fact, and 3) looks to be an attractive play in the energy sector. It also happens to rank more highly in our valuation ranking scorecard. And so, we are willing to let go of GI, pay our taxes, and move on to the next stock that more closely aligns with our investment discipline.

Titanium Metals Corp (symbol TIE), similarly, is a stock that is difficult to say goodbye to. We added TIE to our portfolio in October 2005 at a (split-adjusted) price of $19.78. It is now at $48.55, for a gain of 145% in only six months. This one is much harder to let go, because in most respects it still meets our investment criteria. For example, the chairman of the board has purchased well over $15 million in TIE over the past two months, a very bullish sign. But the stock has risen so fast that it now represents “fair value” based on our valuation metric. We would rather sell it so that we can purchase two micro/small cap stocks that look more attractive on a valuation basis (though also riskier, perhaps than TIE, but then the potential upside is greater to compensate for the additional risk).

Only time will tell if our decisions this month were the right ones, but we are willing to stick to our investment discipline at the risk of being wrong some of the time, in the hopes of greater returns over the longer term.

Farewell to an Old Friend

Next month will mark the sad farewell of an old friend. On May 8 all accounts at deep discount trading firm BrownCo will be officially converted to E*TRADE accounts. A number of The Prudent Investor readers are quite familiar with BrownCo and even have accounts there. This editor has recommended BrownCo for years because of their excellent customer service, good trade executions, and cut-rate commissions. They are being absorbed into E*TRADE, a firm that represents just the opposite—poor customer service and expensive (for a discount brokerage firm) commissions. For those who take advantage of the excellent tax benefits of giving appreciated stock to charity—and we certainly hope that all our readers do so!—BrownCo also provided the fastest transfer times among any of the discount brokerage firms. E*TRADE brought up the rear with the absolute slowest times to transfer. Six weeks was not unheard of for E*TRADE transfer times. Compare that to an average turnaround time of one day for BrownCo.

BrownCo used to pride itself in answering its trading lines by the 3rd ring. While they have slipped from this level of promptness since their earlier acquisition by J.P. Morgan, they still do an excellent job in minimizing hold times. E*TRADE will surely change all that.

Back in the glory days of BrownCo (then Brown and Company), cheeky “in your face” ads in the Wall Street Journal, featuring founder and president George Brown, were common. The ads apparently reflected the attitude of Mr. Brown himself, a cantankerous old man with a gruff voice. Mr. Brown was always featured with an oversized, cartoonish head, inviting only the best and most experienced traders to become clients. You had to be “good enough” to become a Brown and Company client.

For those of us who relied on BrownCo for our trading, what to do now? TD Waterhouse would be a leading candidate, except that it is being merged into Ameritrade. While a much better choice than E*TRADE, Ameritrade’s customer service is not the best in the world, and their commissions are more than double BrownCo’s. BrownCo customers may consider Scottrade as a better alternative to being swallowed up by E*TRADE. Scottrade’s commissions are reasonable, and their customer service is acceptable. If any of our readers have other suggestions for BrownCo customers, please email us at The Prudent Investor and we will pass along those suggestions to our readers who are interested.

If you are considering a switch to Scottrade, please email us at If we refer you to Scottrade, you will get your first three trades free (offer not available for IRA accounts).

Please visit our blog for a more detailed discussion of our Model Stock Portfolio changes.


Copyright 2005-06 The Prudent Investor  All Rights Reserved

[April 06]