Roy the Contrarian
Invest Like a Pro
How Doubling Down Works
Last month (May 24 to be exact), I wrote about a method to find stocks that will likely decline a minimal amount during stock market corrections. I concluded that CVS Caremark (CVS) and Walt Disney Company (DIS) would not decline significantly during future stock market declines. You can read my analysis here.
Since I started writing the Cabot Benjamin Graham Value Letter nine years ago, I’ve instructed my subscribers to double down whenever a high-quality stock declined 10% or more. For those of you who are bold and are looking for a proven method to beat the stock market whether the market is declining or advancing, my “contrarian” approach might make a lot of sense.
I realize that you may be a growth investor and are seeking appreciation without taking unnecessary risks. If you have found a method that made money consistently during the past several years, you should continue to focus on what works for you.
But you also might consider diversifying your approach to diminish your risk and at the same time increase your profits. And if your approach only works part of the time and occasionally leads to mini-disasters at inopportune times, then please hear me out.
I’m a value investor—I buy when I think a stock is undervalued and sell when a stock is overvalued. I don’t trade based on price charts, and I don’t try to time the stock market. I stay fully invested in stocks and bonds all of the time.
We all make mistakes in the stock market. We buy a “can’t miss” stock only to watch it decline immediately after purchase. Or we buy a stock, and an unforeseen political crisis somewhere in the world sends the stock market skidding. What should you do when your stock(s) drop 10% or more?
As many growth-oriented Cabot editors have written, stop-loss orders make sense for growth stocks, momentum stocks, and higher risk stocks. However, when investing in low-risk, undervalued stocks, I strongly suggest a much different method.
Whenever one of your favorite stocks, which you really, really want to hold for the long haul, declines by 10%, try doubling down. However, if your favorite stock is volatile and swings wildly from time to time, then I advise doubling down only when and if your stock falls 20%.
What do I mean by “doubling down?”
Let me give you a few examples, but before I do, let me give you an example of how my system works.
I write the Cabot Benjamin Graham Value Letter and the secret to my success is finding high-quality stocks at bargain prices. I do this by evaluating 1,000 companies to determine those that have lots of cash with little debt, have produced steady sales and earnings growth during the past decade, and whose stock prices are clearly less than they should be.
If you pay attention to the numbers, and you hold patiently, you will reap great profits!
In May 2009, I recommended that my subscribers buy Cash America (CSH), writing…
“Cash America International owns and operates pawn and check-cashing facilities in 1,004 locations in 21 states… The company’s business tends to flourish during periods of economic weakness. My forecast for a sharp economic downturn followed by a very slow recovery will provide adequate opportunities for Cash America during the next several years. I expect revenue and EPS growth to accelerate during the next 12 months. EPS will likely increase 16%.
“CSH shares have declined 50% during the past year, which is unwarranted because the company will prosper during the current economic malaise. CSH shares are undervalued at 9.0 times latest 12-month earnings per share (EPS). I believe CSH shares will recover to my Minimum Sell Price within one to three years. CSH’s balance sheet is strong with loan losses at low levels. BUY.”
At the time, CSH was trading at 23.70.
And two-and-a-half years later, I recommended that my subscribers sell CSH, writing…
“Cash America (CSH) reached its Minimum Sell Price of 62.29 today and should now be sold. During the past three years, the company has racked up impressive sales and earnings gains, which have driven CSH’s stock price to new all-time highs.
“Future sales and earnings prospects continue to look rosy, but there are a few clouds on the horizon. Large U.S. banks are beginning to offer short-term loans to potential borrowers who might otherwise use CSH’s loan services. Also, state governments have passed new laws to limit the fees and interest rates on cash advances and short-term loans.
“Cash America’s stock price has risen a whopping 160% since we first recommended the stock in the May 2009 Cabot Benjamin Graham Value Letter, compared to an increase of 33% for the Standard & Poor’s 500 Index during the same period. I advise SELLING now.”
By investing in CSH when I suggested, my subscribers did almost five times better than conservative investors holding the S&P 500.
Furthermore, four months later, CSH was trading at 42, down 33%, proving my valuations, based on Benjamin Graham’s analyses, were spot-on.
You don’t need to worry about details, because I do all the work and present the results, telling you in plain English what to buy and why. For every stock, I give you specific Maximum Buy Prices, as well as Minimum Sell Prices (i.e., target prices), and I update my buy and sell prices in every issue.
My system is simple: Buy high-quality stocks when they are undervalued, and sell when the stocks become overvalued. Buy low and sell high—it doesn’t get any simpler!
Click here to subscribe to the Cabot Benjamin Graham Value Letter at a special rate! Act now, and I’ll send you two must-read special reports!!
Ok, now back to doubling down during stock market declines.
As an example, let’s say you bought 100 shares of Deere & Co. (DE) at my recommended Maximum Buy Price of 77.61 last month. DE then fell 10% to 69.85 on June 4, whereupon I would have advised that you buy another 100 shares at the lower price. Now you own 200 DE shares. The objective is to take advantage of lower stock prices when they occur.
I would then advise placing a sell limit order at your original purchase price of 77.61 for 100 shares of DE, or one-half of your holding. In this example, DE reached your sell price of 77.61 on June 19 and your 100 shares were sold, lowering your cost basis by 10%. This technique can work wonders if you are bold and are willing to go against traditional investing systems.
In my May 2012 Cabot Benjamin Graham Value Letter, I featured four high-quality companies which I thought would produce solid profits for investors during the next one to three years. My four buy recommendations were Celgene (CELG), Deere (DE), DIRECTV (DTV) and Dollar General (DG).
The stock market tumble in May dragged three of the recommendations down 10% or more. If you used the doubling down system, you would have doubled your investment in Celgene, Deere and DIRECTV, which lost 10% after they were purchased.
As of today, Deere has climbed back beyond its original purchase price of 77.61, but Celgene and DIRECTV have not quite reached their original buy prices. Dollar General did not fall 10% since its purchase and is now 13% higher than its May 1 purchase price. The doubling down methodology produced a profit of 3.9% compared to a decline of 5.3% for the Standard & Poor’s 500 index from May 1 through June 27.
Of course, these are just a few recent examples, but they show that, declining stock markets present a difficult challenge, you can make money when the stock market is declining, which will dramatically boost your long-term investment results.
I will continue to recommend buying Celgene, Deere, DIRECTV and Dollar General, as well as a number of other undervalued, high-quality companies in my Cabot Benjamin Graham Value Letter. My next issue, coming soon, will include a special feature on Undervalued Canadian Companies. I hope you won’t miss it!
J. Royden Ward
Editor of Cabot Benjamin Graham Value Letter
Editor’s Note: You can find additional stocks selling at bargain prices in our new and improved Cabot Benjamin Graham Value Letter. Find out why our subscribers are showering us with compliments!
In every issue, you’ll find Roy’s legendary Maximum Buy and Minimum Sell Prices for over 250 well-known stocks. Click here to get started today!