How to Invest In the Stock Market-Getting Harder

Jae Jun

This is part 3 of the How to Invest in the Stock Market series.

How to Invest in the Stock Market: Part 1 | Part 2 | Part 3 | Part 4 | Part 5

Table of Contents show

Advanced Level Investing – Well…Not Really

For lack of a better description, I’ve titled this stage as advanced.

Following on from Part 2, the next step I took was to try and understand how the financial statements provided a future view of the company. Financial statements only provide a snapshot of the company at the time of writing and there wasn’t any useful information that explained how to interpret each line to determine the ongoing business.

I was stranded on a frustrated plateau for many months until I got to reading The Art of Short Selling. Most books I’ve read tell you what to look for when buying a business. This book focuses purely on the warning signs of the business. Eventually I was able to understand statements better and wrote a series on analyzing and interpreting each financial statement.

An excellent advanced application of analyzing financial statements can also be found at Investopedia.

Special Situations

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So after all the reading and studying, I’m now at a point where I can study the company and be fairly confident in my analysis approach. But buying and holding just didn’t cut it for me. I wanted to find opportunities in places people didn’t know about and somehow I came across my first merger involving Tribune and made a tidy profit of 10% in less than a month while the market was sliding down.

Something clicked.

I did a little searching and found that Greenblatt had written a book, You Can Be a Stock Market Genius, specifically on special situations after which I wrote a series on special situations involving merger arbitrage, spinoffs and tenders.

It was also around this time that Interactive Corp (IACI) spunoff 4 divisions. HSN Inc (HSNI), Ticketmaster (TKTM), Tree.com (TREE) and Interval Leisure Group (IILG). Too bad I didn’t purchase any of them because the volatility of the market got to me. I look back and kick myself for the 200%+ returns from HSNI and TREE and 30+% of the other two.

Ben Graham Cheap Cigar Butts

The only downside to special situations is that the profitable ones don’t appear so often. This led me to start going through Ben Graham’s screen to find many cheap distressed companies. These are the businesses that have one last puff remaining in them. Buffett referred to this as cigar butt investing.

Now that I am comfortable going through the financial statements of each business except financial institutions, I am now over the fear of the dreaded “penny stock”. A company that is undervalued at $1 or $100 have the same thing in common. They are both undervalued. So by focusing on the financials and operations of the business, great opportunities can be found where people fear to tread.

Take iGo Inc for example. It’s stock price is $0.62 with pretty good volume, yet the stock is rock solid. The company lost its biggest customer that accounts fo 42% of revenues but the stock dropped 0% on that news. That’s right, 0%. How many companies can boast the same thing?

Bankruptcies, Debt and Distressed Debt

Bankruptcies and distressed debt is a completely new field for me so I’m afraid I can’t elaborate. But I currently hold GGP and will definitely learn something from it.

Selling

Knowing when to sell is one of my biggest challenges. In a previous article on knowing when to sell, I mentioned the basics of selling.

You made a mistake in judging the company
The company fundamentals have changed
A better value or opportunity comes along

The need for emergency cash
Too far above intrinsic value

What I should also include now is that when buying a company, an exit strategy must also exist. When you put in that trade order, someone is selling it to you. Why is that person selling? Only one person is right in the transaction.

I still have trouble selling some ideas which is all psychological and something that I am still working on.