Messages: What Members Are Asking On-Line

Breaking Rule #1 of Investing

I happened across the September/October 2007 CI article on Phil Town’s recipe for how NOT to lose money when investing in stocks. The article went on to describe several considerations for the selection of investments—wide moat, meaning, management, margin of safety, etc.

Since the approach seemed reasonably safe, I divided $200,000 into eight stocks that passed AAII’s Rule #1 screen. Unfortunately, the project was less than successful. In fact, it may be the worst investment I have ever made. Over the course of roughly five months, I lost over 35% of my initial investment. Of the eight stocks, only one should have been affected by the present mortgage slump. However, even in its case, that slump was well identified before this article was printed, which should have been identified in this “close-knit” screen. Don’t get me wrong, I only blame myself for this catastrophe. I broke my own “Rule #1,” which is “Never blindly take the advice of ANYONE else when making investments.” That includes Warren Buffett and Phil Town. People who give advice seem to be able to edit out the bad results and enhance the good ones.

I expect nothing more than for you to take a close look at this article and try to identify what went wrong. I am sure that it cost many people a lot of money.

—D.D.

CI Editor Responds: I never like to read about investors losing money, especially after following a strategy outlined in an AAII publication, let alone one of my own articles. The last several months haven’t been kind to value investors, and for 2007 AAII’s Rule #1 screen was down over 11%. However, as I always stress when writing a stock screening article: Screening is only the first step.

To summarize Phil Town’s “Rule #1” investment strategy: It attempts to find companies with strong growth and solid balance sheets at attractive prices—a “growth at a reasonable price” approach. One of the pitfalls of value investing is that seemingly “good” value investments may stay value investments or, in this case, become even cheaper. For this reason, Town also uses technical analysis to time his entry into and exit from the companies that pass his initial screens. As Mr. Town puts it in his book: “…even a business that’s on sale for 50 percent below Sticker Price could go down some more….” The technical indicators Mr. Town has found to be most useful to him are the MACD (moving average convergence/divergence), stochastics, and moving averages. He uses technical analysis tools to lower the risk of losing money. Ultimately, he buys stocks that pass his initial filters when the technical tools indicate the price is bottoming out. Likewise, he sells a stock when the indicators point to a near-term peak. He then trades in and out of Rule #1 companies until they no longer meet his initial screening requirements.

While I mentioned Town’s use of technical analysis in the initial article, it was my intention to do a follow-up article discussing how to combine the elements of fundamental screening with technical analysis. This member’s letter has inspired me to do just that, so look for an article on this topic in the coming months.

Dividend-Paying Foreign Stocks

CI Editor Responds: Even as global investing gains in popularity, it surprises me how seemingly difficult it is to find quality financial information on foreign stocks. One potential source is the Dividend Achievers Web site, which is run by Mergent (www.dividendachievers.com). There you will find the International Dividend Achievers Index, which currently consists of 97 companies incorporated out of the U.S. but traded on a U.S. exchange (NYSE, NASDAQ, or Amex) and that have increased their regular dividend payments for the last five years.

Also, the ADR.com Web site (www.adr.com) allows visitors to screen for American depositary receipts (ADRs) that pay dividends. ADRs are certificates issued by U.S. banks representing shares of foreign-based firms that trade on an American exchange. At the site, select DR Search on the left-hand side of the “toolbar” at the top of the page and then select Dividend Payments. You can then filter your results by country and sector and download the screening results into an Excel spreadsheet. When available, the site tracks an ADR’s dividend payments going back to 2000.

Reader Reacts to New Design

CI Editor Responds: Feel free to keep sending your comments (ideally constructive) to ci@aaii.com.