Portfel by Scarry

"Were there any situations in which you bought a stock very heavily because of good earnings growth and prices went down and never recovered?

Sure, that happens a lot. We probably have more losers than winners, but we cut our losses.

Do you always check the chart before you buy a stock?

Absolutely. I won't buy a stock when it's dropping even if I like the fundamentals. I have to see some stability in the price action before I buy the stock. Conversely, I might also use a stock's chart to trigger the sale of a current holding. Again, the charts are a very unemotional way to view a stock's behavior and potential."

"I would much rather invest in a stock that's increasing in price and take the risk that it may begin to decline than invest in a stock that's already in a decline and try to guess when it will turn around."

"I went through the same process that most people do. I subscribed to a few investment letters and most of them didn't do too well. I found that theories like buying low-priced stocks or stocks with low price/earnings (P/E) ratios were not very sound.

When did you first find an approach that worked?

Back in 1959,1 did a study of the people that were doing very well in the market. At that time, the Dreyfus fund was a very small fund, managing only about $15 million. Jack Dreyfus, who managed the fund, was doubling the results of all of his competitors. So I got copies of their prospectus and quarterly reports and plotted on charts precisely where they had purchased each of their stocks. There were over 100 of these securities and when I laid them out on a table, I made my first real discovery: Not some, not most, but every single stock had been bought when it went to a new high price.
So the first thing I learned about how to get superior performance is not to buy stocks that are near their lows, but to buy stocks that are coming out of broad bases and beginning to make new highs relative to the preceding price base. You are trying to find the beginning of a major move so that you don't waste six or nine months sitting in a stock that is going nowhere.
I studied the stocks that were big winners in past years and tried to find the characteristics they had in common before they became major successes. I didn't just limit myself to preconceived notions like P/E ratios; I examined a lot of variables to develop a model based on how the real world worked."

"Wouldn't most of the indicators in your CANSLIM formula, such as EPS, pick up a stock before it goes to new highs? Why not just buy the stock when it is still forming a base instead of waiting for it to go to a new high?

You don't want to anticipate a breakout from a base because a stock may never break out. You can buy too soon as well as too late. The idea is to buy when there is the least probability of a loss. If you buy within the base, the stock will frequently fluctuate 10 or 15 percent in normal trading action, and it is very easy to get shaken out of the position. But if I buy at exactly the right time, the stock is usually not going to go down to my maximum 7 percent stop-loss point."

"My philosophy is that all stocks are bad. There are no good stocks unless they go up in price. If they go down instead, you have to cut your losses fast. The secret for winning in the stock market does not include being right all the time. In fact, you should be able to win even if you are right only half the time. The key is to lose the least amount of money possible when you are wrong. I make it a rule never to lose more than a maximum of 7 percent on any stock I buy. If a stock drops 7 percent below my purchase price, I will automatically sell it at the market—no second-guessing, no hesitation.

Some people say, "I can't sell that stock because I'd be taking a loss." If the stock is below the price you paid for it, selling doesn't give you the loss; you already have it. Letting losses run is the most serious mistake made by most investors. The public doesn't really understand the philosophy of cutting losses quickly. If you don't have a rule like cutting a loss at 7 percent, then in bear markets like 1973-74, you can lose 70 or 80 percent on your holdings. I have seen people go bankrupt in that type of situation. If you aren't willing to cut your losses short, then you probably should not buy stocks. Would you drive your car without brakes?"

"To say that a stock is undervalued because it is selling at a low P/E ratio is nonsense. In our research, we found there was a very low correlation between the P/E ratio and the best-performing stocks. Some of these stocks had P/E ratios of 10 when they started their major advance; others had P/E ratios of 50. During the thirty-three years in our survey period [1953-1985], the average P/E ratio for the best-performing stocks at their early emerging stage was 20, compared to an average P/E ratio of 15 for the Dow Jones Average during the same time. At the end of their expansion phase, these stocks had an average P/E ratio of approximately 45. This means that if, in the past, you were not willing to buy stocks with above-average P/Es, you automatically eliminated most of the best-performing 88 securities.

A common mistake a lot of investors make is to buy a stock solely because the P/E ratio looks cheap. There is usually a very good reason why a P/E ratio is low. Many years ago, when I was first beginning to study the market, I bought Northrop at four times earnings and watched in disbelief as the stock eventually declined to two times earnings."