A couple of notes on the mechanics of our discipline of setting the various stock prices we use:
- Our discipline dictates that we always have one buy price and two sell prices---one as a stop loss if the price declines, and the other the stock price at which we take profits. Like our screening process, the buy/sell discipline is a continuous process. We begin by establishing a long term valuation channel for each company. Without getting into the math of this process, it incorporates a combination of technical and fundamental valuation factors and constantly adjusts them to account for the volatility of the common stock.
- Since the stock price disciplines are determined by a long term channel, the prices at which we buy and sell stock are moving all the time. So, for example, the buy price for Proctor and Gamble will be continuously moving upward over time. That means that on January 1, our buy price might be 56 but by September 1, it might be 58 or 59. The same holds true for both of our sell prices.
- When a buy stock price is reached [that is usually when the price is within 10% of the actual buy price as determined by our discipline], we initiate a buy recommendation. To achieve stock diversification , our initial position in each company is equal to approximately 3% of the total value of the portfolio.
- The stop loss price has a very simple purpose—to avoid big losses of capital. There is nothing magical about our stop loss policy vs. anyone else's. In our opinion, it is absolutely critical in any investment strategy to have a stop loss discipline. When you really consider the range of possibilities, there are only four things that can happen to the stock prices of companies after you make a purchase:
- They can go up a lot- 20%+,
- They can go up a little- 0-20%+,
- They can go down a lot- 20%+, or
- They can down a little- 0-20%.
- The stop loss price we set is tied to the buy price, not the current price. As an example: If the buy price of Proctor and Gamble is 56 and we buy it, our stop loss would be 49 at the time of the purchase. If Proctor and Gamble’s stock rises to 70 in 90 days (we should be so lucky), our buy price might still be at 56 and therefore our stop loss will still be at 49. In deciding whether or not to subscribe to our newsletter, it is very important to understand—we are not traders. So we don't believe in keeping a stop loss price rising with the stock's price because:
- the basic premise of our strategy is to own a rising dividend stream. As long as the company the stock represents continues to meet this condition, and remains fundamentally sound, we are committed long term holders of the stock,
- too much trading frequently results in missing huge long term price rises,
- remember those transaction costs.
- We love to hold the shares of a company over a long bull cycle. For that reason, when we reach the ‘take profits’ sell price, we only sell one half of the holding. This has the effect of taking our original cost out of the stock, but letting our profits run. We hold the remainding shares as long as the company meets our original fundamental screens.
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