We want satisfied customers. Therefore, we want to identify the risk factors and caveats of our strategy as clearly as possible. As a general matter, we need to begin with the disclaimer pertinent to all equities.... that stocks are subject to a broad array of investment risks, including possible loss of investment principal. With respect to our strategy, as we discussed in Stock Selection Strategy, if you are a trader or a buyer of technology or foreign stocks, this is not the strategy for you.

Here are a few more reasons not to subscribe. These are centered on how the strategy works or more correctly, how it doesn’t work. While we would love to tell you that we are perfect and our strategy is perfect, neither is true. So let’s discuss the four biggest risk factors and caveats that can occur. All center around the fact that our buy/sell discipline is just that. It is a discipline, and not a guarantee that the buy and sell prices are perfect numbers. For all the time and effort we place in our strategy, we are not omniscient and, therefore, these prices in the final analysis, while not arbitrary, are none the less a single number that in all likelihood is not the lowest price (if a buy) or the highest price (if a sale). We identify this as a risk factor.

The first problem is with the SSI buy price. There will be times we recommend buying a stock and it will continue to go down. In that case, we were wrong on the buy price. The reason we have a stop loss is to try to mitigate this risk factor. Being stopped out is not such a huge problem and the consolation is that we only took a small loss. But it is a risk factor, we will be stopped out at a loss at times. If that is intolerable to you, don’t subscribe.

The second risk factor is a corollary to the first. It happens when we get what we call extreme negative exogenous news on a company, the result of which is a gap down opening which has the effect of negating the benefit of our stop loss. This happened recently to us. We bought Merck at 43 and had a 39 stop loss on the stock. Merck announced the decision to pull Vioxx and the stock opened the next day at 33. This is certainly not something you want to happen. But by definition, exogenous events can’t be anticipated—so they do occur. All the investor can do is take his or her loss, lick the resulting wounds and go on. So if want omniscience in anticipating specific events, this is not the site for you.

The third risk factor may drive you even more crazy. There will be times when we buy a stock, it goes down and triggers a stop loss, then stops going down and makes a bottom and we will re-recommend buying the stock. Once again, we were off not only with the buy price but with the stop loss price. But now we have a bigger problem--we have a stock we already decided we wanted to own, we were off on the buy/stop loss prices and now it’s starting to rebound. One alternative is to ignore the stock after we are stopped out. But we choose not to—we think that is a wrong decision. We believe that investing is a business of managing your WRONG decisions. If we buy a stock and it declines far enough to get stopped out, we are wrong once (and we took a small loss). If we buy a stock, get stopped out, and the stock actually hits its low soon after and begins rebounding, we are wrong twice (but we still have only taken a small loss). But if we buy a stock, get stopped out, it bottoms soon after and rebounds, and we DON’T buy it back, we are wrong three times (now we have taken a small loss and incurred a potentially large opportunity cost by not owning the stock). Logically, we would like never to be wrong (but it will happen), we hate to be wrong twice (but that may happen too), but we can avoid being wrong three times (which would really be stupid) by admitting we were wrong and correcting the error. So if that kind of scenario drives you nuts—be assured, we don’t want it to happen. But it will—don’t subscribe.

The final risk factor is that establishing a sale price at which we sell one half of the initial position causes some investors problems. This occurs when we buy a stock, it does great—hits our sell one half price, then we sell it and it goes up another 30-40-50%. This is another situation that happened recently to us. We had bought C.R. Bard at 17, we had a sell one half price at 40 (which we did) and the stock went to 53. Our attitude is that if this is the worst decision we ever make, we are in great shape. It is one of the reasons that we don’t sell everything—so we are only half wrong—sort of. Another reason is that if the company is still raising its dividend on a regular basis and remains financially sound, it still fits all the fundamental reasons we want to own the stock. The final reason is that these conditions tend to happen when market valuations in general are high. Hence, this discipline takes money out of the market when valuations are high, providing some extra stability to principal when the market declines and a source of funds for buying new holdings when the market does decline and brings valuations of stocks we want to own to our buy price level. But if you hate selling a stock (even if it's only half a position) and watching it continue to go up, this is the wrong discipline for you.