[AspiringCA]

Hi Everyone,

This is my first post (hopefully of many)!

I was reading an article at theglobeandmail.com recently that's an interview Margaret Wente did with a man named Nassim Taleb. He's the author of a book called The Black Swan: The Impact of the Highly Improbable . Taleb was a derivatives trader on Wall Street who is EXTREMELY critical of bankers and economists and their role in the recent meltdown. The book is called The Black Swan because apparently everyone assumed black swans didn't exist until they were found in Austrialia many years ago. A black swan to Taleb now means something that happens that was highly unexpected (like a stock suddenly shooting up in price - a ten bagger so to speak).

The interview, which can be found here: http://www.theglobeandmail.com/report-on-business/crash-and-recovery/we-still-have-the-same-disease/article1286246/ is a pretty interesting read, but what really piqued my interest was his answer to this question:

Q: Now that you've painted such a rosy outlook, do you have any advice on how individuals can guard against losing 40 per cent of their money in this extremely risky world?
A: My advice is that instead of investing in medium-risk securities, you should put most of your money in very low-risk securities, and a little bit in high-risk securities. Then you might get a good black swan.

To me Taleb is basically advoating for keeping a huge percentage (80 percent maybe) of your money is low risk investments like short term bonds and cash equivalents and taking the rest and spreading it out between several really high risk investments. The hope being that you managed to choose at least one high risk stock that will grow rapidly. This idea intrigued me for two reasons:
1) it goes against the "norm" for many which is to invest in medium risk blue chip stocks; and
2) it actually doesn't sound like that bad of an idea.

Think about it, using that strategy, any given moment the majority of your money is safe and sound and a small amount of it has the potential to double, triple, or more depending on what high risk stocks you chose (with absolutely no guarantees of this happening).

Now my question is, how would an average investor find "high risk" stocks to invest in? What criteria would you use to decide if something was high risk? A start up? A penny stock? It really requires a complete rewiring of your investing brain because many of us are used to looking for stong, blue chip, dividend paying companies. What do you guys think?

Note: Personally I don't have any plans to follow this strategy. I'm happy with my global couch potato portfolio for the time being.

 

[Rickson9]

Now my question is, how would an average investor find "high risk" stocks to invest in? What criteria would you use to decide if something was high risk? A start up? A penny stock? It really requires a complete rewiring of your investing brain because many of us are used to looking for stong, blue chip, dividend paying companies. What do you guys think?

Personally I would not invest in a high risk securities, however, having said that, here are some of the characteristics that would make a company "high risk" (for me):

1. a high price; price to earnings, price to revenue, price to cash flow
2. erratic revenues/earnings/cash flow
3. negative cash flow
4. high amounts of leverage debt/equity
5. low returns on equity and assets
6. low profit margins; negative profit margins
7. increasing amounts of unsold inventory; asset writedowns
8. non-shareholder CEOs; multimillion dollar pay packages to senior execs
9. a company bleeding cash and using leverage to pay a dividend
10. company uses stock options and new issues to dilute equity
11. large, multi-billion, multi-national company doing business on virtually every continent

That would be a nice risky company. "Blue chip" in and of itself doesn't mean anything to me (good or bad).

 

[scomac]

here are some of the characteristics that would make a company "high risk" (for me):

1. a high price; price to earnings, price to revenue, price to cash flow
2. erratic revenues/earnings/cash flow
3. negative cash flow
4. high amounts of leverage debt/equity
5. low returns on equity and assets
6. low profit margins; negative profit margins
7. increasing amounts of unsold inventory; asset writedowns
8. non-shareholder CEOs; multimillion dollar pay packages to senior execs
9. a company bleeding cash and using leverage to pay a dividend
10. company uses stock options and new issues to dilute equity
11. large, multi-billion, multi-national company doing business on virtually every continent

That doesn't sound like a recipe for "high risk", it sounds like a recipe for "high loss"!

FWIW, I know someone personally that invests the way the Taleb describes. IIRC he had 75% of his money in cash, GICs, OSBs and the like. The balance was invested in small/micro caps and high yield securities. He told me that he had invested this way for over 30 years and only ever had one losing year. I don't know how he is invested at the moment because I haven't spoken to him in quite some time. He sold all of his high risk investments in early 2008 so I wouldn't be surprised if his track record is still intact.

 

[Spidey]

Personally I would not invest in a high risk securities, however, having said that, here are some of the characteristics that would make a company "high risk" (for me):

1. a high price; price to earnings, price to revenue, price to cash flow
2. erratic revenues/earnings/cash flow
3. negative cash flow
4. high amounts of leverage debt/equity
5. low returns on equity and assets
6. low profit margins; negative profit margins
7. increasing amounts of unsold inventory; asset writedowns
8. non-shareholder CEOs; multimillion dollar pay packages to senior execs
9. a company bleeding cash and using leverage to pay a dividend
10. company uses stock options and new issues to dilute equity
11. large, multi-billion, multi-national company doing business on virtually every continent

That would be a nice risky company. "Blue chip" in and of itself doesn't mean anything to me (good or bad).

Just curious. Wouldn't #11 comprise many of the components of Berkshire Hathaway (apparently one of your principle holdings) - JNJ, American Express, Coca-cola, etc. As for the "Black Swan", I don't know that I agree with the investing style, but I like to hear different points of views, so it sounds interesting -- I ordered it from the library.

 

[Rickson9]

Just curious. Wouldn't #11 comprise many of the components of Berkshire Hathaway (apparently one of your principle holdings) - JNJ, American Express, Coca-cola, etc. As for the "Black Swan", I don't know that I agree with the investing style, but I like to hear different points of views, so it sounds interesting -- I ordered it from the library.

Yes, I made a mistake with Berkshire Hathaway. My emotions got ahold of me during the tech crash when the class B shares fell from $2700 p sh to $1400 p sh and I picked up a wack of them at an average cost of $1800 p sh.

I don't like large multi-nationals that need to sell their product to half the world population in order to increase their top and bottom lines.

PS: I've made so many investing mistakes over the last decade that it's embarassing.

 

[Berubeland]

I found this cool article.

http://www.edge.org/3rd_culture/taleb04/taleb_indexx.html

I will look harder for black swans

Rickson call me first before you make a "mistake" like that

 

[Rickson9]

Just a small commentary about volatility. Most people dislike volatility, but that is a mistake. With companies that exhibit extreme volatility it is easier to make money. You don't need to be as 'accurate' when picking your buy points.

One of the reasons that it is difficult to make a decent return with Berkshire Hathaway is that it is not very volatile. Your timing actually has to be very good (impossibly good) to make a decent return and my timing is terrible to non-existant.

The example I gave was picking up Berkshire Hathaway class B shares when they fell from $2700 p sh to $1400 p sh at an average cost of $1800 p sh. As you can calculate, the return based on a $1800 p sh cost basis is not great and would be significantly better if I could buy it at $1400 p sh. However, looking back at that time, I don't see how I could possibly have bought the bulk of my shares at $1400 p sh.

One of the reasons I've made so much money with companies like Fossil or The Buckle is that they swing wildly. Once I have evaluated a company like Berkshire Hathaway, The Fossil, The Buckle, or whatever, as something I would like to own, the next 'break' for me is if the stock price swings wildly. As I mentioned with Berkshire Hathaway, a 'wild' swing is pretty narrow and doesn't happen often.

With The Fossil or The Buckle, they can go from $40 p sh to $10 p sh at the drop of a hat (despite improving or stable fundamentals). My timing doesn't need to be very good to make money - I can buy at a number of price points and make a very very good return.

Compared to The Fossil, it is difficult to make a solid return with Berkshire Hathaway:
http://finance.yahoo.com/echarts?s=BRK-B#chart2:symbol=brk-b;range=my;compare=fosl;indicator=volume;charttype=line;crosshair=on;ohlcvalues=0;logscale=off;source=undefined

"There's no reason we should become fearful if a stock goes down. If a stock goes down 50%, I'd look forward to it. In fact, I would offer you a significant sum of money if you could give me the opportunity for all of my stocks to go down 50% over the next month." - Warren Buffett

 

[humble_pie]

taleb was an outstanding options trader with several significant publications to his credit long before the Black Swan became a household word.

a mirror opposite strategy to black swanning would generate a similar return, i believe. This would be the consistent sale, over time, of uncovered options, primarily puts and put spreads. Such a strategy would optimally benefit from an absence of true black swan events. However, it would benefit from a few fake black swans now and then, or possibly some nests full of baby cygnets at regular intervals, in order to stoke volatility.