A common way that Phil's method loses you money

[tombrown1]

After doing Rule #1 for a couple of years I started to notice a trend among the stocks that were coming up on my watch lists. They were all going down. Quickly.

I think this is because a lot of the stocks that show up as being good rule #1 stocks were once high growth stocks that peak and then start to tank. While they're tanking it appears that they will be good value because we use the old (and very high) growth rate numbers as our future growth predictions.

But with some heavy digging (sometimes many, many hours) you can usually find something wrong with the company that doesn't show up in the news blurbs on Yahoo's finance site. And that is what's causing this stock, which used to be a rocket ship, to tank heavily.

This pattern follows in many of the stocks I first followed after following rule #1 around the summer of 2006. FMD, CHS, PNRA, CWTR, CTSH, and WFMI among others.

I do think that Phil's method could work, but I would like to caution any new people out there that you absolutely must know your investment if you want to use this method.

I hope this helps some of you new rule #1 followers. Be cautious of these stocks. I have since abandoned rule #1 in favor of a strictly technical approach. Many of the early forum users have gone to a straight Warren Buffet/DCF approach after abandoning Rule #1.

I hope this starts some helpful discussion about different methods that exist.

Best,
Tom

[KatonahMike]

Originally Posted by tombrown1

I think this is because a lot of the stocks that show up as being good rule #1 stocks were once high growth stocks that peak and then start to tank. While they're tanking it appears that they will be good value because we use the old (and very high) growth rate numbers as our future growth predictions.

Interesting. Is it possible that requiring 10 years of acceptable growth numbers also means that by the time they have become Rule #1 worthy, most of the initial growth has come and gone? Are there cases of companies that can keep up 20% growth for 15 or 20 years?

If that's unusual, perhaps we should scale back the rule to 5 years of good growth, so that there are 5 more good years of growth left? A dangerously broad statement, I know, but does it have merit?

Many of the early forum users have gone to a straight Warren Buffet/DCF approach after abandoning Rule #1.

How does the Buffet/DCF approach work? Where can I learn more?

Mike

[tombrown1]

Changing it to 5 years might help. I'm not exactly sure. I've abandoned Rule #1 altogether in favor of trading high growth companies technically.

As for DCF there is a lot of great information on this site - search for things like 'DCF' and 'discounted cash flow' - read any book on Warren Buffet. There is a link to Seth Klarman's Margin of Safety in a recent post.

Also try general searches for DCF on the web. Pete Koch and NPG, both on this forum, are a wealth of knowledge about DCF.

The basic idea is that you are completely ignoring the price of a company and valuing it based on how much cash it has and can produce. It's what Warren does, and he's pretty smart.