Imagine your stock dropping 50%

Are you confident that the long term fundamentals can bring your stock back up?

If you say yes, then you probably found a good value.

I've just came up with this test watching my mental stock pick the stock Spreadtrum Communications(SPRD) fall down. I thought the company was great, but it has many risks in a fast sector with lots of competitors. There is no telling if another company could produce baseband chips at a cheaper price or if cell phone manufacturers will stop buying their products. I am not 100% confident in the company, which could be a troubling sign.

Compared to NVIDIA(NVDA), I am completely confident in the long term prospects of the company even if the share price drops to $5. It has significant market power and a single weaker competitor, so I know NVDA will be strong for the long term. The barriers to entry are so great and the costs to switching to another archetecture is too expensive, so I am sure NVIDIA will be strong for the long term. I even recommended this stock to my mom I liked it so lunch, which I wouldn't dare do it with SPRD.

When buying stocks, we often focus on chasing the big gains, and forget about protecting against losses. If you aren't comfortable with the stock going down 50%, you are buying it for the price and not for the value. It might work for a momentum play, but you aren't value investing.

The Dow is the worst index ever

All those freaking out about the Dow going under 11000 are fools.

The Dow is a price weighted index making its weightings arbitrary. Stocks with the highest prices have the most influence on the stock regardless of capital size. A stock trading at $100 has 10x the influence than a stock trading at $10, even if the $100 stock has 1/10 the market cap. If BRK.A was included in the index, it would destroy the system. It just doesn't make sense to use it.

The stocks are arbitrarily chosen too, with just 30 selected by a committee. While they are generally a fair representation of the economy, you are just looking at a small sliver of the actual companies trading in the markets. You are looking at a small number of companies whose weightings defy the laws of logic.

The S&P 500 is the best widely known index on the US markets, but most people focus on the Dow and then the Nasdaq (which is good except for it accounts for half the markets). In a rational world, CNBC and all the financial pundits would focus their time on the S&P 500.

The only reason the Dow is popular is because everyone else is using it. It is like every other conventional wisdom on the Street, which people just follow because others are doing it. If you think following the herd (all those fools who actually care about the Dow) then buy yourself an index fund. You aren't gonna make excess returns in the market.

The worst is when I see technical analysis done on the Dow, which is like using a pseudoscience to analyze a pseudoscience IMHO. Instead look at market capital weighted indexes like the S&P, Nasdaq, and NYSE, whose movements focus reflects changes of the capital in the markets, instead of random prices. Maybe you can find some more meaningful patterns in there.

Now is the time to start buying for the long term

I don't know if it was the markets or the Jager shots lost night giving me the sick feeling in the stomach, but today was definitely ugly for stocks. The mood on the street has been just depressing, with GM reaching its 55 year low and oil with a record high.

The good news is that there are lots a values on the street, and the intelligent investor can have some great opportunities out there for value plays. When everyone is panicking, stock prices of even solid companies go down to ridiculously low levels.

The way I am staying sane is to focus on value, and not what is going on in the indexes. You might get punished some in the short term, but if you find undervalued stocks with a good margin of safety, you will be rewarded in the long term. Don't worry about the short term price swings, just the long term fundamentals because the markets will eventually reward you.

Keeping a long term perspective is crucial. If a stock is trading 50% below its intrinsic value, it might take years before the market accurately prices it. Even if it takes four years, you will have 19% annualized returns, which most folks dream about it. Chances are the prices will reach its true value sooner giving you much greater returns, so there isn't much to lose. If you always keep that in mind, you will can keep yourself sane during these troubling times.

This is how the greats like Warren Buffet and Peter Lynch do it, so I would follow their advice instead of all the fools who want to get out to avoid the pain. The time to buy is when everyone is panicking.

Of course you have to have an excellent sense of the fundamentals and business risks involved or else this strategy is meaningless. But if you can recognize true value, these are the times you will make your big gains. Bear markets are a blessing.

Dick's is a strong buy

After doing some research, I think this Dick's Sporting Goods (DKS) is a stock fit for Warren Buffet.

It is fairly priced, simple to understand, well managed, with competitive advantage and growth opportunities. A recession would hurt the company's short term profitability, but its long term growth strategy more than makes up for this temporary risks.

I was excited reading the 10-K from Dick's, but when I read the one from its biggest public competitor Big 5 Sporting Goods (BGFV), it made the case for Dick's more compelling. Big 5 doesn't have a strategy for leveraging a competitive advantage for growth. Big 5 is like K-Mart while Dick's is like Wal-Mart. Dick's is definitely going to be the #1 big box sports retailer in the country.

The best part is the potential growth for this company. As it builds its brand, it can just build more stores in more markets, since there are a lot of places where it hasn't penetrated yet.

The CEO Edward Stack is impressive too, building this company up from a family business he took over form his father in 1984. Owning 10% of the shares, he is passionate about growing this company and has an impressive track record.

Too bad I don't have the cash to get into it now, but I am starting to build a position this summer. These fears in the economy will hopefully suppress the stock long enough for me to get into it at a cheap price.

Look for value this summer

While everyone is looking how to play defense in the bear market, I am going to concentrate on setting myself up for the next bull market.

Consumer discretionary goods are getting to get their ass kicked this summer fueled by high gas and food prices. This means any normal fund manager would want to avoid these stocks like the plague, but it will provide some nice opportunities if you know where to look.

I want to look for companies with long term staying power, good economics, and solid management. These companies should be able to survive the perfect economic storm, and will eventually be the big winners for the future.

One I am looking at right now is Dick's Sporting Goods (DKS). I am probably not going to buy it anytime soon, but it has potential for a long term play. I am going to start digging into its 10-Ks and see if it is a good opportunity for the future.

Why it is important to learn psychology

When I tell people that it is important to learn psychology to invest in the stock market, they assume it is to be able to analyze the market's psychology. They get it all wrong.

You need to learn psychology to protect yourself from yourself.

Recognizing your own actions can be just as irrational and emotional as everyone else is the essential thing you need to know. Only then can you use psychology to correct your own cognitive deficiencies, so you can hopefully make slightly better decisions than the rest of the crowd. This is what makes you a stronger investor.

Only after learning how to correct your own irrational behavior, you can start to entertain the idea of playing market psychology. Don't get too cocky though, because more than likely the market will be playing with your psychology.

New risk for LDK Solar

LDK's founder and CEO Xiaofeng Peng is creating an independent thin film solar company Best Solar, which will spend $2.5 billion in capital. My main concern is that Peng will divert his attention from running LDK to Best Solar.

The one thing that I can count on is that Peng holds over 70% of the shares for LDK solar, which is worth over $3 billion dollars. With so much wealth invested in the company, his interest are inline with my interest.

However, If Peng starts selling his shares, I will start selling mine. If LDK is really as undervalued as I believe, it would be troubling for him to sell his shares at this price. He should know more than anyone whether his company is undervaled or not.

Luckily, Peng has not done this so I am still fully commited to LDK.

Chinese solar and the Olympics

China is facing a lot of criticism for pollution and its environmental policy and you can bet that this former communists government will do what it does best to fix it: propaganda.

The easiest way for a country to appear green is to use alternative energies. If we really want to stop global warming, we would have to make sacrifice, but good luck forcing your people not to drive their cars anymore. Instead you can mandate that you use 10% alternative energy (that's being generous) and get away with using the other 90% of it on fossil fuels.

Solar gives you the perfect appearance of actually doing something for the environment, without actually doing anything meaningful. It is perfect for a country who needs to develop rapidly which requires fossil fuels, while still satisfying the international community.

China will promote its alternative energies all throughout the Olympic games this summer. It will probably display solar panels at its opening ceremony and give every opportunity to show off its status of being the #1 solar producer.

For stocks, this could mean that Chinese solar will be hyped up this summer as all these new buyers start coming in after seeing it on TV.

I wouldn't touch financial stocks

The industry had a nice run up until the summer of 2007, but their profits came from taking on excess risks without even realizing it.

Their profits came from the housing bubble, excessive leverage, and complex derivatives which I don't even understand. The industry is too messy to analyze, especially when you don't even know where their profits are coming from exactly or the value of their assets. If I was a banker, I might be able to analyze them better, but I really don't know what the hell goes behind the scenes at some of these financial institutions.

Many of the institutions look like they have value compared to last summer, but I don't think they can match their profits from the past. They will be forced to take less risks either by pressures from the free market or government regulation. I don't see them getting back to their glory days anytime soon.

If I had to invest in a financial company, I would look for a savings and loan that still has integrity behind its name. One that didn't take excess risks but was sold off due to this financial crisis anyways. Since I feel like this industry is run by greedy pigs, I place value on honesty, integrity, and transparency.

LDK is the lamest name in solar

LDK Solar is just a plain terrible name for a solar company. You can't pronounce LDK if you try, and L D and K are just boring letters. You can at least put an X, Q, or V in there to make it interesting.

Other Chinese solar companies have cool exciting names like China Sunergy, Solarfun, Sun-Tech Power, and Canadian Solar, which isn't even based in Canada (how cool is that). These names provoke X-citing images of cutting edge companies in a hot growing sector that well revolutionize the world. LDK just sounds boring and unimaginative. Who cares?

Luckily I picked up my all time favorite book the other day, One Up On Wall Street by the great Peter Lynch. He stressed that he loves companies with boring names, because the street tends to ignore them for a long time, giving you a better opportunity to get in. If you are able to get in before everyone else, you will enjoy the biggest gains as the stock's earnings growth eventually gets recognized by the market.

He wished Xerox was called David's Dry Copies, so the street would be more skeptical of it when it first went public.

So I found another reason to like LDK Solar: It is the lamest name in solar

Mr Market reminds my ego that volatility has a downside, again

I felt euphoric with my returns in May, but June brought back the pain and suffering as the market gave back half my gains.

One thing that I learned is that you have to accept volatility as a fact of life. Learn to expect it, so it doesn't become a shock when it does occur.

I have trained myself to deal with this most of the time, but when I have a huge gain, my ego starts taking over. I start seeking the adrenaline rush of making the big gains, and forget about the patience it took you to get there. Mr Market usually puts me back in my place pretty quickly, and you are reminded that your stocks can go back down.

I remind myself that volatility is only a factor if you are buying and selling in the short term. If you aren't planning on selling in a year, you shouldn't let the mistakes of other affect your decisions, yet the temptation to do so is huge.

The worst thing you can do when you are value investing is to thinking you can play with the volatility in the markets. The woulda, coulda, shoulda's start kicking in your brain, and its hard to resists the urge to trade. The market is teasing you with all these plays that seemed so obvious in hindsight that you could have done.

From my experience, this doesn't work out in practice. One thing a trader has to do is learn to forgo a trade if the price action isn't right. When you have a stock that is undervalued by 50%, you don't have the ability to say, "I won't buy this because it moved too high technically." Instead you are thinking "I have to get in now, or else I will miss the 'Big One'." Lacking the discipline of a good trader, you will buy and sell at the exact worst times, losing more money.

Besides the emotion side of it, there are also the extra taxes you have to pay when trading which can eat out any of the small trading gains you could theoretically make. A trade had to make you an excess of 15% extra for it to be even worth doing if you have a long term outlook on a stock.

The easiest way to deal with volatility is to not look at the markets all the time. This doesn't always seem like an option for me just because I am thinking about investing all the time. Still, if I do something outside or hang out with friends, my mind is a lot more clear when it comes to my performance. It helps you keep things in perspective by taking a longer term approach to the markets.

I also find that exeperience does help you develop a tough stomach for volatility. If you experienced it in the past, but made it out big in the end, it is easier to whether these rough storms. It is easier, but I wouldn't call it easy at all. Being patient is one of the hardest things in investing, especially if you follow the markets consistently.

Expectations are really high for the 3G iPhone

3G and more business support is nice, but that is already expected. Apple needs to give its customers something new that will make them say "wow" again, like when it unveiled the iPhone last year.

The first iPhone was revolutionary when it came out, doing stuff no other cell phone was capable of doing. When I went to parties, people would be showing it off because it was so cool. The next iPhone needs to have the features that will impress people like this again. It has to be so good, that someone who bought an iPhone yesterday, they would want to buy the new one.

To be honest, I don't think there is going to be a giant leap with the 3G iPhone. Many of the Ipod upgrades were really just adding a few feature and making it slightly lighter. They usually aren't big enough to make someone who already owns an iPod to upgrade to another.

The next iPhone needs to blow people out of the water, or else the stock price will fall. Steve Jobs needs to pull a miracle here. If anyone could do it, it would be him, but I wouldn't put my money on it. How much cooler can you really make the iPhone be.

Seriously, WTF oil

Now that oil is up $11 today, it just gets crazier and crazier.

I guess there is the assumption that Asia won't be affected at all by these oil prices. Their economies don't run by magic, and will suffer from these oil prices too.

But who knows? I don't think there point for rationalizing this market, because they seem to defy the laws of reason and sanity.

WTF oil

I really don't believe this mess that the oil price followed supply and demand when it goes up $12 in two days.

The fact that consumers and businesses are starting to cut back their consumption shows that this argument has little weight. I really don't know what the rest of the world is dealing with these prices, but I doubt they can keep up with these high prices. Something has to give.

The problem is that people believe that oil will climb, hearing high price quotes like $150 or even $200 a barrel coming this summer. If People believe oil will go higher, oil will go higher. The fact that oil has become an investment vehicle for people who don't usually trade commodities is troubling.

I don't think these high prices are sustainable, and eventually demand will shock the system. The problem is that there might be a lag here before it gets to all the traders.

I guess one of the reasons why people think oil will go higher, is the belief in markets. In economics, we are taught that markets are efficient allocators of goods are resources. I think markets can be far from efficient, hence why I invest. There will eventually be a correction when the markets fall way out of balance, but right now we all have to pay for irrational exuberance at the gas pump.

My paper trade was going well, but got stopped out of this morning, but what can you do? The only thing that took a hit was my ego.

Perfect time to get into GM?

GM is trading at its 26 year low while being hit is being hit by the perfect storm of a possible recession and high gas prices, making it the perfect time to get in.

GM brought in $205 billion in revenue last year, but the whole company is worth less than $10 billion. Given that GM is making an effort to turn itself around, it will offer huge rewards if it succeeds. An only 1% profit margin would equate to a PE of 5 to put it in perspective. 5% profit margins would make a PE of 1.

The CEO, Rick Wagoner, is setting the company up for a turnaround, attacking its core problems of labor costs, but more importantly, producing quality cars that people want to buy. It might take years before GM solves these problems, but the rewards should be worth the wait.

While there is no guarantee of this, the current price is so low that the only risks you have to worry about is bankruptcy. It is a possibility, but I don't think the chances are great for a company that size. You can manage the risks by position sizing while adding more when the company's prospects start looking better.

Hell, if GM does face bankruptcy, they can probably just fire it unionized labor and they are on their road to profits. It will suck for all those workers, but there isn't much GM can do if they aren't bringing in the money. Hopefully both the UAW and GM can come up with some fair compromises, so that workers can get good compensation while still being competitive with the rest of the world.

I am not getting into GM before 2009 because I like my current holdings better, but I think now is the time to think about building a position.

Why I don't diversify

The reason is simple: I can't find any better opportunities to put my money in.

Sure there are many good stocks I could invest in that will beat the market, but I only care about the best. Why put my money in lower returning assets? It ain't rational

One thing I really don't care about is how my portfolio looks like. I know my portfolio looks like it was created by some kid who just graduated college who doesn't know what the hell he is doing. I tell people that I have my money into two stocks with one of them being a Chinese solar (double the risky words), and they think I am crazy. Luckily investing isn't a beauty contests, it is about making money.

The one investment strategy that I have is to make as much money as I possibly can. I follow a long term fundamental approach, but that is only because I believe it will bring me the best returns. As my knowledge expands and markets change, I might try other strategies but I am pretty content with what I am doing now. However, if I find diversification will bring me greater returns, then I will do that.

Now I don't recommend this non-diversification to anyone because it is just damn risky if you don't know what you are doing. Unless your name is Warren Buffet, I don't trust anyone playing such a concentrated strategy, so don't do it. To be honest, I wouldn't even trust myself if I was someone else.

It may look like to any sane person that I am taking too much risks, but I don't see it that way. To me adding assets that will bring lower return for the risks is riskier in my portfolio so I don't do it.

But I can rationalize this concentration strategy all I want. I'll leave it to the market to prove me right or wrong. In the end, its about making money.