chk999 (99.98)

A bittersweet farewell

August 14, 2009 – Comments (4) | RELATED TICKERS: AXP , JNJ , GE

Sometimes you just have to say goodbye.

I've been guilty of hanging on to a relationship long after it was obviously over and I've finally cowboyed up and ended it. It hurt, but it is for the better.

I'm talking about my CAPS outperform pick on Northfield Laboratories. It was one of my first CAPS picks and I made it on the strength of a recommendation by a well known poster at the Motley Fool. He has experience with their blood substitute at a local hospital and said it was a winner.

I made the outperform pick on 10/12/2006 at $14.68 and closed it on 8/12/2009 at $0.04 for a loss of 72.4 points. I closed it because I expect that the benchmark will go up over time and this will make the loss worse. I've had bigger losses on other calls, but most of them were honest mistakes on my part where my analysis just wasn't good enough.

So what have I learned out of this? (And what have I learned out of some real money debacles?)

First, it doesn't matter who made the recommendation, you have to do your own due dilligence. Even Buffett makes mistakes (like buying COP at the top of the oil bubble last summer.) If you don't understand the company, don't buy. Your due dilligence must be deep enough that you have the confidence in the situation that you won't get shook out when Mr. Market has dyspepsia and prices drop. Read the financial statements and understand the capital structure. This has more bearing than you think it does. Then use your friend google to do some Phil Fisher style scuttlebutt digging. But be skeptical about what you find, there are pumpers and trashers all over the place. Figure out how you will react to various situations before you make the buy and have a plan at the ready so you don't have to make complicated decisions on the fly.

Second, understand your circle of competence and stay inside of it. (And work to expand it, but stay humble.) I know nothing about development stage pharma/biotech/biomed, so I should not make stock picks there. I bring no value to the table so my picks in that area have been poorer than average. If you have no advantage and no margin of safety, don't buy.

Third, when you lose confidence in the company, get out. This has nothing to do with price action, but your estimation of management, the business situation and the industry the company is in. If you strongly respect the company and the price goes down, buy more. If you lose respect for the company, even if the price is going up, get out. Life is too short and capital too scarce to waste it on poor companies. Cash is better than a bad investment.

Fourth, if the price of the stock goes way down and you still really respect the company, buy more. It will be scary at the time, but the stuff I gritted my teeth and bought around the lows in November and March have done well.

Fifth, if management starts making stupid capital allocation decisions, get out. The place where management tends to perform the worst is on deciding how to allocate scarce capital. When management does things that have the stupid alert sirens wailing and huge flashing warning signs, get out. They will trash the company and your investment. Also watch executive compensation. If it seems excessive, you can be sure there are other bad things hiding below the surface like a crocodile slowly swimming into range to grab your leg.

The last year has been a true learning experience and I am the warier, if the poorer for it.

Chris - long JNJ, GE, AXP, DIS and other companies I respect the heck out of