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A Learning Experience

July 07, 2011 – Comments (0) | RELATED TICKERS: ABT

Board: TheBMWMethod

Author: BuildMWell

The intent of this post is to share some of my short term experiences with the BMW Method. Remember, my definition of "short term" is two to three years. I tend to establish positions based on the 30-year low CAGR line and sit on those shares while the business goes to work for me. I spend absolutely zero time looking at what happens this week, this month or this year. My overall goal is to achieve a huge long-term gain that is taxed at 15%.

So, let me discuss the following:

1) What I have learned about the BMW Method in the last three years.
2) How I still use the method to my advantage.

Actually, what I have learned in the last three years is based on what I thought I had learned since 2004 when I started this board. But, my 2004 learning level was based on what I had experienced since beginning to develop the BMW Method in late 1994 when I retired. I actually did not have much money to invest as I was building houses and reinvesting the funds in more houses. However, in 2000 I sold my last house and had a sizable pile of cash. I also had developed the BMW Method to the point that I believed I could actually make more money buying and selling stocks than the +20% I was making in the construction business. If I could do better "not working" than busing my chops building houses, why not get out of the way and leave the real estate business to others? By the way, I am buying real estate now...at the 40-year low CAGR.

For, you see, the BMW Method is not just a stock selection scheme. I use it for everything that reverts to a mean.

Anyway, to explain the last three years, I need to begin in 1999. If you will recall, at that time the market was expanding great guns at a CAGR of over 15%. In late 1999, as my initial experiment with the method, I invested 20% of my funds in an S&P 500 Index fund (SPY), about 20% in the Dow 30 Index fund (DIA) and 10% in the NASDAQ (QQQ). Then, I took the remaining 50% and bought large Cap stocks that were at their 30-year low CAGR. These included MO, CAT, RJR (Now RAI), and NGH (Now KFT). Whereas those Indices all matched the CAGR of their respective markets, my individual stocks doubled and some even tripled over the next three years.

In 2001 I added HAL and DUK and at least one other stock that I cannot recall as I write this. But they all more than doubled. The details are all documented on the various boards here at TMF if anyone is interested. I was a very prolific writer back then, but had no way to explain my exuberance for the various stocks because no one had a clue what the BMW Method was back then. In fact, my method did not have a name in 2001. It was just what I did for myself.

By 2004 I was so "sold" on my method that I took my idea to the "Foolish Collective" and was soon persuaded to start this board because a number of Fools liked the concept. IcyWolf was one of the first advocates, soon followed by TMFMurph, Mike Klein and others.

From 2000 to 2003, the overall market dropped from a high in 2000 of 11,700 to a low of 7500...a drop of 36% for a CAGR of -11.2%. Meanwhile, everything that I bought using the BMW Method was up 25% to 40% annualized. There were no losers!

Now, I am not trying to brag, but you will have to admit that any person looking at that sort of performance in the face of a market going down like a rock has to think he is onto something great. And, that is precisely why I was so excited by the BMW Method.

Then, from 2004 to 2008 we experienced a number of great buying opportunities right here with our BMWM Portfolio. But again, please recall that the market soared back from that 7500 low in 2003 to a new all-time high in 2008 of just over 14,000...a CAGR of +13.4%. We actually beat that here with our "Voted by Poll" portfolio. It seemed that collectively we could make the BMW Method work, but we could not take advantage of the fine positions we established because we had a difficult time collectively agreeing on the correct time to sell. Still, there was a great deal of excitement about the method and this was one of the most active boards at TMF.

Then, the collapse of the financial markets came in late 2008. The weak bank stocks drew me to them due to their long-term strength, good dividends and impressive CAGR's, but they failed to recover. I spent a lot of hours looking at the annual reports and could not find the weakness. Plus, I had been with several of these banks for my whole working career. I had jumped through their hoops on many occasions to borrow money or to get a long-term mortgage. It never occurred to me that these same banks that dotted the i's and crossed the t's with me, would actually loan money to people with poor credit based on income figures that the banks never bothered to verify. I am still astonished by books like "The Big Short" that show what was going on within the big financial institutions.

So, what did I learn during the last three years. I learned that the BMW Method still works well for me, but it works better in a down market when you buy and hold the companies that are not going to fail...like MO, RAI, CAT and NGH back in 2000. Back then my due diligence worked because the company's books were no "fudged". In 2008, my due diligence was worthless because the financial's books were bogus. The problem is, I have not learned how to tell the difference. Wall Street shysters are significantly smarter than I am. Thankfully, they are in the minority.

But, it makes sense to me that in 2000, with the overall market making new highs, once the fall started, money would seek the best places and solid, low CAGR stocks were the logical place for the money.

So, in March of 2009, I renewed my belief in the BMW Method by doubling down on bank stocks even though several had totally failed. I think I wrote about it right here because I remember talking about how it bothered me to be doing what I was doing. I was not applying the BMW Method to the long-haul. Rather, I was making huge short-term bets on FAS options. FAS is the "Triple Bet" on financials that is able to triple the exposure to gain or loss through the purchase withing the stock itself of options. Then, I was buying "In the Money" calls on FAS. I recall buying the $2APR09 call for $0.80 when FAS was at $2.35. I sold that option just before it expired at just under $8...a ten-fer in six weeks. We made back most of the loss from 2008 by trusting the BMW Method to spot an anomaly in the share pricing due to excessive pessimism. The way I saw the situation at the time was as follows: Either we were all going to fail together or sanity will take over and the market will have to recover quickly because it is hugely over-sold.

On March 9th, Mark Hanes on CNBC said, "The market has been down 21 of the last 23 days." I was listening to CNBC in the background as I was nailing down shoe molding. I put down the tools and immediately started buying. No due diligence, no worries either. When the market is down 21 out of 23 days, it is time to rally or we are all dead! I had no time to think about individual stocks, so I bought the whole sector. Plus, I could see no advantage in buying the actual sector at $2.35/share if what I believed to be true was, in fact true. So I bought the April options on FAS which included options. As I wrote here at the time...that was crazy, and I hated it, but that was what the BMW Method told me to do. And, how does anyone do any due diligence on FAS anyway? It wasn't even in existence two years at the time. But, I felt in my gut that people would come to their senses and the financials were destined to recover quickly. Luckily I was correct. I could have lost my whole investment in less than two months. As you can see, I am still a believer in the Method.

Three months ago my wife and I sold ABT $45JAN13 LEAPs for $6.40@. Today those same options are at $3.40@...a gain of 88%! We also sold the ABT $55JUN call at $1.25 at a recent price spike upward and bought them back three weeks later for $.15...a 733% gain. This, of course, fails to meet my goal of paying a 15% Cap gains tax, but I actually am paying no tax because I still have losses from 2008 to write-off. You see? The beauty of being in the market is that you only pay taxes on gains AFTER you write off any losses. And, long-term losses are written off against short-term gains so the short-term gains are not taxed at a high rate after all. Once you have a loss, it behooves you to make gains as fast as possible. Long or Short term...it makes no difference, so the short term is best. I learned that in the last three years.

Now, this is NOT my proposed BMW Method, but we surely use the BMWM charts to spot the right times to buy and sell options and the market seems to cooperate just as the curves suggest it will. I think I have found that when the overall market is below the 30-year average CAGR, there are too many places for money to go. This is exactly the opposite to the year 2000 when there were so few stocks at a 30-year low. I think that is something else I have learned recently in the school of hard knocks.

Back to Abbott Labs:

The overall price is well below the 25-year mean, the dividend is at a historical high yield, the P/E Ratio is at a historical low and the stock seems to refuse to go higher than about where it is right now. The question is, how long will Mr. Market fail to see the great buy that is available. Meanwhile, ABT's earnings are looking quite nice, the company is raising the dividend at a impressive rate and no one seems to see it. I happen to think the average investor is oblivious because he is buying mutual funds and is not interested in individual stocks. At least, that is true for 95% of all investors I meet. They have no time for evaluating stocks.

To me, this post is a good example of why the BMW Method Conference is valuable. I can present this same information in a power point presentation, answer any question as they come up and point out the details that show this whole concept. But here, I have expended several hours in trying to explain it all with the internet, and I bet I have lost most of the readers due to the length of this epistle. If you have stuck around this far, I thank you!

BuildMWell