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What's simple isn't always easy.

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December 06, 2006 – Comments (10)

I can’t tell you how much I’ve learned in just these first several months I’ve been playing CAPS. I’ve learned about new companies, stocks, industries – found some terrific investors I might have not otherwise have found and whose ideas and insights I have used, and will continue to use, in making my own investing decisions.

One thing CAPS has been especially good at, however, is reinforcing lessons I’ve already learned. CAPS has reminded me that the simplest investing lessons are often among the most difficult to implement.

While CAPS has reinforced a lot of investing lessons for me, one of the biggest so far has to be what Warren Buffet taught us. "If [investors] insist on trying to time their participation in equities, they should try to be fearful when others are greedy and greedy only when others are fearful.” A simple lesson that certainly rang true with me the first time I heard it, but one that is sometimes difficult to implement.

How has CAPS reinforced this lesson? At the risk of being a bit redundant as I touched on this briefly in my “My Best Picks” blog, my CAPS calls on a basket of homebuilders has shown me, in spades, just how powerful this lesson is, and how difficult it is, sometimes, for many of us (including me) to implement.

What is to follow might strike some as an “I told you so” moment, but if you’ll indulge me, there’s what I hope is a real lesson here – and one that has impacted and will continue to impact me as an investor.

I made my first CAPS outperform call on homebuilder Toll Brothers on July 12. The housing market was, and still is, under some pretty stiff pressure. Sales had dropped off dramatically, pricing was showing significant signs of weakness, skeptics pointed to growing inventories, the softening dollar created fear of higher interest rates on the horizon – there certainly was, and is, a lot to be afraid of.

I picked-up 5 additional homebuilders on August 22 (MDC Holdings, Lennar, KB Home, DR Horton, and Pulte Homes). My reasoning, as you can read in my pitches, was simple. Trailing P/E ratios were in the single digits – and mid single digits at that (many around or below 5). I knew that the housing market would eventually turn around, and I was getting what I believed was a really good price on these stocks. While I knew, and stated in my pitches, that there might well be more short-term pain, I believed that over a long period of time these entry prices would make for successful investments.

I received a lot of pitch replies to these calls… things like:

“Wow, I hadn't noticed that the TOL PE had dropped so low. I'm going to wait a little while here (and kid myself that I CAN time the market), but I agree with you that you're picking up TOL on sale.”

“I absolutely agree with this one, and for the sentiments you shared, but I think you're awfully early. I may STILL add this one to my CAPS pick (I debated for a good while, and decided to wait)….”

“Since we have opposite opinion in this matter, lets have a friendly bet. I expect those homebuilders will behave like internet stocks in March 2000, before end of this year.”

I included the last pitch reply because I think it typifies the fear that surrounded the sector at the time I made the calls – and to be fair, the year isn’t over yet so the bet is still live – but I want to concentrate on the first two pitch replies.

Here, a couple of my fellow Fools agreed with me, and yet couldn’t bring themselves to make a CAPS call at the time (I haven’t checked to see if they’ve added homebuilders since) because they, like so many others, seemed to be afraid. As Warren has told us, however, that would seem *precisely* the time to make such a call.

Now, before you think I’m tooting my own horn a bit too much, there’s one very important thing I *didn’t* do – and that was to put *real* money on the table and scoop up shares in one or more of these homebuilders at what I believed were bargain prices at a time when most investors were fearful. It’s easy to make a CAPS call and take the risk when my and my family’s financial well-being isn’t at stake. Doing so in the real world is an entirely different matter and I must confess that I, too, felt the fear of further short-term pain in this sector and therefore didn’t act.

Sometimes the simplest investing lessons are the most difficult to implement.

While I certainly have incorporated this lesson to some extent in my real-life portfolio (like adding more to positions on dips), I've come to the realization that I have a ways to go in learning to utilize this principle to its greatest advantage. But thanks to Warren for teaching me the lesson in the first place, and thanks to CAPS for helping to reinforce that lesson, next time I see an opportunity like this I will hopefully be much more inclined to put *real* money on the table. I’ve invested a lot of time with CAPS, but I think what I’ve learned here, or what’s been reinforced here, is, by itself, a very nice return on that investment.

10 Comments – Post Your Own

#1) On December 06, 2006 at 6:46 PM, TMFSpiffyPop (99.37) wrote:

Another charming and informative lesson from a CAPS Master. Thanks, Russell. Are you going to break the 2000 barrier tomorrow? :) --DG

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#2) On December 06, 2006 at 7:17 PM, TMFEldrehad (100.00) wrote:

Your guess is as good as mine... as you know I've been bouncing around between 1,500 and 2,000 for a good little while now. Whether I sink or soar from this point forward, it sure has been one heck of a run!

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#3) On December 06, 2006 at 7:20 PM, mateub (97.53) wrote:

You wrote: "like my blog? let me know!"

Well, your blog is fine, but among the things these blogs lack, the inability to link reduces them to the newspapers the internet is supplanting. I just don't get it.

adéu,

Mateu

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#4) On December 06, 2006 at 7:56 PM, QualityPicks (59.72) wrote:

I have also "learned" the same things you mention but I just want to add few points:

Homebuilders trailing PEs might be in the mid single digits, but forward PEs are double digits. While forward PEs are really what matter, one just has to understand that they can be unreliable. A company without growth is not worth more than a PE of 15 I have always believed. That is pretty much where homebuilders are right now (so they may not be that cheap anymore).

Also, I personally like to stay away from stocks without growth in the relatively near future (<1 year).

House prices are another variable, I still have reservations about house prices. If they do come down further, forward PEs might be adjusted and all of a sudden the stocks could be considered "expensive".

Lastly, I have also noticed, that very often, after I tout a "big call" I made, it starts to go the other way :) Or, if I put money into it, it also does not work :) (probably because there was no real fear). Often the fact that you are willing or not to put money in a stock, is an indicator of the level of fear.

No worries though, there is still likely more room for homebuilders to rise though, because I'm not bullish on them :)

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#5) On December 06, 2006 at 9:25 PM, SH2F088 (90.30) wrote:

I read in a separate post that CAPS was not meant to be a market simulation. I believe that the real goal is to create a site that enhances our collective ability to invest and rate stocks.

I do feel that incorporating a method to weight picks (a la CAPS dollars?) would further enhance both the stock rating. I think it would have two advantages over the current system: (1) due to a better understanding of how strongly a player feels about the outperform or underperform call, and (2) due to a superior system for deciding investment savvy (ie individual ratings).

There would be no need to try to properly simulate short sells, margin interest and the like. The idea would be to enhance the current system for rating stocks. The promised dividend tracker is another important missing component.

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#6) On December 06, 2006 at 9:57 PM, MKArch (99.67) wrote:

Russell,

One thing I like about the homebuilders is they give you a chance to re-up your call in a way. Since they mostly trade in a herd you can start with one and add more later if better buying opportunities present themselves. I started with Centex because I owned it a couple years ago. I plan to add one or two more homebuilders in the next healthy correction and leave a couple out there in case we get something worse than just a correction at some point. Sort of the TMF1000 buy in thirds strategy.

Mike

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#7) On December 07, 2006 at 1:00 AM, sdt2000 (< 20) wrote:

thank you for the candor. quiet refreshing.

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#8) On December 07, 2006 at 2:07 AM, hhasia (65.89) wrote:

Careful there.. Pride always comes before the fall.

My rule.. When they serve coffee on the airplane.. there will be turbulance.

When you land the dry cleaners will be closed and someone will have taken your look-alike bag.

But cheer up your wife will smile that " knowing" smile.

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#9) On December 07, 2006 at 3:28 PM, squished18 (98.19) wrote:

"It’s easy to make a CAPS call and take the risk when my and my family’s financial well-being isn’t at stake."

I would like to make a comment about following Warren Buffett. I have a personal belief that one of the key factors that allows Warren Buffett to make certain investment decisions is his modest lifestyle. It seems well published that his lifestyle likely demands an annual income below $100,000. (Except his admitted penchance for private jets.) It seems to me that one thing that enabled him to make certain bets is that he knew his family's financial well-being was never at stake, at least not after he made his first million. After a certain point, even if he lost all his investment funds, as long as he kept one or two million, his own lifestyle would not change. All the rest was "play money".

So many of us profess to admire Warren Buffett's investment ability, yet how many would still be spending hours studying stocks if we knew we would never actually use the funds to life the high life? Are there some investors who accumulate $10 million, but when their lifestyle adjusts accordingly, they find themselves unable to wager $9 million because "their family's well-being" is now at stake? It's hard enough to get to $1 million, harder still to get to $10 million, but $100 million, and then $1 billion? It seems you have to bet the farm over and over again to get there. And unless you're willing to live the humble life, it makes it much harder to bet it all.

my two cents

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#10) On December 07, 2006 at 5:12 PM, TMFEldrehad (100.00) wrote:

Good points there squished!

I was using a bit of poetic license when I talked about my family's financial well-being. It's not like I'm investing in the stock market with money we need to buy groceries next week - but you do make an excellent point.

When one is investing in the stock market with money one feels one *needs*, I think emotion is much more likely to enter the decision making process and cloud what might otherwise be good judgement.

I'd never seen this presented this way before, so you've taught me something. It's long been a Foolish principle to not invest in the stock market with money one needs in the short-term as this just makes good financial sense. It had never occurred to me that it *also* makes sense from a trying to avoid emotional decision-making point of view as well.

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