Eating our own cooking - part 1

It's been a turbulent, exciting few months, a period where members have put cash to work on the stocks on our Buy List. For your analytical team, too, it's been an active period.

Whilst we disclose in each article whether the author owns any of the stocks mentioned, we don't reveal individual trades. To do so runs the risk of members reading too much into not necessarily pertinent detail. Here, we're going to make an exception, disclosing the stocks particular analysts have traded recently, and their reasons for doing so.

The past few months have been wonderfully turbulent. A weak, volatile All Ordinaries Index has produced some great opportunities. The reason why we're revealing these trades now is to make a crucial point in a practical way: bad news – or the expectation of it – creates opportunities.

To be successful, you must train yourself to buy on bad news. A behind-the-scenes look at our recent trades makes this point better than anything else. With this information we hope you'll have the confidence to buy in the next period of instability and really make the most of the opportunity.

It does not mean, however, that you should be replicating these trades. Despite their grey hair and sagging eyes, your analysts are experienced investors on the younger side of life. With time on their side, they can take on more risk. The point about acting on bad news, or the expectation of it, is general rather than particular. Okay, let's get into it.

James Carlisle, research director

I did well to build up a bit of cash from November to January - or pay down my mortgage a bit, to be precise. Everything seemed pretty expensive, so I was happy to take profits. To a large degree valuations still reflect the long-term bond yield, but not to the same extent. Yes, the mortgage has now gone right back up, plus a bit more. [If his bank manager is reading, James wants to reassure him that it's still comfortable, and is not recommending any strategy that might put his home in danger - Ed].

The major beneficiary of this is GBST. I started off with a small stake in May (ouch) before increasing in July (ouch again). But this goes to show what you can do by controlling your entries and exits. Although the share price is down 25% since my initial purchase, after increasing my shareholding again after the recent profit warning I'm now only 10% down on my average price.

The lesson is obvious but no less useful for it; as the price goes down (relatively even to a slightly lower valuation), the opportunity improves and the risks reduce. Of course, I now have a bigger chunk of my portfolio in the stock but I'm comfortable with that at these prices, particularly given the strong balance sheet and annuity revenue streams.

My other main targets have been the online classifieds companies, starting with iCar Asia. It'll be awhile before the company reaches profitability and it could be a bumpy ride, but significant shareholder Carsales has done it all before. Last year I sold about 75% of my original stake purchased in 2013 but I'm now back up to where I was before this trade.

After buying in last year I also doubled my holding in Trade Me in July. As with GBST I'm happy to have a large weighting in this stock due to its defensive qualities: large market shares in four different markets – general merchandise, property, cars and jobs.

I also bought into Carsales and Seek this month, probably at prices higher than I should have. After missing the bottoms in September I got a bit fixated on those prices (Seek at $11.75 in particular), so I watched them creep higher and higher, hoping they'd fall back. Of course they didn't (at least, not yet) and I've ended up paying more than I needed to. Such are the problems of anchoring.

We really do need to train ourselves to ignore the ones that get away and focus on the opportunities before us. My wife would tell you, though, that I generally need more than one reminder, and to prove her point I made exactly the same mistake with Perpetual, watching it edge higher and only seeing sense and buying last week at over $43.

My other two purchases have been Virtus Health and ASX. Virtus was a bit of a whim really. My initial view of the stock was probably a bit negative when it floated a couple of years ago (there's nothing like a private equity seller to make me see the worst in everything), but I've warmed to it. A near halving of the share price since last year's high around $9 helped. Again, I didn't get the bottom (of course), but this time I bought on the way down so I didn't have the problem of regret at a missed opportunity.

As for ASX, I've again increased my holding. After years of static profits and a flat share price, people seem to have got plain bored and moved on. I expect earnings growth of perhaps 5% a year instead of the 30% or so a year the company enjoyed ahead of the global financial crisis. But at $40 the stock yields almost 5% fully franked so it doesn't need much growth to wash its face.

Graham Witcomb, analyst

Like James, my latest trade was Virtus, first purchased after the company issued a profit warning and loss of market share in June. The stock fell 26% but I kept buying until late August. I always liked the company and it had been on our buy list for a long time under the 'good company, fair price' banner. Now we were getting a good company at a great price.

The biggest psychological barrier I had to overcome was a nagging feeling of 'what am I missing'. I felt I knew the company well and, for several reasons stated in our reviews, I didn't regard the entry of Primary Health Care to the sector to be unbearably disruptive (which was a big part of the media freak out).

Still, my first purchase was at $6.03. then at $5.85, $5.39, $5.23, and finally $5.02. Ugh. The stock kept falling and hit a low of $4.55 so I was down 25% at this stage on my initial purchase. I wanted to keep buying but had reached my self-imposed 'maximum capital at risk' weighting. I've never hit that limit before, so I'll need to exercise vigilance to avoid future confirmation bias. We want our biggest bets to work out and that can blind us to negative data. 

There were plenty of negative media headlines, especially around the Primary issue and I read them eagerly. Whilst confident I had judged things correctly, I wanted to hear the other side to the story – the reasons why people weren't buying the stock - in case some fact arose that I hadn't considered. I was waiting for an 'Oh, so that's why it keeps falling' moment but it never came. The stock was down 25% at one stage and yet no new material information had emerged since the original announcement.

By that stage I was confident that even if I had missed something and overpaid at $6.03 (though I am still perfectly happy with that purchase) this was definitely a good buy now. Even my margin of safety now has a margin of safety! Price declines in and of themselves don't bother me – in fact my eyes light up – but when companies make discouraging announcements after I've purchased (I'm looking at you The Reject Shop), then I get more uncomfortable. It's when my investment case starts to sway that I get unsettled. That is not the case with Virtus.

We'll leave the final word to our newest team member, analyst Andrew Legget, who's been paying down his credit cards. 'After getting married, buying a new house and going to university, I haven't had the free cash available to invest. It's been a frustrating time. I would have loved to have picked up some Myer shares under 90 cents recently and Disney under US$95 but credit card debt is expensive. Paying that down first is a no-brainer. Time is on my side. There will be other opportunities.'

That's smart thinking on Andrew's part, making the point about horses for courses. Later this week, in Part 2, Gaurav Sodhi, James Greenhalgh and Jon Mills reveal their trades.

Disclosure: This shouldn't really need saying after that but some of the analysts might possibly own stock in some of the companies mentioned.