CHICO'S: CASE STUDY RE: THE IMPORTANCE OF VIRTUAL TRADING

Laura left this comment very recently:

I'm having a heart attack today because I bought into Chicos (CHS) when the arrows said to "buy" and I have been watching it in gross detail everyday. I felt good about it closing yesterday at 37. I woke up this morning and it has taken an enormous nose dive and all of the signals have gone to sell. It's killing me to sell right now because I have faith in the wonderful company and I would lose a lot of money. I'm violating Rule 1! If the big guys move so slow, how can this kind of nose dive occur so quickly without any bad news! Anyone can help with advice?

Laura

ARGGGHHHH!!!!  This is not good!  Losing money and getting caught in a big drop just isn't fun.  So first, what went wrong, and second, what to do about it?

Laura bought in using MSN Money tools.  Had to because if she was using Investools and a 30-Day MA the third "green" signal never showed up.  What she was looking at was both the MACD and Stochastics telling her to get in, but only the 10-Day MA said get in, too. 

So what's wrong with using the 10-Day MA in this case?

Here's where just a little experience with the tools will really help you -- so, Laura, if you are not experienced, what are you doing using real money????  Didn't I tell you to trade virtually for a while until you get good at this thing?  You don't fly a plane after reading a book and you don't invest real money right after reading a book either. 

So gang, a reminder: Don't Lose Money!!!!  And to do that we need a bit of experience in using the tools.

Let's look at this situation deeper:  Why not the 10-Day MA in this case? 

Because a quick look at CHS tells you that the stock price is moving down like crazy over the past two months.  If something is wrong in the business that you don't know about, the Big Guys can burn you over and over by creating brief bull runs in the stock and then dumping into it.  This is called a Bear Trap -- set by the guys who want to get out and need buyers. 

While you can get caught using longer term MA's, the 10-Day is particularly susceptible because it moves to positive signals so much quicker than the 30 or 50. 

So the way to use MA's when a stock is crashing is to use slow ones like the 30 or even the 50.  Since MSN Money doesn't give you a 30 day MA, you'll have to either extrapolate between the 10 and the 50 or use the 50.

Should I have warned you about this in the book?  Yeah, on hindsite, I would put in a bit to insist you use longer term MA's on wonderful businesses that have crashing stock prices.  Next edition. 

Meanwhile, too many of you are jumping in there on tech signals with real money without taking the two months or so of virtual investing.  You need to test this out for a while to get the hang of it.  So go do that now.  Practice first and don't violate Rule #1.

Back to Chico's.  They just announced April sales up 18% from last year, a new record, but same store sales were 5% instead of the 8% the street expected and the earnings figures are coming in at $0.28 instead of the average expectation of $0.30. Since Wall Street is all about what have you done for me lately and not much about the long term expectations, the stock crashes on the news even though the company is doing great.

So let's look at the Sticker Price and see if we love the biz: 

If you plug in 18% as the future growth rate and use a 36 PE (2 x the growth rate) you still get a $49 Sticker Price, well above the current $30.  There is a lot of head room even with low expectations.  That's good news.

Now the question is, should Laura stick with this or bail?  Depends on her way of trading.  If she is very comfortable with CHS as a business, given its Sticker, this price isn't likely to last.  But she better understand the business well, I think.  Short of that, she doesn't have a choice.  She has to sell it and get out even though she took a beating. 

So gang, first lesson here is to not try to buck the general trend of the stock by using a quick MA.

The second lesson is to be sure you really do your homework on the first and second and third M BEFORE you buy the stock so that if there is a crash, you can figure out whether you are a buyer at the lower price or a seller, regardless of the signals.

Now go play!

Phil

Comments

[Ben Renfroe]

Hate to be a knuckle head, but I don't remember any mention in your book about the bear trap. Or what constitutes a stock "crashing" so that one should switch to the 30 MA. Perhaps I missed it. I do recall you saying you prefer using the 10 MA. Unfortunately, I fear that paper trading would not have helped me since I was sure (incorrectly) I had traded by the book.

As I suspected and should have been smart enough to accept, there is much much more nuance to this than is explored in the book. I lost nearly 15% of my investment today even though I had a trailing sell. I am completely disappointed, ashamed and discouraged. I blame only myself.

[Steven]

First Phil I have a question:

when you tal of the MA's do you mean the simple or the EMA?...please let me know...

now for my unsolicted commentary

[large sigh]

by no means am I an expert..far from it...if you read my blog I am quite candid how long I have been doing this (5-6 months)..but unfortunatly the unintended consequence of Phil's great advice is the pain we now see in email's like the ones above...

to use an example that Phil loves to use...Harley-Davidson...if after explaining to someone how to ride a motorcycle..who has never riden a bike before...is it prudent to let someone hop on this

http://www.harley-davidson.com/PR/MOT/2006/06_template.asp?bmLocale=en_US&family=softail&model=flst&market=US&modelsection=gallery

for their first ride or this bike

http://www.vespausa.com/products/gt.cfm

obviously most people choose the second over the first because most people no matter how well you tell them how to do something...they need to get some reasonable experience before they do it...

but unfortuantly Phil has told us how to use real powerful tools but some of us insist on jumipng on the big bike before we are ready to ride it...we are putting to much money at risk too soon...

and Phil is quite clear that we should all ride a moped for about 6-12 months first before we jump on the harley...

Now I do not mean to sound as if I am poking fun at anybody...i am not...I am just trying to make a point using a good example about...that just because you know how to do something in theory does not mean you should do something in until you have practice...

now the one thing I disagree with Phil on is paper trading...but the disagreement is a matter of semantics...

I think paper trading is not very useful because it is just make beleive...and people wont learn unless it acutal means something...

but that does not mean yo go out and put everything you have into the market...i beleive in "paper" trading with a very small amount of real money...

lets say you got a couple of K's or even a couple of hundred bucks to invest total...

most online borkers let you open an account with nothing, zero, zilch, nada...

and there are a couple of brokers like foliofn.com that even let you buy fractional shares i.e. 2.1 shares of a comapny.

So take $150 bucks open an account at foliofn.com..or anywhere else it is cheap to trade for a few dollars...and actually trade......

at foliofn.com..you can take a $100 and buy 2.30 shares of a stock that trades at $43.39...

a trade costs $4 to get in and out at foliofn.com....

and practice with a stock over a few months ...not to make money but to get some real experiecne with real money...

sure paying a $4 commisison on a hundred dollar investment is not the smart thing..but you are paying for experience...and until you get some real money on the line it is just all make believe...

after you get it than take your whole bankroll and send it in and start doing it for real...

thats what I am doing...and so far I am breaking even...I took $300 bucks..bought three stocks...made a little on one...lost a little on another...broke even on another..after commisisons..I am about right around $300 bucks..

but even if I was down $20, 30, or even one hundred...I am paying for the experience like I am at school...I am investing in myself..and thats the best investment anyone can make...

Ut just bums me out to read about people losing thier money and I hope everyone can take a step back and take some time to really think about what Phil is saying...

[B]

Good points. The truth is I had only invested $2500....lost about $400...not earth shattering. My not-so-obvious point was that I did things to the best of my ability and the thing that hosed my trade was something not covered in the book. I could have paper traded for a year and probably not recognized the "bear trap"...that is nuance...not technique. That is what is discouraging.

[Rick]

I've been disappointed in CHS this week as well, BUT ONLY VIA INVESTOPEDIA! Thanks, Phil, for your strong advice to NOT start out with real money. This stock has been very volatile (based on the charts) this past week! I've bought and sold it twice, trying to just follow the charts (because the Ms are all there). Your "bear trap" explanation helped a lot.

[Laura]

Thanks Phil for your response. Yes, you're absolutely right. If you said it once, you said it a hundred times, "Don't use real money to start!" Of course, surely that didn't mean me!

The insight on the 30 day MA is very helpful. I actually did see it using Stockcharts which was suggested by an earlier person on the site. I just ignored it because the 10 day said "get in". I did ponder this but decided to go with the original advice of 10 days. (Wow, am I making myself sound even worse?!)

My question on your sticker price. I showed growth numbers as follows:

(10, 5 and 1 year)
Sales
36.17, 40.19, 31.65
EPS
59.42, 44.2, 35.9
Equity
42.35, 52.40, 41.85
Cash 5, 1
31.48, -14.55
ROIC: 25.6 and 24.1
Current eps at 1.06
I used the analysts growth rate of 25% as being the conservative number (as the other growth rates computed were much higher)
I used a conservative PE of 28 (hist. avg)
I came to a sticker of $76 and MOS of $38. Very different from yours. Did I some how mess up the calculation?

Everything I have read/learned about CHS is nothing but wonderful. My gut tells me to hang in there.

[Kevin Lund]

Laura,

I think Phil chose the 18% growth rate because that is what the store just reported. You could stick with the more aggressive 25% estimate if you are confident they can meet that kind of growth, I suppose.

Kevin

[Gregg]

I don't understand why we would change all of the growth %'s just because they post a 1st quarter that is less than expected? Aren't we using 10 years of numbers to come up with the growth %'s? Why would we be so quick to change these? If we always do that then whenever a stock goes down because of earnings problems then the new MOS will always be out of reach....

[JB]

Because the stock market is volatile and value and price aren't equal very often. When the Big Guys hear "bad quarter", they may freak out and pull out their $$, so part of the process is trying to anticipate these trends so that you are understanding the tools when you look at them.

[Phil]

Wow you guys are learning fast! Laura, I'm glad to hear that you just used a small amount to test. Good job. Its really important to get the hang of this without getting burned. That said, you are all correct that I should have gotten the bear trap stuff in the book. My bad. Its a great point that I'll reiterate here. There is an old saying that "The trend is your friend." This saying has been abused horribly by day traders but it applies well to what we do with Rule #1. If a business's stock price is getting hammered for long periods of time, it is really important to either have total faith in your superior understanding of the business (and this is of course what Buffett has) or stand back until the stock price finds a floor. There is no guarantee about a floor in the price but there are a couple of signals. The most important one I'll mention here: the volume starts to go up and the price goes up with it or at least doesn't continue to go down. And that makes sense, doesn't it? If people are selling more stock and the price isn't going down, somebody big believes in that price quite a lot.... enought to put their money where their faith is. But my preferred way of dealing with a major price crash is to review the first three M's: Meaning Moat Management. Is something changing on one or more of the three.

So Laura, you did a fine job of extrapolating a long term growth rate for CHS from their history of the four growth rates and I know their ROIC is going good at 23% and holding pretty steady long term. So sure, you should use the 25% you came up with and the historical PE. Exactly right. (I just dropped it to 18% to see if we still had a big MOS even at a lower growth rate and we do. More confidence for us that we have room in the price almost no matter what.)

So here is your homework that I'll post when I get it. What is going on that is causing the big guys to be so skeptical about the future? Has something major changed in the first three M's that should make us suspect the MOS is not all that great? Or is this just a classic big guy panic bailout on short term issues and therefore a great opportunity for us to get ready to buy the heck out of CHS?

Now go play!

Phil

[theresa]

i too spent real money on chico's, partly b/c i realized i might never figure out all the formulas. but i'm going to stay the course for awhile and even wish i had the nerve to buy more at 29 and change.

phil, i don't need motivation, i need a workshop! figuring out the big 5 is very confusing. but its comforting hearing that it was (sort of) the right thing to buy in the first place.

[Justin Brand]

Theresa,

if you are having trouble with calculating the big five, i strongly reccomend you visit www.ruleoneforum.com

Under the fundamental analysis link you will find a link to my "Big Five Worksheet". it is a template form that drastically reduces the time/number crunching you are having trouble with.

Let me know what you think!

[Jerry]

How does one extrapolate between the 10 and the 50 MA on MSN?
Does this also mean that a decision should not go forward unless the new extrapolated 30 MA reads clear vs. just the 10 as in the book?

[Darren]

Phil, a few comments on this - fortunately it appears I just avoided a costly lesson (sorry, Laura) as I was close to making the move in but decided not to based on a previous surge then drop in the price. The Bear Trap is great new info and something I wondered about - the Big Guys do this for a living and I wondered if they played games manipulating the stock price to their benefit and you explained it.

A follow on question - is there any reason not to always use a trailing stop to minimize losses for just such an event?

On the homework, I'll take a shot although I've not done a lot of research but some reading on CHS. My guess is it's the big guys hammering them for the slowing in the growth at comparable stores but isn't their acquisition on White/Black and their continuing expansion also valid growth? Management acknowledged some misses in merchandizing and identified some ways to fix things - if we have faith in the 'jockey', I'd say stay with them. Which is what I plan to do unless I hear/read something to change that.

Final question/concern - the attraction with the Rule #1 approach was a way to make money buying businesses without having to be an expert or spend too much of our limited free time on this....it seems there will always be some other 'gotcha' - in this case the 'Bear trap' - which is what drives many back to Mutual Funds or Money Managers. 20%+ losses in one day even with a great company like CHS test the intestinal fortitude for getting into this!!

[Laura]

Homework from Phil:

Let's start back in March.

Chico's has a long history of beating or at least meeting analyst's expectations. Last quarter Chico's fell a penny short with its profit of $.24 a share. Worse, February sales growth was 5.7% versus expected 8.7%. However, the company still reported a 15% rise in same-store sales and 35% boost on the bottom line. CEO Scott Edmonds explains that the company's growth strategy (expanding WH/BM, Soma, and Fitigues) designed to position Chico's for sustained long-term growth, will continue to pressure margins. (Chico's margins were hit by higher costs and growth in the Wh/BM and Soma brands). At this times he anticipated full year earnings growth "in the neighborhood of 25%".

Interesting Note in March: Scott Edmonds announces that Chico's will repurchase stock to the tune of 100 million within the year depending on the market. (I took this as a very good sign that management felt the stock price was underrated).

End of March: CFO Charles Kleman joins Jim Cramer on Madd Money to talk about Chico's. Kleman states he isn't worried that skeptics on Wall Street believe 1) chico's will have trouble growing because of the law of large numbers, 2) that Chico's is experiencing problems growing comparable sales figures and an indicator of a coming numbers miss. Kleman defended: Chico's is no where near saturation and they continue to open and grow new stores.

Another interesting note in March:

CEO Scott Edmonds and Director Michael Weiss purchased 400 and 3,000 shares of stock respectively. The buying suggests that both believe the risks to Chico's to be overstated. Management does have minimum stock ownership requirements. Weiss was a little short at the time and was probably playing "catch-up".

Now to doomsday:

Chico's posted comp store sales of 5.4%. Wallstreet expected 7.8%. Edmonds professed disappointment in the Chico's brand for this period. They have identified several merchandise misses which contributed to its performance. "We probably needed more color, certain additional novelty products and some specially targeted offerings for our Chico's brand cold weather stores which experienced significantly lower same store sales results than did the warm weather stores. We think we have addressed most of these issues going forward and thus continue to believe that the core Chico's brand should be able to deliver a mid single digit same store sale increase for the balance of the year."

The Chico's brand has had a cult following throughout the years with the 35 and older crowd. Chicos FAC acquired the WH/BM stores which appeal to women 25 and up. It is a phenomenal store to shop in. WH/BM boasted 30% same store performance in this quarter.

I strongly believe in the company, the jockey and the future of Chico's. I'm down now but I'm going to stick with it and see where it takes me.

[Amy]

That was a great report, Laura. I'd be holding on to my shares, too, and it sounds as if this business has its act together. Mr. Market is a strange one... I'm watching this company daily!

[JB]

Darren,

Nothing's easy. The truth is there is no miracle shortcut to gaining returns without a little hard work. The bear trap thing was a surprise but I'm sure there's a finite # of things like this that we need to learn once and then move on from there.

[jcowger]

New to rule 1- still in the pretend paper only mode.I checked out chico's after the recent fall.Here are my #'s- PE-24 EPS-4.48 PRICE-107 in 8 years(best case).Now the math- because it doubles every 4 years 107/4 =STICKER $26.88 Now for the all importante MOS. 50% MOS BUY AT $14. Question- Does anyone else have these same #'s or should I go reread chapter 9 ?

[Laura]

Amy: Thanks for the vote of confidence!

jcowger: I came up with different numbers than you did. I got a future value of $308, sticker of $76 and MOS of $38. I used Phil's calculators on the website. I plugged in current eps of $1.06, estimated eps growth rate of 25% (this is the lesser between the analysts and what the sales, eps, equity and cash rates were showing for 10, 5 and 1 year. The growth rates ranged pretty high between the 30's - 60's.) For the estimated future PE I could have used either 50 (which is double the growth rate) or avg historical which was 28. That is what I used.

[theresa]

justin, thanks for the chart. its beautiful and i will try working with it.

and phil, thanks for the explanation of the stochastic. but is it fast or slow? i guess you didn't realize how basic you have to be.

[Amy]

Laura, I did the numbers on CHS again and I got almost the same MOS as you, less a couple bucks at $36.60. It's now below MOS price, however when you bought it at $37, it's still at or close to MOS. Are you hanging on to your shares then?

[Phil]

Here's the difference between using the ten day MA as I describe in the book and extrapolating between the 10 and the 50 (extrapolating meaning that you see it cross the 10 and then guess about where the 30 would be as the price heads toward the 50 line.)

The 10 Day MA is, as I described in the book, going to get you in quicker so that you get the maximum amount of upsurge in the price. This is effective when you have all 4M's solid.

If you are not so sure about all four M's (usually the problem is that you don't understand the business) then you could be in for a lot of volitility as we've seen in some recent examples. Doesn't mean that these folks didn't pick good businesses available at attractive prices... but it might mean that something is going on in the industry or economy relative to that industry, or maybe some problem is cropping up in that company that is still undercover and the price just keeps drifting down.

Remember gang, that the trend really is your friend and fighting it just doesn't work out well. If the Big Guys are consistently moving out and the trend is down, then it's time to take shelter in Cash and wait patiently for the bottom and a new uptrend to get established. During this time, find another great business at an attractive price... or just hang out and do nothing. Doing nothing turns out to be the right answer more often than not.

So here is a way to think about this: If you are not dead sure about the value of this business based on experience as an investor and this thing is trending down, don't touch it.

Now go play!

[Mike]

I've found a way to show the 30 day MA on MSN. If you use the MA envelope and change the settings to a 30 day period and 0.00 width, you'll get the 30 day MA.

[Greg]

http://news.moneycentral.msn.com/ticker/article.asp?Symbol=US:CHS&Feed=Bcom&Date=20060824&ID=5968857

[Mark]

You rock Phil, De Oppresso Liber.

I am a newby and after seeing you in Orlando in Jan 06, I've prepared myself using the investools, I've read your book and everything I can get my hands on, esp warren buffet.

Ive read this string on this particular stock CHS from back in May and this thing has really tanked the past few months.. My question is when do we know its the real bottom and not a false bottom.

We got our Third GREEN arrow on Aug 16th, and the stock rallied nice for a couple of days around $ 23 to 25.

Then all of a sudden on Aug 24th Three REDs all at once as the stock drops to $ 19 at open and now sits at just under $ 18.

Ive done the math, run the numbers and love the historical information on this company and I'm wanting to get in somewhere, but how do know for sure to be safe to get in the water. Ive been watching this stock for months and am eager. Any assistance would be helpful.

[Jamie Flibott]

Hey a big thank you to mike for figuring out that 30 day MA on MSN. I'm just starting out and dont yet have the capital to invest in something like investools and i've been frustrating myself trying to find a point between the 10 day and 50 day MA on MSN. This makes it much easier (and cheaper!)