Here's a letter I recently received from a Rule #1 reader:
Dear Phil Town:
I have done very well with Rule 1 investing, and I am very disciplined about it.
However, one of my wonderful companies, Immucor (BLUD), which meets every criteria and then some, was served a subpoena by the Department of Justice relating to anti-trust and the stock plunged as much as 34% in one day. For many days before the announcement, the stock had been going down, even after a good earnings report in early April. I kept asking myself, “Who’s dumping this stock?” and happily buying more.
Is there some way I could have seen this coming? Am I correct in not panicking and taking the view (as some analysts have) that there is most likely nothing to this investigation? Have you ever experienced this “disaster” phenomenon?
Regards,
Jan
Jan has given me a wonderful example of the difference between stockpiling (or consuming) a business and trading it. In both cases, we want the business to be wonderful, but if we are going to stockpile this business as it goes down in price, the bar is raised for knowing that the business is wonderful. Trading sucks up some of the risk.
She bought Immucor as it went down in the days prior to the DOJ announcement that the business was under investigation.
If she was following the Rule #1 rules for tools, she would have been selling on the red arrows by April 8th at $23, well before the crash down to $14 on April 24th.
Someone knew something was going on. Someone big. And they were sneaking out. And they would have dragged Jan along with them... except she was in stockpiling mode.
So what's the investing lesson? If she knows her business well, she'll know if this is a real problem or a false alarm. If its a false alarm, she's absolutely right to be stockpiling BLUD.
But what if even the people running the business were blindsided, as they well might be by over-zealous regulators or bureaucrats? They never saw this problem coming. Then what?
Well, that brings us to a key point in KNOWING the business: If you aren't sure you really know it, you can't stockpile it. You can trade it on marginal knowledge. But you can't stockpile it.
That is relevant to this example because Immucor is a tech business, and tech businesses are rife with this sort of unexpected black swan phenomena: you can get shot between the eyes out of nowhere. It can be a breakthrough by a competitor that wipes out your moat. It can be that your key people leave and start their own business. It can be you get so successful the government charges you with monopolistic practices.
IF YOU STOCKPILE TECH, YOU BETTER REALLY KNOW YOUR STUFF, KIDS.
So, Jan, you now own a business where the risk of this action is in the current price pretty good. Should you feel you really love it and the price is excellent relative to the value, you should continue to stockpile it. But if you're not sure, you shouldn't own a business you don't really, really understand.
Now go play,
