People often ask me what the difference is between trading and investing.
It was the year 2019, the third and fourth quarter. I was diligently studying discounted cash flow models and dividend discount models in determining the value of a stock. The macroeconomic environment was a clear blue sky. Using my models I calculated an intrinsic Alibaba value of 300 us dollars. At the price of 190, it was a significant value to be taken, great opportunity.
Alibaba was the king of the Chinese stock market. The biggest by capital, with a strong income statement and even better cash flow statement. The balance sheet did not show any warning signs. This was certainly a ten beggar.
Then came the year 2020. and Trump’s economic trade war with China worsened. The CEO of Huawei got indicted for espionage. The USA and China diverged more and more. Alibaba stock tanked suddenly, with my position still in as an investor I kept holding. From big profits to now holding a loss.
My valuation models, based on financial statement analysis and future projected growth, showed stocks to be extremely cheap. I was a long-term, hard-core investor, or so I thought.
It dawned on me: how can I price the geopolitical risk in the value of the stock? Alibaba is an ADR stock, which effectively means you do not own a real company but a spinoff on some island. As events unfolded China started cracking the tech sector, punishing its companies, and significantly reducing the value of the Hang Seng index, of which Alibaba was a part. If Alibaba gets delisted from the US exchange, I will either lose my investment or have to switch my holdings to the Hong Kong exchange, where the stock is also ADR.
Stock continued to tank. How is it possible that everything taught about in University can turn out to be wrong? The discounted cash flow model was screaming a buy, that price was undervalued, so all the investors kept flocking in to Alibaba, but the stock continued to move lower.
This is the first lesson in investing and trading:
Usually, definitions say that traders are short term and investors are long term. The truth is that investors are traders who cannot take a loss.
Investors who buy and hold certain stock for the long run, not knowing at which price they will take a loss or where they will take a profit, are in fact gamblers (by words of famous Jesse Livermore).
Weather you hold your stock for any time period you choose, you must have price where you are willing to take a loss and a price where you will take profits.
Some may say, yes but what if I bought Coca Cola 40 years ago? Well, great! But what if you weren’t that lucky and bought Nokia, World Com, Arthur Andersen, Lehman Brothers, Enron…
Predicting which stock to buy and when to buy it is more complex than valuation models. At 20th March 2023, I suggested buying JP Morgan Chase at 130 dollars to GTC members. Now the price is close to 200$. (40% increase!)
I had to upgrade my knowledge on stocks through year long research and countless books to find best ways to find a winning stock.
These stocks are shared in the Gotham trading club.
Remember the moral of the story: “When you buy a stock, you have to have an exit point and profit point. The market can stay crazy longer than we can remain solvent.”
Here is an example of how I predicted a significant correction in McDonald’s stock: