Wednesday, January 9, 2008

“Explain Why You Are Buying”

As you have no doubt already observed, the Covered Calls Advisor's approach to identifying great covered calls investing opportunities is primarily a value-oriented, top-down, and quantitative process. The systematic process followed each month might suggest to you that this is a fairly rigid process that affords little room for any subjectivity in making ‘what to buy’ decisions. While it is true that the majority of the approach is very analytical in nature, there is also the opportunity to accommodate the investor’s ‘gut feelings’ as to the merits of a particular investment.

One of the fundamental principles of legendary investor Peter Lynch (formerly of Fidelity Magellan fame) was that you should be able to “explain why you are buying”. Before making a purchase, you should be able to provide a clear, concise, and confident explanation as to why this purchase is a good one right now.
This explanation can be done either verbally or in writing, but you should not neglect an attempt at ‘making your case’ as to the desirability of the investment. So when you think you’ve completed your research and analysis of a particular company, but before you make the actual purchase, follow the advice of Peter Lynch and try to summarize with a clear, concise, and confident explanation as to why you are buying this equity.

Try it! For practice, select a company that you are currently invested in. Try to make a clear, concise, and confident explanation as to why you own it. Two out of three is good, but not sufficient. Suppose you sense that your explanation was clear and concise, but there is some aspect that you feel is inadequate in your explanation so that your confidence in the investment is not as strong as your gut tells you it should be. Then it’s time to go back to do further research in whatever area(s) are of concern to you. This will enable you to further refine your explanation to the point where you convince yourself that the company either is (or is not) worthy of your investment.

To give you an idea of how this can be done, here is what is hopefully a “clear, concise, and confident explanation” as to why the South Korea ETF (EWY) is included in the Covered Calls Advisor Portfolio:
South Korean companies now provide attractive values to the investor. The country is growing at about 5% a year (about twice as fast as the U.S.), yet the overall P/E ratio is only 15 times trailing twelve months earnings (U.S. is about 17.5). Central Bank interest rates are currently at 5.0% (4.25% for U.S.). In the recent national election, new President Lee was elected with a strong mandate and he is committed to lowering taxes, growing the economy, reducing barriers to starting new businesses, and not trying to appease the bully to the north (North Korea). To me, the situation is somewhat analogous to the U.S. when Ronald Reagan was elected in 1980: lower taxes; business friendly; and a strong defense posture with the Soviets. Recall what followed in the U.S. – a 20-year bull market. Something similar could be brewing for South Korea.

Remember: Before making a purchase, you should be able to provide a clear, concise, and confident explanation as to why this purchase is a good one right now. As Peter Lynch would say, "Explain Why You Are Buying"!

Regards and Godspeed

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