I always divide my capital up into roughly equal amounts and spread it across a wide range of shares and asset classes. The key phrase here, of course, is “roughly equal amounts”. Let’s face it, when you read that latest hot tip about the tech share or South American diamond mine that could turn you into a Rothschild overnight, there’s an almost overwhelming temptation to ‘go for broke’ and ‘bet the farm’ on it. I strongly urge you to resist that temptation – however much of a dead cert the share in question might appear to be.
In my opinion, even the biggest, safest and most solid-looking of blue chips should be approached with caution and doesn’t merit allocation of more than a few percent of your available investment capital. I suspect that many investors are currently learning this lesson the hard way as the ongoing disaster in the Gulf of Mexico takes its toll on Britain’s bluest of blue chips – BP.
Speaking as someone who put some of his own hard-earned cash into BP, I can sympathise with the plight of my fellow investors – provided, that is, they invested no more than 3 – 5% of their ‘at risk’ capital in the company. If they invested any more than that amount, then in my book these people are no longer investors, but gamblers – and judging by the current performance of the share price as I pen this article – they’re paying a very hefty price for this particular punt.
If, on the other hand, you are a serious investor and, like me, you like to take a disciplined portfolio approach to your investments, then, to a great extent, you’re protected on the downside. If, for example, you bought BP shares at their recent high of 650p and these shares make up no more than 5% of your overall portfolio, then by now you’ll have lost around 40% of 1/20th of your portfolio’s value – irritating but not a disaster.
However, if you’d overlaid this portfolio strategy with one more layer of discipline, then you’d have made no losses at all on your unfortunate investment in BP. At this point, perhaps you’ll find my own experiences instructive.
As most investors will tell you, the hardest challenge they face in managing their investments is knowing when to sell. I’m sure we’ve all managed to pick winning shares from time to time, only to see healthy profits drain away into painful losses. When I was new to the world of investing, that’s an experience that I could all too readily identify with.
However, I’m pleased to say that with the arrival of a few more grey hairs and the evolution of my 3 point checklist, dilemmas over when to sell an investment have, thankfully, been extremely rare.
A chance to put my checklist to the test came just last week when I had to make a tricky decision over whether or not to sell my own BP shares.
I bought the shares in May ’09 for about 500p per share, so up until the company’s recent problems in the Gulf of Mexico, with the share price riding high at over 650p I was enjoying a very healthy profit of around 30% on capital growth alone. A 30% rise in a year isn’t a bad return by any standards. Throw in a dividend yield for the year of over 6% with the prospect of above inflation increases in future dividends and you’d have every reason to feel extremely pleased with yourself – as I did. After all, what could possibly go wrong?
Then disaster struck. The oil rig leased by the company from Transocean blew up with the tragic loss of eleven lives. As I write, millions of gallons of oil are still gushing into the Gulf of Mexico threatening a massive ecological disaster. The human tragedy and the scale of the threat to many people’s livelihoods on the Gulf coast is obviously a huge worry and my deepest sympathies go out to those affected.
However, viewing the matter purely as shareholders, and in no way trying to diminish the awful plight of those directly affected by the tragedy, we’re obliged to address the far more trivial issue of assessing whether or not BP still stacks up as a good investment.
Obviously, if this tragedy hadn’t occurred, it would appear that, on the surface at least, BP would still have been a good solid home for our money. But would it really? It’s now emerging that, despite CEO Tony Hayward’s attempt to break with the past and improve the company’s approach to safety issues, serious deficiencies still remain. The full story of what went wrong won’t be known for a long time, but even at this stage, it’s clear that, despite Tony Hayward’s new broom, corners were still being cut when it came to compliance with safety procedures. It’s that sort of careless approach to safety issues that meant that the Gulf of Mexico disaster was an accident waiting to happen.
So as the share price began its steady, relentless descent in response to the unremitting torrent of bad news from the scene of the accident, the company’s safety record was one area where doubts began to arise in my mind, i.e. had BP really made a clean break from the cavalier approach of the Lord Browne era? It would appear from the evidence that has emerged so far that, at the very least, there’s still a long way to go on this front.
It was when this realisation dawned that I began dusting off my seller’s checklist which is as follows:
1) Are the reasons behind my original purchase of the shares still valid?
2) Has the share price slipped below its 25% trailing stop loss?
3) When taking a profit, are the shares at extreme overbought levels according to my preferred technical indicators?
Obviously, in this case, point 3 doesn’t apply so let’s start by addressing point 1.
The reasons I was originally attracted to BP shares were twofold: a) BP was a big solid company that was emerging from years of underperformance with a new, dynamic management that promised to turn this super-tanker (excuse the pun) around and b) the shares offered a very high and growing dividend yield.
So are those two reasons still valid in my mind. The answers are, respectively, no and probably not. As far as the new, dynamic management is concerned, Tony Hayward has obviously been trying hard to correct the company’s failings that took root under the Browne stewardship, but it’s obviously a mammoth task and, in the light of evidence emerging from the Gulf of Mexico, it’s likely to take a lot longer to turn around than anyone thought. As for the high and growing dividend, my feeling is that the dividend payout is likely to be scrapped or drastically cut for this year at least.
Regardless of whether the company can actually afford to pay the dividend after taking account of all the clean-up costs, can you imagine the political hue and cry if the company attempted to reward shareholders after such a colossal failure of management? It would be a PR disaster!
As for point 2 on my checklist, by the time I’d reached my conclusions vis-à-vis point 1, the share price was already approaching my 25% trailing stop loss of about 490p. In the end I sold for about 505p. As it turned out, my automatic trailing stop loss would have been activated shortly afterwards.
So after taking into account previous dividends minus buying and selling costs I emerged with a profit of about 4%. Certainly nothing to write home about and nothing like the 35% or so I could have potentially had before the accident, I grant you, but the point is, thanks to my checklist, I still came away with a profit, not a loss. When it comes to investment, I like to follow Warren Buffet’s advice: “Rule no. 1 of investing – don’t lose money. Rule no. 2 – don’t forget rule no. 1″.
So my dual-layered protection strategy worked exactly as it was supposed to in this situation – BP shares were a small component of my portfolio, and my selling checklist prevented any serious loss. In fact, in this particular case I came out with a small profit. Compare that with the approach of the gambler who probably thought you couldn’t get much safer than BP shares and put a third of his capital into them. Or compare it to the person who leaves it to fate and fails to implement a stop-loss, assuming that BP shares are “too big to fail”. The temptation in these situations is to believe that the shares of a big, safe company like BP will soon bounce back – again, this is the mindset of a gambler, not a disciplined investor.
Now, it may well be the case that the worst possible scenario has already been factored into the price of BP shares and they have a huge bounce upwards from here. In my experience, two times out of ten you get caught out after selling and the price does indeed shoot straight back up, making a relatively healthy recovery in a short space of time. However, I don’t like odds of 5-1. More often than not, it’s right to step aside at times like this. It seems to me that a huge amount of technical damage has been done to the share price of BP with the price sinking well below the 200 day moving average. Any bounce in the shares will therefore, in my view, be short-lived.
Does this mean I won’t be looking to buy BP shares at any point in the future? Of course it doesn’t. When the time is right I’ll examine BP shares dispassionately in the same way I evaluate any other potential new investment. At the moment however, I’ve got to see some clear signs on the charts that the share price is bottoming in some way – and we’re currently a long way from that point.
So I hope you’ve found this article to be a timely and salutary guide to some of the more fundamental dos and don’ts of investing. I’m afraid that if you’ve been one of the unfortunate owners of BP shares and haven’t already plugged this particular leak in your portfolio, then you’ve left things a little late. As I write (Tuesday 1st June) the shares have just plunged 15% in one morning, thus conveniently validating my arguments.
So would I sell now if I hadn’t already? Probably yes, as the shares still don’t meet the criteria for point 1 on my checklist. Take the pain and move on, but next time act like an investor, not a gambler.
