FPH - Fisher Paykel Healthcare.

A significant number of competent ST posters have suggested that FPH might be fully valued - or even overvalued. The shareprice keeps going up though, so are they all wrong? I don't think so.

The market carries a lot of momentum. Rising stocks almost always overshoot their "true value", just as falling stocks almost always fall below their "intrinsic worth". The trouble is everyone has their own view as to exactly where these levels lie. Even if there was some way to precisely calculate the exact worth of a stock, there is no way of knowing just how far the market will overshoot in any particular instance. To sell simply because a stock had reached your theoretical value caps your profits at that point and you miss out on any "overshoot" which can be quite substantial. It seems to me that the answer here is to use FA to determine when a stock is approaching its "value" then switching to TA to time your exit - with a view to selling when the uptrend shows signs of weakness. Many people think that TA and FA can not and should not be mixed and you must choose one or the other, so such an approach will offend purists on both sides.

Looking at the chart we can see that FPH was in a steady long-term uptrend (dark green trendline) but since December the uptrend has accelerated and FPH is now in a steep uptrend. Too steep to be sustained. There are technical indications of potential weakness such as RSI divergences. There is a new confirmed trendline in place (light green) with price action clearly above it. I would suggest that a break of this trendline would provide an appropriate exit signal. Very conservative looooooong-term holders might prefer to wait until the long-term (dark green) trendline is broken but this would mean giving perhaps 50 cents or more of profit back to the market. Any exit system is better than none though!
For those that do not like trendlines, there are other tools such as Trailing Stops that can be used. Long-term, I had been using a 16% trailing stop with FPH but it became evident that this was a bit too conservative so I tightened it to 13% as soon as it became obvious that the uptrend has accelerated. When I found myself in agreement with others here that FPH was looking a bit overvalued, I tightened the stop yet again to 10%. I do not anticipate tightening it any more than that.
http://img.photobucket.com/albums/v4.../FPH529001.gif

Phaedrus, I am genuinely surprised that you are letting fundamental considerations influence your choice of trailing stop margin.
Given that 13% seems to based on back testing recent data, I would have thought you would have kept to that.

regards

Paper Tiger

From the FA point of view, I calculate fair value to be around $4.00. You certainly aren't getting a bargain with this one.

If I already owned this I would not sell unless either:
a) The market was pricing it far beyond its' intrinsic value or
b) The fundamentals looked like they may deteriorate significantly over the next few years.

There. See how quick and easy it is to simultaneously offend both sides!

Mr Market, You say that "If I already owned this I would not sell unless....the market was pricing it far beyond its' intrinsic value..." This sounds as though you have an exit strategy, when in fact you haven't. Without defining just how far "far" is, you are free to sell or hold at whim. Your sell trigger is not pre-determined. What you have is an idea - not a system. You probably put quite a bit of effort into estimating your $4.00 "fair value" for FPH, why not utilise this and resolve to sell when the market exceeds this by a certain percentage? Even if you make it a target range, you will have set minimum and maximum exit points. Without defined exit criteria, you are simply holding and hoping. If you had bought FPH, I would guess it would have been on the basis that it was undervalued (x% lower than your $4.00 estimate). To me, it seems only logical to then sell when it is y% higher than your best estimate.

Paper Tiger, Any decent system will pull you out of a stock long before a trailing stop is hit. To my mind, trailing stops are best used as a secondary backup to the primary system. They can provide an exit strategy for people that do not have a system - as such they are a lot better than nothing. You can see from the chart that the trendline will probably be broken long before any stoploss is hit. I speak a lot about "tightening your stops" and FPH provided a nice practical example of how this can be done. I let fundamental considerations influence my Buy decisions, so it seems only logical to let fundamental considerations influence my Sell decisions as well.
There is another factor here that I have not mentioned at all. As you are aware, I monitor the Index (NZSX50) very closely, using it to guide my overall market strategy. Right now, I am a gnat's eyelash away from moving into "Caution" mode, where all sell signals must be acted on, buying is frowned upon, and all stops are tightened. I'm just being a good boy and keeping to my system. I'm in anticipatory partial caution mode.

PT, I thought you were a TA sceptic. Have you changed or did I read you wrongly?

I am a sceptic of many things.
TA is something that interests me and I have set out to understand it. But I currently make little use of it for making buy and sell decisions.

EEERRRKKKK! I just bought some FPH warrants at $2.50. Couldn't you have posted this a few days earlier Phaedrus?? :D

I consider it to be a good stock and bought because I have usually missed out in the past thinking stocks such as RYM were overvalued - only to see them consistantly rise further.

But one thing I've learned from this forum is that stocks over-shoot and thus I'll sell if need be.

Thanks again Phaedrus for your thoughtful analysis.

Quote:

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quote:Originally posted by Phaedrus
Mr Market, You say that "If I already owned this I would not sell unless....the market was pricing it far beyond its' intrinsic value..." This sounds as though you have an exit strategy, when in fact you haven't. Without defining just how far "far" is, you are free to sell or hold at whim. Your sell trigger is not pre-determined. What you have is an idea - not a system. You probably put quite a bit of effort into estimating your $4.00 "fair value" for FPH, why not utilise this and resolve to sell when the market exceeds this by a certain percentage? Even if you make it a target range, you will have set minimum and maximum exit points. Without defined exit criteria, you are simply holding and hoping. If you had bought FPH, I would guess it would have been on the basis that it was undervalued (x% lower than your $4.00 estimate). To me, it seems only logical to then sell when it is y% higher than your best estimate.

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Hello Phaedrus, I don't think our paths have crossed much before on this board even though we've both been around a while.

I imagine that you, as a technical analyst and judging from your line of questioning, would have liked me to have provided a more precise response to your assertion that FPH is fully valued. Unfortunately, fundamental analysis is not a precise science.

You have assumed that 'quite a bit of effort' went into determining my estimate of fair value at $4.00. In fact it took me no more than 30 seconds to arrive at that number. All that one requires is the current earnings per share and a suitable discount rate. It is easy to remember the multipliers for various discount rates. Now, as reported earnings per share can deviate from the true value, and the discount rate is estimated, my valuation is necessarily an estimate.

You are correct in assuming that I would only have purchased FPH if it were undervalued. And it is true that I would set the price at some percentage of my estimated value. This is my margin of safety.

Now as far as an exit strategy goes, that is an interesting question, and one that I find TA's have the most difficulty in understanding from the value investors point of view. Simply stated - the value investor seeks to buy at a price at which he will never need to sell. This of course requires choosing the right stock as well as the right price. In fact most of my effort goes into trying to understand the long term prospects various types of business. Now in the real world even the best businesses sometimes dissapoint. If the predicted earnings don't come through then the instrinsic value goes down. This outcome is precisely the reason for purchasing at a discount. So, in the unlikely event that the price falls below my purchase price, I would consider selling.

As for selling on the upside, as I said I would prefer to hold the stock forever. The only time I would consider selling an excellent stock is if I percieved the market to be pricing it at an irrationally high price, since such irrational pricing is often followed by market crashes.

Finally, I do have a system, but is a system based upon the evaluation of probabilities, rather than the calculation of certainties.

Mr Market, I have to admit to agreeing 100% with your investment philosophy. I have held FPH (or F&P as it used to be) since 1991 and never sold any and indeed topped up my holding on occasion. I would have to lose confidence in either the management or the healthcare products market in general to be inclined to sell them.

Since my going-in cost is effectively 36c per share after splits I figure I can ride the downswings.

Interesting comments Mr. Market. And how, pray, do you determine the discount rate for any stock?

Thanks Phaedrus, for reaffirming that most successful systems are simple. Value benchmarking should indeed be a more profitable stop loss.

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quote:Originally posted by beacon

Interesting comments Mr. Market. And how, pray, do you determine the discount rate for any stock?

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Discount Rate = Risk-free rate. i.e long term average rate on a long-term government bond. Of course this will vary over time, so is necessarily an estimate. All the more reason for purchasing at a discount (you build in a margin of safety).

Mr Market, You say you would prefer to hold stocks forever. So would I! We both know that this is not a good idea though. The bluest blue-chip does not keep going up for ever. I have a lot of sympathy and understanding for your approach. In fact, I used a very similar system for over 10 years when I first started out. I was happy enough with the "buy" side, but gradually became increasingly dissatisfied with the fact that I was giving a lot of my profits back to the market by holding stocks too long. The crash of '87 was the last straw. I lost an awful lot of money and it took me over 2 years to recover. The lesson that I had to be a lot more active in order to protect my capital and profits was rammed home. Never, ever again, would I pursue a "buy and hold" type of system.
Look at the charts of RBD, BGR, CAV, HBY, TLS, SCT, TEL etc etc etc. Every single one of these stocks was in a really good uptrend for literally years. Each and every uptrend ended. I have held all of these stocks, selling each one when it became clear that the uptrend was over. Anyone that continued to hold such stocks ended up giving the lion's share of their profits back to the market. I won't mention Snoopy because Duncan thinks I am picking on him.
It's almost as though truly staunch Buffett followers have determined to emulate his mistakes too - take a look at this Coke chart. I haven't bothered to apply any technical indicators such as moving averages or trendlines etc because blind Freddy could see when the uptrend suddenly ran out of steam. Maybe Buffett has such a large holding of KO that he is stuck with it but he has certainly given a lot of his profits back to the market and would have been better off selling years ago. Sound vaguely familiar?
http://h1.ripway.com/Phaedrus/KO003.gif

Dont be to hard on yourself PHAEDRUS. I feel a bit guilty picking on SNOOPY myself, when in fact he taught me more than anyone. I see where he and his FA BUFFET type followers are blinded to reality. He saved me a lot of money by not making similar mistakes. It put me off reading any BUFFET style books. Buy and hold with your eyes closed to the market is plain stupid.
My investment methods require people like that to make the market work for me. macdunk

Phaedrus,

What time period do you use in calculating the trailing stops and is the period the same for each percentage.

I have been using periods as short as 5 days for tight stops (95%)and up to 60 days for looser stops (80%) but now wonder if there is any value in doing this.

Thanks,

TerryA

I was under the impression that a trailing stop was generally based on the highest single [closing] price.

eg a 10% stop.
Previous high is $1.00 the stop is $0.90.
Then next day the SP moves to $1.10 and the trailing stop moves to $0.99.

PS take a look at Phaedrus' chart at the start of this thread.

Thanks Mr. Market. Maybe it is my weak maths, or that I simply haven't twigged yet, but I still can't see $4 FPH valuation from your system. Thanks in anticipation

Terry, The actual construction of a trailing stop is as simple as PT's post suggests. No specific period is involved at all. The thing is to be clear as to which trend you are trading. For example, with FBU you would be using a trailing stop of about 24% if you were a long-term holder, but if you wanted to trade the secondary "medium-term" trends, a figure of around 9% is required. These figures are derived by looking back over the previous 5 years or so.
The secondary trends of FPH are insufficiently well defined for this to be a good trading stock. In any case, a 5% trailing stop such as you describe would be way too tight to trade FPH medium term trends and too loose to trade the short term trends.
Wait! The penny has just dropped! Charting programs like MetaStock need to be told how far to look back to find the "highest high" and you are enquiring as to how to select this lookback period. Yes? Answer :- It should be as short as possible. Make it too short though, and your trailing stop will sometimes fall in the middle of an uptrend - something it should not do.

Quote:

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quote:Originally posted by beacon

Thanks Mr. Market. Maybe it is my weak maths, or that I simply haven't twigged yet, but I still can't see $4 FPH valuation from your system. Thanks in anticipation

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A discount cash flow valuation of $4.00 is very easy to hit if you use Buffett's interpretation of the risk free rate of return. In NZ the 10 Year bond rate was 5.79% the last time I looked. DCF allows for many permuations but a simple $4.00 permutation for FPH would be...

EPS 13.76c
Discount Rate 5.79%
Growth Rate 12% for 5 Years
Termination Growth Rate 0%

In my opinion the risk free rate of return is far too low for any company. By its nature, equity investing is not risk free and requires higher long term returns. In times of low rates it relies upon continued low rates for long periods of time. While the boomer savings glut has assisted this thinking, particularly over the last 10 years, inflation in part fueled by those savings risk shifting the equilibrium. A 5.79% discount rate will quickly be blown away by a lift in inflation to say 5%. The margin of error at low discount rates is an illusion quickly swallowed by changes in inflation and interest rates.

Quite obviously though, in FPH's case, a PE of 32 is not justified by a 5 year 12% growth assumption. So either growth rates or the discount rate need to be changed. I think it's a bit more of one and a bit less of the other. A discount rate below 10% is asking for trouble. Who would invest in equities for results below historical equity returns? Because I like the business and the demographic trends it is riding my DCF assumption would be along the lines of...

EPS 13.76c
Discount Rate 10%
Growth Rate 15% for 7 Years
Termination Rate 3%
Value $3.92

Not exactly an obvious long term fundamental buy on those assumptions, particuarly if you are looking for a margin of error as well.

PT & Phaedrus,

Thanks for your responses.

If as PT suggests the Trailing Stop (TS) changes each time the closing price changes the TS would replicate the closing price line at the percentage set. This is does not do.

The flat portions of Phaedrus's TS indicate, to me at least, that some form of averaging or, as he suggests, a look back for the previous high is being used.

My programme is Metastock and it does require a "days" function to be included in the TS formula.

Looking at Phaedrus's TS's shown above it appears that your the period is at least 35 days. The best example is the period April - May which has that flat TS until a new ( higher) high is achieved. The TS is then adjusted upwards. Earlier flat periods would suggest that the time period is open ended

I now realise that I may be wrong to shorten the time period for a tighter TS, as this would allow for a gradually falling closing price to never hit the trigger point.

I obviously need to do some more testing but any further comments from you both would be welcomed.

Regards and thanks,

Terry

You have misunderstood me, probably because you are thinking MetaStock and I was not. I have never used the program.

Here is how I implement trailing stops using MFT and a 10% trailing stop as an example

http://i7.photobucket.com/albums/y26...T-20051130.png

The trailing stop value rises with higher highs but should the closing price be lower than the trailing stop value then it drags the stop down with it. It starts with day one of data

One of the advantages of writing your own application, is that it can be made to do what you want. :)
Mind you the technical support leaves a lot to be desired at times. :D

PT,

Thanks again. I think we are almost on the same wavelength and I will work on getting metastock to do what I want it too.

I empythise with your comment on self technical support. My equivalent is anyone who works for himself has a b'd for a boss.

Best wishes,

Terry