Investing methodology

A clip from Barry Ritholtz's blog:

"I want you to look at the process, not the outcome. The suggestions of scaling in over time, looking at the 40% below enterprise value price, waiting until an upside break over the 20 day moving average (for a freefalling stock) — these are all general methods that can be as applied to any name, not just BP."

Looking deeper, at the original "when to buy it" post,

1) BP’s Stock is in Freefall: As the nearby chart shows, BP is down more than 50% from recent highs. Its 200 day moving average is up ~45% from current prices — near ~55.

The current market cap is about $100B, almost 40% below its Enterprise Value of $141.65B.

When making a trade in a stock like this, you want to do more than merely hope for a binary outcome – i.e., Make money or Lose money. The goal is to understand what the risks and rewards are, predetermine the losses/downside, and put ion the best risk/reward you can.

Research project: In distressed companies, at what levels have we seen ideal entries — in terms of price off of highs, below enterprise value, percentages below 50 and 200 day MA, dividend yields, and P/E ?

2) Is this a Trade, or an Investment? : There are different rules for Trading than Investing. you should be thinking in terms of a longer holding period — years, not months.

A universal rule: Never allow a trade to become an investment.

3) Beware the Value Trap: There can be no doubt that BP, at a 5 P/E and 10%+ dividend yield looks cheap. The question is, how much cheaper might it get? Cheap stocks can and do get cheaper, just as dear stocks can (and do) get pricier.

Suggestion: Investors should not try to bottom tick the stock.Rather than catch the falling knife, plan on adding a good chunk of the position after the stock breaks the 20 and 50 day moving averages to the upside. That way, you are averaging UP rather than DOWN.