Steve Watson: Dialing For Dollars
After working as a broker for 2 years, Steve Watson decided to fulfill his goal in stock trading. He attributes his success to his attitude of overcoming obstacles and achieving success through determination.
When it comes to trading, Steve is always willing to accept risk but never willing to take it.
One of the most important lessons that he learnt is to stick to his own beliefs.
While selecting stocks, he talks about two kinds of funds: a micro fund that invests in companies with a market capitalization of under $350 million, and a small-cap fund that invests in companies with a capitalization of $350 million- $1.5 billion.
In both funds, they start by looking for relatively cheap companies—trading between eight to twelve times earnings. Within this group, they try to identify those companies for which investors' perceptions are about to change. For example, these may be companies that are having some trouble now, but their business is about to turn around. They try to be the first ones to find out that information.
Two key components while buying a stock are its low price and the prospect for imminent change. To identify the prospect that will change market sentiments, Watson extensively communicates with companies, their competitors, consumers, and distributors. Beyond that, insider buying by management also helps because it confirms the prospects of improvement.
He mentions that his largest holding is 3% of his assets and that is also very rare. For short positions, his maximum is 1.5%. His total exposure usually is 20-50% net long.
While selecting for short positions, he looks for high-priced shares that are trading at thirty to forty times earnings or stocks that have no earnings. Within that group, he tries to identify those companies with a flawed business plan (like product failure).
He explains that he can hold his position (even if the stock is down 40%) if his fundamentals are sound. However, if a short position goes 20-30% against him, he will start to cover irrespective of the fundamentals.
Watson controls risk through a combination of selection, diversification, and loss limitation rules. Watson is constantly upgrading his portfolio —replacing stocks with other stocks that appear to have an even better return/risk outlook. Therefore, he will sell a profitable long holding after a sufficient price rise even though he still expects it to go higher. He will then find another stock with better return prospects and less risk.
He believes one should do his research and stick to it instead of getting swayed by other people's opinions. Emotional investments are bad decisions according to him. People who are willing to lose money in this business are the ones who become successful.