Within the S & P Quality Rating, Additional Factors & Numbers:

• The Selection Methodology presented in "Brainwashing" is a management technique employed to simplify, organize, and control the decision making process so that a consistent approach to stock selection, and trading, evolves... the KISS Principle. A basic assumption, and the rationale for using the S & P letter rating system in the first place, is that their thousands of analysts consider the important fundamentals in determining the Quality rating.
• A key problem that most users of  investment letters, newspapers, chart selection techniques, and computer models have in common is the inability to make decisions... simply because they have much too much information and opinion in front of them. The Selection Universe removes the "analysis paralysis" and provides an efficient tool for identifying buying opportunities.
• As you become more experienced as a user of the Methodology, you will find that the vast majority of the stocks you purchase will fall within the "Lower P/E" category. Generally speaking, stocks that are ready to buy will have reasonable P/E ratios, but there can be exceptions.
• When making the final selection from the candidates for purchase (and before you have the experience referred to in the Brainwashing Book) it may be wise to use P/E and/or other Stock Guide data (profitability, current ratio, institutional holdings) to select your daily "Best Buys".

• Yes, absolutely. I focus on the right hand columns of the "Stock Guide" ( Earnings per Share) to make certain that there are no recent negative numbers (a recent operating deficit). It's not uncommon for companies to pay a dividend for a while after they begin leaking oil. A dividend cut or omission won't be far behind. We want both, profits and dividends.
• Always keep in mind that a bad "quarter",  in a generally profitable long term picture, sets the stage for those good quarter to quarter comparisons that Wall Street gets all excited about down the road. Such "earnings surprises" always make the news, and often cause a severe decline in market price. 

• For the most part, but there are certain industries where the current ratio can't be calculated [financial companies]. Also, if there is a lot of inventory [retailers], I like a higher ratio. If everything else looks good, see if there is a simple explanation for a negative number. If not, find something else.

• The more institutional interest there is in a stock, the more likely it is that there will be the kind of volatility we need for successful trading, and the amount of trading volume we need for instant liquidity. Also, analysts follow the larger holdings, creating more news and more volatility. These are the guys who buy on good news and sell on bad. 
• Although I've never tried to come up with a "level" of institutional popularity that is the best, I'd tend to avoid issues where there seems to be very little interest.

• No, they are purposely excluded if they average less than 5,000 shares per day, because the trading methodology really does require liquidity in Common Stocks. Some newspapers include only the x,xxx most active issues in their listings, and this may be an inconvenience for travelers without Internet access.
• On the other hand, many investors will have CEFs (Closed End Funds) in the Fixed Income portion of their portfolios, and these trade in much smaller volumes. When selling, this needs to be taken into consideration because, believe it or not, even small traders can affect market prices. It's not unusual for me to trade positions a few hundred shares at a time, based on the supply and demand numbers.

• That's really a function of how low it goes. I'll get out ASAP if it goes below "B+", taking even a minor profit or loss as soon as I'm aware of the change. Then, if it's a larger loss, I'll consider it a candidate for "ATH" loss taking, but some judgment is certainly required. For example, when IBM went to "B" status years ago and Dupont did the same more recently, I held out for those small profits. With a less well known or widely held issue, say good bye as quickly as possible.
• Downgrades between the "A" categories are not as significant to me, dependent again on my familiarity and experience with the company as a trading vehicle. I don't give up too easily on issues that I've had good experience with, and even though the overall trading objective can be somewhere between four and seven months, you will always have situations that you wind up holding on to for much longer periods. There won't be many, and it's perfectly acceptable to take a smaller profit or even a small loss on a seriously long holding.
• A downgrade to B+ should raise a cautionary flag, but it's nothing to be too afraid of, unless your overall portfolio seems to lean in the B+ direction. I've made a lot of money over the years at this end of the Quality spectrum and such a downgrade may just turn out to be an excellent buying opportunity. Keep in mind that we are looking at the bigger and stronger companies in the first place and that many of these become more attractive as takeover candidates at lower prices.

• Within the "Brainwashing" book methodology, there are management controls (checks and balances) that warn of problems at the companies we invest in. Specifically, a cut in or elimination of the dividend, and an S & P downgrade of the stock below investment grade. Rarely is there a situation where serious trouble won't come to our attention in time through one of these mechanisms. 
• I can think of only three glaring instances over the years where an Investment Grade Rating held up to the very end: Ames, Enron, and Friedman's. But, and key to the overall methodology, major individual portfolio disasters were avoided because of individual security % of portfolio diversification rules that must never be violated and which must always [absolutely always] be calculated using The Working Capital Model.
• Also, in each instance, profits had been made on the security more than once prior to the disaster.

• Generally, I won't buy more of an existing holding if I have an adequate supply of new opportunities to choose from. Stocks that go down this much on news or because they are in a weak sector (the drug companies, for example) don't seem to bounce back as quickly as the newbies.
• I also won't consider buying more of a stock that has been downgraded  to "B" or lower. These become candidates for the "ATH" decision.

Assuming that the "fundamentals" haven't deteriorated, and that the current buy list isn't wonderful, is the "30% down from cost basis" a hard number or a guideline?

• I stick to the 30% faithfully, although I do consider it a guideline rather than a strict rule. As your experience grows you'll be able to judge better, but there is nothing wrong with doing nothing. Buying should always be done slowly.

The "ATH" Decision:

What is the "ATH" decision, and what is it used for?

• Most of the investment world worships the bottom line Market Value of portfolios, and such a focus (without an understanding of too many things to mention here) causes a book full of problems. Within the "Working Capital Model" method of portfolio management, Market Value is compared with net deposits to determine if and when a portfolio is at an "All Time High" Profit Level. 

• When it is clear that an ATH has been achieved, the portfolio should be looked at carefully to cull the worst performer, at whatever the realized capital loss. Issues that have fallen below investment grade must be eliminated eventually, and this is the least painful time to do so. 

• Be careful not to get carried away with this process. Examine weakness in fundamentals, not in market price, and if you have a choice between more than one loser, pick the one that loses the least capital... it will give you more to work with than the others. 

• Major losers (although quite rare) need to be dealt with or your Working Capital Totals will become unrealistic. Again, when the portfolio value is at an ATH, in spite of that holding, it is the right time to bite the bullet.

• The stock selection strategy of the "Brainwashing" book tracks individual, Investment Grade, Common Stocks. Although CEF common shares represent individual Investment Companies, the investment purpose is significantly different. The CEF shares are being purchased because they represent the experience of a diversified portfolio of Fixed Income or Equity Securities.
• Yes, you should still look to sell them and move on to another if the 10% gain objective is reached, but there is no need to look for a 20% decline in price for a purchase decision. With a fixed income fund, focus on the yield, avoiding those that are unusually high or low, and diversify with a maximum of 10% to 15% if possible. 
• Yes, I do use Equity CEFs, and not just in very small managed portfolios, where they are the primary security. When the "Buy List" shrinks to 10 or fewer issues, you can "steal" some Capital Gains dividends while continuing to participate in a broad rally with one or two of the best CEFs. With an Equity Fund, diversify with a maximum of 15% to 20% in portfolios under six figures, and normally above that level. 
• I absolutely never touch an Index CEF. 
• For a more complete discussion, and links to other websites (click here).

• Actually, I don't use a rating guide at all. Remember that these are portfolios of securities of a (presumably) less risky nature so an absolute rating of quality might be a little hard to believe in. I look at the range of price movement over a minimum of three to five years to assess risk based on the current price, and try to avoid buying at extremely high historical levels.
• The next issue is reasonableness of the yield vs. the amount of leverage used. Avoid excessively high or low leverage in the same way that you avoid excessively high or low yields.
• The relationship to NAV is certainly important to consider, but don't let it become the primary issue.
• The S & P Stock Guide is "still the one". Most of the information you need is provided, toward the back of the book.
• A significant issue, and this is something you need to develop, is confidence and experience with these securities both generally and specifically. It takes time and patience.
• Remember, the ability to trade is a secondary benefit of fixed income CEFs.

• No, not really. In Fixed Income CEFs, low volume may be symbolic of the satisfaction of existing shareholders with a steady, dependable cash flow, and not a real shortage of shares. If the price is right, they'll trade. Think about the underlying security... built to hold on to.
• Another reason for lower volume, at this time of year (3rd or 4th Quarter), could be the habit of some CEFs to pay their Capital Gains and/or "special" dividends after January 1st. This is always something to consider, and information that you can ask your broker to investigate.
• On the flip side, it's generally a good time to buy CEFs after all of the irregular dividends have been sent to shareholders,,, theoretically, the prices should be a bit lower. So check the early year volume to get the big picture.
• Here's a rare tax note. When you own CEFs, it's likely that some of the dividends you receive in January will be "booked" as the prior year's income... check with your accountant before you rush to get that 1040 on its way.

• Go ETF Connect: http://www.etfconnect.com/education/fundamentals_etf.asp
• Click on "Fund Sponsors" and find the drop down menu on the left side of the page. Scroll down to the appropriate company name and select it. Then locate the symbol of the fund you are researching.
• Finally, scroll down through the Fund details until you locate the information on Preferred Shares and "leverage %".
• Take a look at a dozen or so to get a feel for the "normal" amount of leverage. Note that leverage only sounds like a bad thing. It's an excellent business practice, and one that is used in all fields... not just by investment companies.

In the book, you mention that there is no reason why this approach wouldn't work with NASDAQ stocks. Do you ever trade the Investment Grade Issues there?

• In the 25+ years that I've been fine tuning this methodology, I just haven't had the need to go there, although the specific stock selection rules would certainly apply. However, my "Statistics That Matter" are based on the NYSE alone, and I would avoid getting involved in securities that trade within a Market that is generally known as a more aggressive and speculative medium. 

• Also, the Brainwashing Book only reasons that the approach should work with NASDAQ stocks. That possibility has never been tested.

What's become clear to me over the three years I've been using this approach is that there are aspects of both art and science inside. Do you agree?

• Absolutely, and that is totally a function of the amount of experiences that is reflected in the overall methodology. The science is a near-equal partner with the management art that applies it to the day to day decision making, and all of this takes place within a structured and well thought out portfolio investment plan.

• However, it is not "rocket science", and not even one fancy formula is necessary to do it profitably!

• Interestingly, I think that there is more Psychology than Mathematics and Finance involved, on both an individual and on a group basis, but that's all covered in the book.

• In my experience I've found that engineers and attorneys have the most difficulty with it while retailers and generalists have the least. The three people who I personally know have been using the approach since 1979 are a Restaurateur, a Dentist/Orthodontist, and a Manager.

• This question comes up often. 10% is a target, not a hard and fast rule. Three sevens beats two tens in this game as well.
• Experience will hone your profit taking judgment. On an old position, any profit is just fine. Quick profits take the best advantage of the "McDonald's Principle", and there is always something else to buy. If not, the market will correct soon anyway.
• Never hold on above the target 10%, but there is no shame in 5%. Remember, you'll never get poor taking profits.

• The KISS principle strikes again! There are a lot of people following this information on a regular basis... particularly the institutions. This type of activity finds its way into price fluctuations and adds to volatility. I feel that it is just another of the thousands of different pieces of information that you could look at if you wanted to but really don't need to deal with at all. It's in there!
• There's a statement about the word "know" in the Brainwashing book. It doesn't exist in the Investment World. So if insider trading figures make you feel like you "know" something, you are probably wrong.

Is cyclical just one of those buzzwords coined by the Institutions to make us afraid of these stocks? Their volatility seems to provide more frequent trading opportunities.

• You got it! Volatility is your dearest friend, and cyclicals are perfect trading stocks. It's the "Market Value" obsession that does this... as far as I know, the Working Capital Model is the only cure.

• Having the rules on one page, as you put it, would be a big (but convenient) mistake. There are some rules and many guidelines, I've found that many people take an "engineering" approach to the methods I describe. That's not necessary or recommended. These are decision making thoughts and approaches to be implemented as things happen during the trading day and for the overall long term goals of the portfolio.
• It's more important to understand the concepts and the rationale for the guidelines than to commit the guidelines to memory.

Im really interested in starting a portfolio based on the ideas outlined in "The Brainwashing of the American Investor" and Id like to know the risk-side of the equation. What is the average % draw down for a typical portfolio? 

• I don't pay much attention to Market Value "draw down", I expect it. The larger it gets, the more opportunities either for "buy more" or for new portfolio additions there will be. This is a basic principle: you must learn to love corrections almost as much as you love rallies...they're just not as much fun.