Avoiding Torpedo Stocks

Last week McGrath (ASX: MEA), an integrated residential real estate services company (which we don’t own) saw a 31% decline in the company’s share price after the company downgraded estimates for future earnings. This was very painful for investors in this recently listed company, but for us was not particularly surprising.

In this piece we are going to look at the mechanisms we use to filter out companies that are more likely to have a higher chance of issues in the future to improve performance and reduce heartache. This exercise is based on the position that removing a few “losers” from the long only portfolio is more consistently beneficial to a portfolio’s performance than focusing on picking the next Aconex (up 207% in the last year). As we can also short stocks this process is also a component of what we use to identify “torpedo” stocks. Also like most investors I am somewhat irrationally loss averse[1] in that I strongly prefer avoiding losses to acquiring gains, even when the probability weighted outcome is the same. One of the mechanisms we use to filter out noise and narrow down our investment universe is our quality filter model (QFM).

Read more here.

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