Research and Patience: The Two Virtues of Successful Investing

By: Steve Rubis

Many times investors analyze a stock and come to the conclusion that it looks like a good investment but do not make a purchase. The bain of any investor’s existence is when a stock that fell into the above statement goes on to a lofty price without you. This phenomenon happens to both novice and expert investors alike. The question is how do we guard against something like this reoccurring in the future? Here at Stock Research there are two specific stocks that fall into this category: (1) Arryhthmia Research Technology (HRT); and, (2) Imergent, Inc. (IIG). Each of these stocks posed a compelling value proposition when I analyzed them. Unfortunately, in each case I failed to yield to patience and allow my thorough research to be vindicated. At this time, our reader can benefit from an analysis of what happened to each stock over the last year (this article will be limited to a discussion of HRT). It is our view that investment returns can only get better when mistakes are analyzed and we apply the lessons we learned from the specific mistake.

This first company on our list is Arrhythmia Research Technologies which is a small medical device company. The company first came to our attention while attending Catholic University of America back in 2004. HRT had been a high flying growth stock which never seemed to drop off of IBD’s hot lists. The stock had a small float and seemed continually rise in price. HRT was in the medical device business selling a product that helped to identify and curtail lethal arrhythmias of the heart. During the period starting mid-2003 and ending mid-2004, the stock moved from around $5 to nearly $40! Talk about a high flying growth stock.

Nevertheless, like all growth stocks on a vertical price rise, it had to come back to earth (see this link for a chart of HRT). Back to earth it came, dropping all the way to $10. However, near the end of 2004, the company regained ground and rose to around $30. This rise would be short lived and the stock cratered around $10 again for most of 2006. Unfortunately, we looked at the stock around May about the time the Market did a nose dive.

At that time HRT was only a $40Mish market cap, and today it trades at about $72M. When we did our analysis, we calculated about five or six different valuations, which were as follows: Take Out Value, Graham Intrinsic Formula Value, and Relative P/E, P/S, and P/B. The average of these values came out around $18, which was a substantial premium to the then current stock price of $10.50. After reading the annual report and most recent 10Q, it became apparent that there did not seem to be any real issues facing the business model. At that time, we made a purchase of 100 shares which we promptly sold out around $11.50, due to numerous false starts in price movement.

The moral of the story is two fold: we were impatient and did not allow our research to pay off, and we were “shaken out” of our position. First, we spent considerable time generating a spreadsheet of companies that were in the same industry as HRT. The analysis took into account many factors ranging from P/E to Take Out Value. Furthermore, we relied on the Earnings Yield (Price / EPS) which converts the P/E to a percentage that can be compared to bond yields. The difference between the two certainly confirmed the premium generated by our fair value estimates. This confirmation should have been enough to stand pat.

Instead, we were “shaken out” of our position by those who had lost money on the stock. From May to July, HRT experienced numerous false breakouts. A breakout is where a stock suddenly jumps on greater volume and penetrates a high or low resistance point in price. There was no reason to sell our shares, since there was no bad news regarding the stock and all was normal. Instead, we became impatient and allowed the sellers who wanted to get out of HRT to dictate our actions. This is a cardinal sin of investing; the pain incurred by a $17 run up is a more than adequate price to pay for this transgression.

Readers can infer from the above discussion that nothing beats a well calculated fair value target and the ability to wait patiently. HRT illustrates that Mr. Market will exact a steep price for the transgression of impatience. Successful investors need a system which allows them to generate a reasonable fair value target. However, this target price is not enough. At the same time, all investors must be able to exercise patience, for if they are not the price of impatience is a costly one.