It was the biggest mistake of his career…

Bill Miller had just lost $551 million of his investors’ money.

Bill’s no average Joe. He’s one of the best stock pickers of his generation.

He ran the Legg Mason Value Trust mutual fund. At one point, Miller beat the S&P 500 for 15 straight years. That puts him in the top echelon of investors.

His biggest mistake came in 2000. That’s when he bought camera maker Kodak. As we told you yesterday, Kodak was a classic “value trap” at the time.

Miller bought Kodak shares when the price dropped from $60 to $41—a nearly 32% plunge. At the time, he had projected Kodak was worth $100 per share.

Miller was so convinced he was getting a bargain at $41 that he had Legg Mason’s funds buy 25% of the company.

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Little did Miller know, Kodak was just starting its massive fall from glory.

After he bought in at $41, Kodak shares nosedived even further.

Shares plummeted to less than $4 in 2011 (see chart below). Miller was forced to exit his position with an incredible 90% loss. Kodak entered bankruptcy a year later.

Kodak was a value trap waiting to happen.

And these traps can snare even the best investors. Sometimes we just miss the signs. (We went over the five common signs of a value trap on Monday.)

But if you happen to fall into a value trap (as Miller did), there are ways to get out before it’s too late.

Today, we’ll share our emergency escape plan. You should keep this plan in a safe place because you’ll never know when you’ll need it…

A Three-Step Emergency Escape Plan

As we explained Monday, a value trap is a company that appears cheap because of a large price drop in its shares. Yet it’s actually expensive compared to future growth.

Miller’s experience shows just how devastating these traps can be to your portfolio.

But what if you miss those warning signs and fall into one anyway?

If you do fall into one—and want to avoid major losses—take these three simple steps… We call them “stop, drop, and roll”:

  • “Stop” refers to a stop-loss price. A stop-loss price is simply a preset price at which you or your broker will sell the stock if its price drops that low.
  • “Drop” means that you immediately sell your position once it hits the stop.
  • “Roll” means that you take the proceeds from the sell and roll them over into another position that you’re comfortable with.

The Emergency Plan in Action

Before every investment you make, you should have a plan. Part of that plan is to figure out when to exit the position. The stop loss makes it easy.

That’s why we use stop losses in most of our portfolios (with the exception of the Legacy Portfolio).

At Palm Beach Research Group, we use a combination of hard stop losses and “trailing” stop losses. A “trailing” stop is a stop loss that automatically adjusts higher as the value of the underlying stock climbs. Then it stays pinned to the highest price.

To explain this, let’s use an example…

Let’s say we’re looking to buy Apple today. Apple is a large, stable company. So we’d use a 25% trailing stop loss. That should give us plenty of room for normal fluctuations in the stock’s price.

Assuming a $120 entry price, our initial stop would be $90.

As the price of Apple rises, so does our stop. If Apple goes up to $200 per share, our 25% trailing stop automatically adjusts to $150.

If Apple drops to $150 or below, that means the story has changed (or a bear market has begun). Either way, it could be a sign that Apple might become a value trap.

At that point, we’d immediately drop (sell) our shares of Apple.

Then we would “roll” the proceeds into another company on the upswing. Or, if we can’t find a good investment right away, holding on to that cash for a better opportunity is a perfectly viable option.

If you follow our “stop, drop, and roll” plan… you’ll be able to escape any value trap you’ve landed in with much smaller losses.

And you’ll avoid a near wipeout of your principal, like Miller had with Kodak.

Regards,


Nick Rokke, CFA
Analyst, The Palm Beach Daily

CHART WATCH

U.S. stocks aren’t the only ones reaching new highs. Markets across the world are setting records.

The MSCI All Countries ex USA Index tracks stocks in 45 countries (U.S. companies are not tracked in the index).

As you can see in the chart below, the index just broke out to a new 16-month high.

Stock markets around the world are currently performing well.

With foreign markets breaking out, it’s a good time to consider adding some exposure… Plus, these markets are cheaper than the U.S.

—Nick Rokke

MARKET BRIEFS

Pension Plan Reneges on Benefits: We told you they were coming… And now they’ve arrived. The financially strapped Iron Workers Local 17 Pension Fund in Cleveland became the first plan to approve benefit cuts for current retirees. The move could open the door for other troubled pension plans to follow suit. Now that the plan has received final approval, roughly half of the 2,000 participants will see their pension benefits shrink on Feb. 1. Benefits will be cut by 20% on average, but some retirees are expecting their monthly payments to be slashed by as much as 60%.

We’re following this crisis in our special Palm Beach Letter pension report. PBL subscribers can see if their state might be among those cutting pension benefits right here.

Two-Income Retirement Plan: Meanwhile, the man who founded the world’s largest mutual fund says you’ll likely need at least two sources of income in retirement. John C. Bogle founded The Vanguard Group in 1974. It’s since grown into a $3.9 trillion giant. Bogle says your retirement goal should be to get two checks every month—one from fixed income (like Social Security) and another from an equity account (like an index fund). You can read more about his retirement plan right here.

Trump’s Momma Didn’t Raise No Fool: President Trump could really “go to war” with the Deep State. And lose. If this were to happen, investors would almost certainly get caught in the crossfire. But don’t worry. This is extremely unlikely. The only way to bring the Deep State to heel is to cut off the EZ money funding that feeds it. Mr. Trump has not even suggested it. It’s not going to happen, not voluntarily at least.

So, what will Donald Trump do? Longtime PBRG friend Bill Bonner answers that question right here

Have you ever been caught in a value trap? If so, how did you get out? Share your story with the Palm Beach community right here.

IN CASE YOU MISSED IT…

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One Ph.D. shares a radical new secret that lets you collect $1,000s in unclaimed money… on every stock you own. Click here to watch the video…

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