I should've made 600% on Alliance Resources Stock. Here’s What I learned

Legal Disclaimer: 

Legal Disclaimer: The Author is not a registered investment advisor. Investing involves risk. Financial information provided is believed to be accurate but we are not responsible for inaccuracies. I may own these securities for myself or in accounts that I manage. Past performance is no guarantee of future returns. Some links provided may be affiliate links and the author may receive a small commission. 

I’ve been reviewing my trades from the last few years. It’s been humbling, since I’ve made many of the same mistakes I hoped to avoid.

As a value investor, when I find a stock that’s undervalued, I try to wait until it forms a proper base. For many years I’ve had a sign on my computer monitor that read, Wait for a Base. It’s hard to do when you find an extremely undervalued security like Alliance Resources was during the oil Selloff of 2020.

In this article, I will review my investment in Alliance (ARLP) and also describe the new strategy I’ll be using going forward. The goal being to avoid the pain of the short term losses I suffered after purchasing Alliance and watching them lose another 70% of their value.

The green circles indicate where I purchased shares. The red is where I sold them. *Alliance is actually structured as a Partnership that holds interests in Coal and energy. In a typical year, there was over $3 in cash flow.

First Buy: While the shares were Very Undervalued at $10, there was no reason to buy the shares there. No base. Clear down trend. Shareholders wanted out.

Patience was required. And I didn’t have enough.

Purchasing shares at $10 leaves you with less capital to buy at the proper buy point at $3.50, after the sellers had been exhausted and the shares had formed a proper base. In addition, we see the catalyst for the uptrend - improving earnings.

Buying early has more problems - it depletes your mental capital.

Watching my P & L lose money because I purchased shares before waiting for a proper base is extremely disheartening. It’s brutal owning a stock at $10 and watching it go to $2.60. Also, you’ve tied up capital in a position that is clearly in a downtrend.

New Strategy:

10% sell stop.

Not a mental stop. A sell stop order. If I’m so tempted to buy an undervalued stock, I will use a 10% sell stop. If it’s triggered it means I’m early.

If the stop is triggered, it means either I am wrong or I am early. It also means the downtrend is continuing. I can revisit the shares at a lower price or after it has formed a proper base and is continuing a new uptrend.

This avoids the value trap that hurts most value investors. The thinking goes, If a stock is undervalued at $10 then it’s much more attractive at $4. This is how value investors can wind up owning way too much in a value trap stock. This is one of the reasons why value investing is so challenging.

The goal however, is to own the greatest amount of shares at the most attractive price after a base has been formed and a new uptrend has emerged, which makes it less risky and less susceptible to a new leg down caused by earnings shortfall or exogenous event.

With Alliance, it was at $3.50 - the optimal risk / reward point. (see Below) And it allowed one to own the shares as it began to ascend a new uptrend, thus minimizing the mental strain of owning a stock gapping down due to news, nervous shareholders, and weak earnings.

If executed properly, this is a massive winner. Greater than 600% Gain. However, if you entered early as I did, the gains drop to 200% - still good, but leaves much room for improvement.

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