A Tale of Two Trades and What I've Learned

NEW YORK (TheStreet) -- Eating a bowl of humble pie is not my favorite assignment. Remembering the lessons learned from both my profitable trades and my losing ones is an instructive exercise that's worth the time.

When TheStreet's Jim Cramer wrote to Real Money subscribers about an important goal of virtually all traders and investors, he didn't mince words: "Remember, the real goal for all people in this market is to make this business less of a guessing game about what the Fed will do and more of an investment business where we judge stocks by what companies say."

That was foremost in my mind when I went long shares of Lockheed Martin ( LMT) at the end of February when shares fell below $86 each.

The financial markets were riled by the possibility that the so-called budgetary "sequester" that the federal government was embroiled in would hurt defense companies. I noticed that at $86-a-share Lockheed was trading for around 9 times both current and forward (1-year) earnings.

Lockheed's leadership held to its guidance for the company's sales for the year. What really caught my eye was its dividend. With an annual payout of $4.60 and the share price at $86 the yield-to-price was a very rewarding 5.35%. I rubbed my eyes with disbelief, checked the numbers again and went long.

In less than 3 months I was sitting on close to a 22% gain as Lockheed shares moved above $105. Knowing that bulls make money and bears makes money but pigs get slaughtered I decided to sell. The annualized rate of return for this trade was nearly 88% and that pleased me greatly.

This one-year chart illustrates how Lockheed shares behaved.

LMT Chart LMT data by YCharts

Perhaps it was mostly luck, but looking back when I bought Lockheed I'd been screening for stocks with unreasonably low price-to-earnings ratios, a price-to-earnings-to-growth (PEG) ratio that was well below 1, and a sustainable dividend yield that was better than comparable companies with similar market caps.

Today Lockheed has a dividend payout ratio of 50% and a forward P/E ratio of almost 12 with a PEG ratio (5-year expected) of 1.53. By one metric, its price-to-sales (P/S) ratio, shares are selling for a trailing 12-month P/S ratio of 0.70.

That means PEG shares are selling for 30% below a reasonable 1 times its TTM revenue per share of over $145. PEG will stay on my radar screen for another reason. Its TTM return on equity is more than 302%, and that's downright amazing.

Now I'll share with you my tale of woe and losses. Once upon a time it looked like the gold mining titans were undervalued and the price of gold was around $1,600 an ounce. As of Wednesday the price has plunged to just north of $1,230 per ounce.

Back when it was much higher I thought I'd get clever and buy some longer-term call option contracts on Newmont Mining ( NEM). After all Newmont was "only" $48-a-share and paid a nice dividend of almost 3%. With the longer-term options I was also getting lots of leverage.

As of Wednesday Newmont shares cratered to a new 52-week low price of $27.07 before closing at $27.22. As my friend Joe likes to remind me, "If you like Newmont at $48 you ought to love it at $27." I'm embarrassed to confess I bought more at about $40 and those shares are down 33%.

The long-term (LEAP) contract I purchased expired worthless this year. Yes, I lost 100% of my premium that I paid for them, and feeling certain that gold would do well in 2013 and Newmont would move much higher I bought too many of them.

My realized loss was more than $1,000 and I'm sitting on another $1,200 of unrealized losses on LEAPs that don't expire until the third Friday of January 2015. It's times like these when I ask myself, "What was I thinking"? Take a look at the following gut-wrenching, crash-like chart of Newmont.

NEM Chart NEM data by YCharts

The first huge take-away lesson was if you don't own a real, functioning crystal ball don't try to predict the future prices of any investment class or sector. I bet big with precious metals over the past two years and I lost big as the price-per-ounce of silver and gold went the opposite way.

If I had subscribed to a trailing stop alerts service like TradeStops and diligently acted upon this objective way to keep unacceptable losses from happening I would be many thousands of dollars ahead.

With stocks or options always remember to hedge your bets and firmly decide not to lose more than you can afford. Use position sizing disciplines to keep from being too exposed to one stock or sector.

One final thought: It's prudent to decide ahead of time how wrong we must be before we sell our losers. A 20% loss is easier to recover from than a 90% loss. Trailing stops can help with that process, plus it empowers an investor with a discipline that lets the winners keep moving higher.

At the time of publication the author was long shares of Newmont but neither long nor short shares of any other stock mentioned in this article.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

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