I wanted to touch a little bit more on the topic of volatility.

On my Investing Style page I go over some of the risks and potential pitfalls of not just investing in the overall market, but specifically with micro-cap and small-cap stocks in which this site will specialize in.

I wanted to take this discussion one step further by analyzing our first pick for our portfolio, AAR Corp (NYSE: AIR), an its volatility as a prime example of exactly what I am talking about, and how you can deal with the potential fear, or frustration that comes with it.

Let’s Take A Look At The Charts:

Ok, let’s start with a 1-year price chart for AIR:

Click to enlarge.

This chart is from October 16th, 2006, through October 16th, 2007.

When you click on the thumbnail that opens a page with the chart in it, keep it open so you can follow along with what I am talking about.

Notice the following as you look at this chart:

• AIR’s stock price at the beginning of the time period was around $25 per share

• AIR’s stock price at the end of the time period (10-16-07) was about $32 per share

• Once AIR’s stock price reached a new support level (where there are more buyers than sellers) at around $28 per share in early 2007, the shares NEVER dipped below that point.

• Once that new support level was established, the share price ranged from $28 per share to a high of around $34 per share.

Why is all this important?

Simple.

The reason we are investing in COMPANIES and not stocks on PeakStocks.com, is because sometimes the underlying STOCKS of those companies can be quite volatile, and jump all over the place on their way to a higher level and ultimate long term gains.

If we take the trading range of the 1 year chart from $28-$34 per share, this represents a loss of about 18% from top to bottom ($34 down to $28), and a gain of about 21% from bottom to top ($28 up to $34).

This is what they call volatility!

This is quite normal with all markets and stocks, but ESPECIALLY with micro-cap and small-cap stocks that will be picked quite frequently on this website.

What Does This Mean For Me?

If I would have told you that you could invest in a company that was $25 per share, and that in about 1 year’s time it would be at $34 per share, representing a gain of 36%, you would say, cool, get me into that stock!

Now, on-the-other-hand, if I explained to you that within that time frame, the stock would have peaks and valleys that would leave you sometimes being DOWN in your investment, and sometimes being even, or up slightly with large fluctuations and riskiness involved, that would probably change your feeling about investing in that stock right?

Well it shouldn’t!

This example with our first holding AAR Corp., is a relatively TAME example of volatility!

In fact, out of all the stocks that I will be picking over the coming years, this one probably will represent one of the most stable investments of all of them and it STILL exhibits large amounts of volatility and rapid price swings!

That’s why on my Investing Style page I outline the inherent risks and potential gut-wrenching volatility that WILL take place with the companies we invest in. I also note that a loss of 50% or more in any particular stretch of time, be it a few weeks or months, will not be uncommon!

Like the saying goes, if you can’t stand the heat, get out of the kitchen!

But there is a method to the madness. These stocks are also our friends, and will yield us the greatest long term gains. Don’t believe me? Let’s take a look at some more charts.

Let’s Take A Look At The Chart, Part 2:

Now let’s look at a 2-year price chart for AIR:

Click to enlarge.

Hey this is starting to look really good now huh?

This chart is from October 16th, 2005, through October 16th, 2007.

Notice the following when you open this chart:

• AIR’s price at the beginning of the time period was around $16 per share and ended at the same $32 per share as previously discussed.

• From about November 2005 till about February 2006, AIR’s stock rocketed up from about $16 per share to about the $24-$26 range, even going as high as about $28 per share around May of 2006! That represents a gain of 75% from bottom to top!

• Oops…then came a “little correction”. The stock went from that peak of $28 in May to about $20 in the middle of June! In less than 2 months AIR lost 30% of it’s value!

• But then look what happened: the stock traded sideways for another couple of months until October, when it again started another steady climb to new highs.

What Does This Mean For Me, Part 2:

Here we go again!

If I would have told you that if you put your money in a certain stock at $16 per share, and in 2 years it would double to $32 per share, raise your hand if you would take that in one second flat?

That represents a 50% CAGR (Compound Annual Growth Rate), which is a fancy way of saying, you would be rich if you had a basket of 10 stocks that all did this every year and you put everything you owned into them.

Also notice something interesting: at the beginning of our time period, say we bought at around $16 per share, if the stock goes up $4, that represents a 25% increase from our buy price.

Now, as the stock goes up, that dollar move represents less and less of the overall % price increase, but remains the same for our initial buy amount.

In other words, if the stock is at $32 per share, a price increase of $4 represents a gain of 12.5%, but for our original buy-in price of $16 per share, it represents a gain of 25%!

This is when things get juicy and you really start creating wealth for yourself! It’s called compounding your gains and its a great reward for patient investors (LIKE US!) who calmly put our money down in a good COMPANY, and wait for our investment thesis to play out over MANY YEARS!

Of course, let’s not forget, the same counts on the downside! A move down from that level of 12.5% also equates to a loss for us of 25%, but you get the idea, over time, our money increases at an exponential rate, and thus are returns CRUSH the market!

One more item of good news:

There’s one more thing that I forgot to mention but that I would like to point out.

When the stock declined from say $28 per share in May to about $20 per share in June, guess what? We wouldn’t have just sat there looking at it and freaking out.

Nope we would have BOUGHT MORE!

That’s right. The market presented us with a gift. A declining stock for no good reason, other than overall market turmoil that was not specific to our COMPANY.

The fundamentals would have been intact, the thesis the same, and so, because the shares were on sale, we would have bought more shares, and be sitting on even larger gains as it rose shortly after this!

This is the whole point of this blog posting, to help you realize that a strong patient approach is one that will lead you to maximized gains over long periods of time.

In addition, never buying your full position at once can help you limit losses, and accelerate gains over long periods of time!

One more and then I think the point will be clear.

Let’s Take A Look At The Chart, Part 3:

Now let’s look at a 5-year price chart for AIR:

Click to enlarge.

This is the last one, I promise!

This chart is from October 16th, 2002, through October 16th, 2007.

Notice the following when you open this chart:

• At the beginning of the time period, AIR was trading at around $5 per share, and at the end $36 per share as previously discussed.

• Even within this time period there is volatility, albeit it is over much larger time-frames (months or years, instead of weeks or months).

• An investment in AIR in 2002 at around $5 would have grown in value over 540%, making an initial $1,000 investment become $5,400 in 5 years yielding you a CAGR of over 100% per year!

Look at how as we get farther and farther from our initial investment, each gain of AIR becomes a larger and larger gain on a % basis for our holdings and overall portfolio!

This is when you REALLY start creating long term wealth and what I adhere to on PeakStocks.com.

Sometimes things change and the investment thesis for a company changes, but the way I see it is, if you can’t hold a stock for 5 years or more, you probably shouldn’t be investing in it anyway.

Of course that being said, sometimes there are short term plays that are just too juicy to ignore, but for the most part, this is the philosophy that I stick to for most of my buys.

The Bottom Line:

I wanted to illustrate market volatility with a specific example of a stock that was in our portfolio.

I’m sure we all remember the bursting of the .com bubble in 2000 when the Nasdaq lost 50% of it’s value in a year’s time or so.

Well, always keep this in mind: If a major index that holds thousands of stocks in it can tumble 50%, then imagine just 1 stock in that index and how far it can also rise and fall within a short period of time!

But fear should never enter into the equation because over the long-term and assuming I choose sound and well-researched companies with long-term growth prospects, we’ll almost always come out on the winning side of the equation with time, patience and all the attributes that long term, successful investors share.