Investing FAQs
Here are some common
investing questions
from our readers answered by Cabot editors. To submit a question, go the Cabot blog, http://www.iconoclast-investor.com using the link on the right or send an email to customerservice@cabot.net.
How do I get started as a new investor?Answered by Elyse Andrews, Editor of Cabot Wealth Advisory: The best thing to do is educate yourself about investing and find a system that works for you. The more informed you are as an investor, the better off you'll be. Reading investing books is a great way to learn more and we have recommendations for many helpful books on t
he Investment Books section of this Web site. Cabot's Web site also has many additional educational features that can introduce you to the investing world including
Investing Advice,
Stock Investing Lessons,
Market Timing Indicators,
Technical Stock Analysis and much more. These features can help you decide which investing system is right for you. This is something we stress a lot—finding a system and sticking to it is the key to success.
How do I know which exchange a stock is traded on?
Answered by Elyse Andrews, Editor of Cabot Wealth Advisory: In the United States, modern letter-only ticker symbols were developed by Standard and Poor's to bring a national standard to investing. One- or two-letter symbols trade on the New York Stock Exchange; three-letter symbols may trade on either the NYSE or AMEX; four- and five-letter symbols trade on the Nasdaq, although five-letter ticker symbols are usually a special class of stock. In July 2007, the Securities and Exchange Commission approved a plan to allow companies moving from the NYSE to the Nasdaq to retain their three letter symbols. The change does not apply to companies that have symbols with one or two letters. You can find out the exchange for any stock by going to Yahoo! Finance and entering the name or symbol of the stock. The page that comes up will give you the exchange.
Why are earnings so important?
Answered by Michael Cintolo, Editor of Cabot Market Letter and Cabot Top Ten Report:Companies
are in business to make money. Thus, earnings are the ultimate score
card. Companies that can grow their earnings rapidly and do it
repeatedly see their stock prices rise to reflect their success.
Conversely, companies that stumble on their growth path see the price
of their stock fall. Investors are always looking ahead to what they
believe the company's earnings will be in the future. Thus investors'
perceptions of the company's prospects can be as important as the
reality in the short term. But in the long run, earnings and earnings
per share are most important.
What is a price/earnings ratio?
Answered by Michael Cintolo, Editor of Cabot Market Letter and Cabot Top Ten Report:
If
you divide a company's stock price by its earnings per share, you'll
come up with a price/earnings ratio, or PE. This simple number reflects
how well-thought-of the stock is by investors. A single-digit PE is
considered to be low, while a number over 20 is considered to be high.
If stocks were commodities, like bananas, a low price/earnings ratio
would represent a bargain, a good value. But stocks are not
commodities. A high PE simply confirms that investors believe a company
will experience fast earnings growth in the future.
Are investors always rational?
Answered by Michael Cintolo, Editor of Cabot Market Letter and Cabot Top Ten Report:
No!
While the long-term course of a stock's price will ultimately reflect
earnings, its short-term course is highly dependent on investors'
perceptions. . . and their emotions. Investors, generally, can be
motivated by fear or greed. When they are fearful, they can sell a
stock so that its price falls to unreasonably low levels. And when
investors are greedy, they can bid a stock's price up to unreasonable
heights. The challenge for the individual investor is to avoid getting
caught up in the emotions of the crowd.
What is short selling?
Answered by Michael Cintolo, Editor of Cabot Market Letter and Cabot Top Ten Report:
Short
selling is the practice of borrowing shares of a stock so you can sell
it (short), planning to buy it back later at a lower price …returning
the shares and keeping the difference in price as your profit. In
brief, you're betting that the price will fall. At Cabot, we do not
recommend the practice, for a couple of good reasons. First is the
long-term trend of the market, which has been generally upward over the
decades, even centuries. When you invest (long) in a stock, you're
investing in synch with the long-term trend. But when you go short,
you're betting that the stock you're shorting will move contrary to
that long-term, upward market trend. And you're betting that you're
clever enough to time both your entry and exit points to catch this
move. It's tricky. Equally important is the fact that the potential
profits of a short-seller are limited. If the stock's price falls to
zero, the best you can do is double your money. Contrast that with the
potential of a fast-growing company that could triple your money, or
more, in a year or two. Conversely, on the long side the worst you can
do is lose all the money you invested in that stock, while if you're
short, your potential losses are unlimited!
What is investing on margin?
Answered by Michael Cintolo, Editor of Cabot Market Letter and Cabot Top Ten Report:
Someday
your broker may ask if you'd like to invest on margin. In effect the
broker is offering to lend you money so that you can invest it and
profit from it. The broker is a guaranteed winner, because you pay him
interest on the money you borrow and he gets the commissions when you
trade with that money. But your profits will be harder to come by.
You've got to pay that interest and those commissions . . . and your
risk is increased. If you're doubled up on margin, for example, a
simple stock drop of 10% will hand you a loss of 20%! And a 20% drop
will give you a 40% loss plus a headache. In general, we don't
recommend investing on margin.
What is market timing?
Answered by Michael Cintolo, Editor of Cabot Market Letter and Cabot Top Ten Report:
We
are strong believers in long-term market timing, mainly so we can sell
stocks and preserve cash when the broad market enters into a major
decline. This is not an exact science, but it can be tremendously
rewarding to avoid losing money. And we've had great success with
market timing over the years, so we feel confident in recommending that
all investors practice it. On average, Cabot Market Letter gives two
major market timing signals per year. If it's a sell signal, we work to
reduce risk by selling our poorest performing stocks and putting close
limits on the others. The object is to reduce the risk of loss and to
raise cash for the next buy signal, when bargains abound. When that buy
signal comes, we invest aggressively in the best-performing stocks we
can find. Interestingly, that's the time most investors are scared to
death.
Is it risky to invest when public sentiment is negative?
Answered by Michael Cintolo, Editor of Cabot Market Letter and Cabot Top Ten Report:To
the contrary, that's the best time of all! The public, in general,
tends to react to what has already happened and assumes that the past
will continue. Investors have no way of seeing the end of a trend until
it's well behind them. But we know that all trends end when the last
holdout joins the crowd …when the last buyer buys or the last seller
sells. The trend ends when sentiment reaches an extreme level. Then,
because all the fuel for that trend is exhausted, the trend reverses.
In general, the better you are at gauging the mood of the crowd, the
more confident you will feel about buying when all about you have sold
in panic…and moving to the sidelines when all about you are buying
feverishly.
What are your top rules (or tools) for growth stock investing?Answered by Michael Cintolo, Editor of Cabot Market Letter and Cabot Top Ten Report:My top tools for growth investing are:
1. Cut losses short (definitely rule #1 for growth stock investing)
2. Search for strong sales and earnings growth (especially triple-digit sales growth)
3. Search
for revolutionary products with major benefits (First Solar and Crocs
filled the bill in '07 and were our two biggest winners)
4. Heed the message of the overall market
5. Never average down
6. Be prepared for all contingencies (always have an exit plan ahead of time, just in case)
7. Never try to buy at the bottom or sell at the top (if you try to do it, you'll just lose more money)
8. Stick with stocks that are liquid to avoid gut-wrenching volatility (usually at least 600,000 shares traded per day or more)
9. Only put more money to work after your past purchase or two is showing you a profit, and
10. Be
humble—making money in stocks is tough, so don't kill yourself over one
or two bad trades, and be thankful when you hit a big winner.
You recommended XYZ stock a couple of weeks ago, and today you're advising to sell it. How can you change your opinion that quickly?
Answered by Michael Cintolo, Editor of Cabot Market Letter and Cabot Top Ten Report:As Paul Goodwin (editor of Cabot China & Emerging Markets Report) has written a few times, you need to have three things for a successful stock—a good story (i.e., good future potential based on a unique product or industry upswing), good numbers (particularly strong sales and earnings growth and big profit margins) and a good chart (telling you deep-pocketed investors are accumulating the shares). Paul calls this the SNaC system—Stories, Numbers and Chart—and it's a useful acronym to remember. The most fluid of these three pieces is the chart—the story and the numbers don't change overnight, but in rare instances, the chart can (either positively or negatively). Most investors refuse to change their minds that quickly, but our studies show that a rapid change in the price of the stock—especially if it comes on earnings news—usually leads to more movement in the same direction. So if your stock collapses soon after you buy it, your best move is almost always to get out. Yes, it's painful ... but stubbornly sticking with the stock usually causes only more pain over time.
Business remains great at XYZ company, yet the stock is down significantly. Isn't it a good buy?
Answered by Michael Cintolo, Editor of Cabot Market Letter and Cabot Top Ten Report:The answer is generally no, and the reason is that a stock is not the company. A stock can fall sharply and persistently even if sales and earnings are growing quickly. That's especially true in a bear phase for the overall market. A good stock needs not only a good story and good numbers, but a good chart as well. One without the other two is far less reliable.
The CEO of XYZ stock, which you just recommended, just sold $2 million of his shares last week. Should I still buy the stock?Answered by Michael Cintolo, Editor of Cabot Market Letter and Cabot Top Ten Report:Simply put, insider actions (either buys or sells) have never proven to be a great indicator of future price performance one way or the other. Sure, sometimes a stock tops out after the insiders dump shares, but just about all of the big-winning stocks in history have experienced plenty of insider selling as they rose to scintillating heights.What really matters is what institutional investors think of the stock—which is why we watch the chart.
Many of your stocks have already
rallied before you recommend them. Why don't you bring them to our
attention a few months earlier, at lower prices?Answered by Michael Cintolo, Editor of Cabot Market Letter and Cabot Top Ten Report:
We don't recommend stocks earlier because guessing which stocks will
successfully rally off their lows is a low-odds play—for every stock
that comes back nicely, many more just sit there, or actually decline.
We watch stocks for confirmation of strong accumulation before we
recommend them, so you see the stocks that offer the best potential.
Waiting for the wheat to separate from the chaff allows us to pinpoint
leading stocks and avoid the thousands of laggards and mediocre
performers in the market.
Why is portfolio management important?
Answered by Michael Cintolo, Editor of Cabot Market Letter and Cabot Top Ten Report:
While finding the best stocks in the market is obviously a very
important aspect to making big money, it's just as important to know
how to handle these stocks. Those who do know how to handle them can
made big money; those who don't can make decent money. Broadly
speaking, my top portfolio management rules are
1. Cut all losses short—if you do this, it's nearly impossible to get
into serious trouble (assuming you're also adhering to rule #3, below).
2. Let at least some of your winners run—it's OK to take some chips
off the table on the way up, but you want to give yourself a chance to
benefit from a huge winner.
3. Don't risk too much—you shouldn't be risking more than 2%
(preferably less than 1%) per trade. If you buy something at 50 and cut
your loss at, say, 44 (a 12% loss)—a normal occurrence which is going
to happen from time to time—you shouldn't lose a huge chunk (5% or 10%)
of your total portfolio. If you don't cut your losses short, you can
quickly go bust during a rough patch in the market.
4. Don't risk too little—while you don't want to risk too much, part
of your goal is to make good money when you do land a big winner. If
you only have 2% of your total portfolio in a stock, why bother?
(You're not running a mutual fund.)
5. Follow the bottom line—too many investors fail to track their
accounts. Big mistake! You don't need to follow things on a daily basis
(in fact, that's probably counterproductive), but weekly or monthly
tracking will help you stay on track and know when things go amiss.
What do you make of stock price reversals on earnings reports?Answered by Michael Cintolo, Editor of Cabot Market Letter and Cabot Top Ten Report:
In general, big down openings followed by higher closes are bullish,
which bodes well for the stocks. But the bigger thing to remember is
that decisive, powerful earnings gaps (up or down)—i.e., a 10% to 15%
move through support or resistance on humongous volume—are meaningful.
The most meaningful earnings gaps are the most obvious; if you see a
stock move 20%, 25% or more on earnings, that move is likely to
continue.
Many growth stocks have great sales
and earnings growth, but also very high P/E ratios. Isn't their
growth priced in?
Answered by Michael Cintolo, Editor of Cabot Market Letter and Cabot Top Ten Report:
For growth stocks, P/E ratios are simply not an important factor in
determining future performance. Rapid growth and (most important) a
revolutionary product or service are better predictors. Eventually,
valuation will matter, but you should let the stock tell you when it
does—its own topping action will let you know it's time to move on.
Just remember that a valuation is the result of good performance, not
the cause of it.
What do you do when you buy a stock
and get stopped out because it trips your loss limit, only to see the
stock quickly reverse course and begin advancing again?
Answered by Michael Cintolo, Editor of Cabot Market Letter and Cabot Top Ten Report:
This is a good question to think about because, frankly, such a
scenario is going to happen a few times—that's life in the stock
market. Here's what I would suggest: First, make sure you're buying
properly; if you're buying a stock in the stratosphere, you're more
likely to get shaken out on normal pullbacks. Beyond that, you should
consider buying the stock back if it knocks you out but turns tail
POWERFULLY. Remember, if you got shaken out, the odds are that many
others did, too ... eliminating lots of potential resistance. So if the
stock turns around, it could be ready for a nice upmove. I know it's
psychologically difficult to do, but oftentimes, buying after a
shakeout is one of the higher-odds investments you can make. So keep an
open mind to it.
How do you handle stocks that announce new share offerings? Answered by Michael Cintolo, Editor of Cabot Market Letter and Cabot Top Ten Report:
More often than not, a strong leading stock will not break down because
of a share offering, although such stocks usually decline on the news.
And these stocks will often be "capped" in the short-term, until their
offerings are out of the way. Just make sure you're buying because the
stock truly merits your support, not because you're trying to get even.
Really, though, it's best to just watch the stock's chart. If a stock
announces a big follow-on offering and it breaks below its 50-day line,
that's bearish. But if it pulls back but remains above support, it's
usually worth holding.
What is your opinion about various stock-based indicators like MACD, RSI and Stochastics?
Answered by Michael Cintolo, Editor of Cabot Market Letter and Cabot Top Ten Report:Very good question. To be honest, I like to keep it simple—my charts just look at a stock's price history, volume history, a couple of moving averages (especially the 50-day moving average) and the stock's relative performance (compared to the market). All those "indicators" you mentioned are basically short-term overbought-oversold measures, which don't carry much weight with me. That's not to say they're totally useless, but if you're looking for intermediate- to longer-term profits, you want to know whether a stock is under accumulation or not. And MACD, RSI and the like don't help you determine that.
Should I use trailing stops? Answered by Michael Cintolo, Editor of Cabot Market Letter and Cabot Top Ten Report:A trailing stop is simply an order you place with your broker to sell your stock if it falls a certain percent off its high, or if it falls through a given price level. In general, I do believe stops are a good tool for the average investor. They will, first and foremost, allow the investor to cut losses short if his stock heads south after purchase. And they do help lock in profits should your stock, after a good advance, begin to break its uptrend. But as with all tools, the success of using trailing stops is based on the smarts of the user. Randomly placing trailing stops on a winning stock isn't a good idea; you can too easily get stopped out on normal fluctuations. I think the key to successful selling isn't having a blanket "sell anytime my stock drops 20% from its peak" strategy; the key is studying and understanding charts. If you're going to use a stop, put it somewhere that's technically relevant—having it just below the 50-day moving average, for instance, is a sound strategy. Or, if you're shorter-term, you might place it below the stock's lowest price of the past few weeks. Thus, I think stops are a good idea, especially if you can't watch the market and your stocks all day. But it's like anything else—if you put effort into learning the best methods to trail your stops, your results will improve.
What is your policy regarding naming your paid letter's stocks in the
press or in Cabot Wealth Advisory, your free e-newsletter?Answered by Paul Goodwin, Editor of Cabot China & Emerging Markets Report:Here's
the rationale: When I'm called to do an interview, I don't have a list
of second-class recommendations that I can deliver to the non-paying
public. My watch list is my watch list. When the media asks me for
recommendations, I feel that I have to give them the best stuff I have
on hand. Occasionally, I may mention a stock that I'm watching for
Cabot China & Emerging Markets Report but have not yet recommended
... but I can assure you that I'm not such a media star that it happens
often. As for Cabot Wealth Advisory, we are careful to feature favorite
stocks at least a month after we named them in the paid newsletter.
And, of course, non-subscribers don't get the rationale, the buy/sell
signals and the opportunity to ask questions.
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