2. Market Timing—A stock, like love, thrives on romance and dies on statistics.
We've all experienced romance in our lives. It's full of intangibles and mystery. It can be exciting, with even your greatest expectations exceeded. And pleasant surprises just keep coming, often times convincing you that the good times will never end.
Most people relate romance to a real life relationship of one kind or another. They truly feel all of the emotions listed above, both in their minds and in their hearts. Thus, considering that growth investing is as much a product of psychology as it is fundamentals, it should be no surprise that we see romance in many individual stocks as well.
Where do we find this romance? For the most part, it's concentrated in the market's highfliers including some of our Cabot Market Letter recommendations. Thousands of investors simply cannot understand why certain young growth stocks (some of which we profile in our publications) soar month after month to astronomical valuation levels for no apparent reason. More often than not, these stocks have growing sales but no earnings. Also, the product or service offered is usually not well understood by the masses. Yet, despite little fundamental improvements and even less concrete information, the stock continues to advance past everyone's wildest expectations.
How can this be? And old Wall Street adage, one that we've found as useful as any, explains this phenomenon: A stock, like love, thrives on romance and dies on statistics. There are plenty of investors out there who are able to understand the long-term potential for the aforementioned growth companies. These investors see something exceptional and even revolutionary that other investors miss, and are willing to buy and hold onto the stock, even at prices that appear to be completely unreasonable and unjustifiable to other investors. It isn't until much later that the romance fades. At this time, the mystery and sexy expectations are replaced by cold, hard facts. This reality, even though it may be exceptional, seldom matches the dream. Reality, in fact, tends to suggest limitations. And that's when the early investors usually jump ship, pushing the stock down and ending its run to record heights.
So how does all this help you make money? Our studies over the years have convinced us that you can make a great deal of money from a stock in its Romance phase, before most investors realize the full thrust of the company's story. If you wait for reality and a slew of fundamental facts (like growing earnings and a knockout of all competitions) to pour in, chances are you're too late; the stock has already discounted the great news you're now reading!
Thus, our advice is to look for exciting growth companies that are presently in their Romance phase. Once invested, your job is to exit your position at the end of the stock's Romance phase, when frankly, all of the news is usually excellent. The fundamental facts will begin to support the stock's lofty stock price, and investor sentiment regarding the company will be outstanding. However, you'll notice the stock and relative performance (RP) line gradually eroding, unable to reach new highs. Over a period of weeks, if the RP line falters, you'll know the romance has ended, and reality is taking over. It's at this time you want to sell the stock and look for your next love affair.
Lesson 3. Selling Stocks
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