A Dangerous Business

 
Getting In at the Bottom (NOT!)

Appliance Complaint

A Hot Bet on a Chinese TV Stock

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I make my living writing advice about aggressive growth stocks in emerging markets, which is a fairly risky business.  I don't just mean that emerging market stocks are risky, although that's true, too.  No, even the writing part is risky.  It's not as risky as writing about penny stocks, bulletin board stocks and pink sheet stocks, but there's enough risk to make things exciting.  

It's entirely understandable that people who read my recommendations can get a little peeved when the stocks I write about go down ... and sometimes they do.  After all, I'm supposed to be an expert, and even when people understand the risk involved in investing, losing money is painful.  But one unexpected result of airing my opinions about growth stocks is that I sometimes get complaints from people even when stocks go up!

The complaints usually go something like this:  "You just recommended XYZ after it had already gone up from 13 to 38.  Why the [heck] didn't you recommend it at 23?"

The question is a fair one, but I have a fair answer.  Our growth disciplines at Cabot tell us that, in most cases, we should look for stocks that have been in uptrends for at least 13 weeks, which means there is a momentum component to our strategy.  We use a rising price chart as evidence that investor perception about the company is improving.  And the higher the trading volume during the advance, the more likely it is that large, institutional investors are providing the fuel for the advance.

Why 13 weeks?  Mostly it's just that our experience with growth stocks tells us that a stock that's been advancing for 13 weeks puts the odds of gains in your favor because the stock has a better chance of going up than a stock that's only been in an uptrend for 12 weeks, or 11, or less.  

Reasons?  Well, a 13-week advance requires that a stock successfully weather at least one quarterly earnings season.  So surviving at least one opportunity to disappoint investors is all to the good.

Also, 13 weeks up usually give a stock a chance to correct a couple of times, which will often cause pure short-term investors to bail out.  We call a significant correction to the 25-day moving average (or sometimes even the 50-day) a shakeout, because it scares away (shakes out) those who lack conviction in the stock (the weak hands).  

If you want an example of how the process works, just go to your favorite online chart facility (like http://www.stockcharts.com/ ) and pull up the chart for China Life Insurance (LFC).  Look back to October 2005 when the stock was trading at 11 on very low volume.  There had been a little movement in July and August that pushed LFC up to 12, but it quieted down quickly.

The real action started on December 1, 2005, with a push above 12.  Thirteen weeks later on March 2, the stock closed at 17, down a little from its high of 18 earlier in the month.  At that point, the Cabot growth system would have put its stamp of approval on the stock despite its advance of over 40%.  And those who had jumped on the stock and held on until the top (107 in October 2007) would have reaped a reward of 530%.

At least in a perfect world, that's what would have happened.  

In the imperfect world that we really live in, I didn't actually recommend LFC until it was trading at 25.  And that, to return to the original point of the story I'm telling, is when I received a spate of notes from subscribers asking why the [heck] I hadn't recommended the stock back at 12?!

LFC hit a climax top at 58 in January 2007 and the portfolio sold for a nice profit.  The correction following the climax took a nearly 40% bite out of the stock, dropping it to 36 before it got back on track.  It later made a nice run and peaked at 107 and the Cabot China & Emerging Markets Report portfolio made another nice profit on that upleg as well.  

The takeaway from all this is that buying a stock that has already enjoyed a big advance may seem counterintuitive.  But in fact, the circumstances that have been pushing a stock up are exactly the ones that will keep pushing.  Now all you have to do is figure out the actual buy point, which is something I'll discuss in a future issue.

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I have a complaint to get off my chest, so I hope you'll bear with me.  

My wife and I bought a new refrigerator in 2005, finally replacing the one we'd owned since our graduate school days.  Even after 35 years, the old one still worked!  But it wouldn't fit into our new kitchen scheme.  

So we confidently bought a new one (same good, old U.S. brand of course!) and settled in for another 35 years of faithful service.  But that's not how things have turned out.

Two weeks ago, the power to the ice maker and the lights in the freezer flickered and went out.  Then we began to smell an electric odor and heard the sound of something arcing under the unit.

With visions of electrical fires dancing in our heads, we unplugged the fridge and started transferring our frozen and refrigerated goods to a friend's house.  We called the manufacturer's toll-free number and got the name of the local authorized repair shop, called in our problem and waited for the service guy.

When the repairman showed up, he quickly found a loose wire near the compressor that had been arcing into the water in the evaporation pan.  It looked like all he needed to do was re-connect the wire and everything would be good to go.

Not so fast.  

It turns out that just reconnecting the wiring wouldn't be allowed by safety codes.  Further, the wiring for the refrigerator is foamed into the case, and can't really be replaced.  So what we needed was to replace the refrigerator because a wire came loose.

It looks like our local dealer, the one who sold us the unit in the first place, is going to try to make good on the problem, which is very nice.  It's actually why we bought local in the first place.

But for the refrigerator maker whose shoddy wiring came loose and the authorized repair shop who took our money but declined to fix the problem, my wife and I have nothing but nails to spit.  When we checked online to see if anyone else had experienced this kind of problem, there were dozens of similar complaints.

There's no moral to this story, although I'd love to blow the whistle on an American appliance maker that has dropped its quality standards, outsourced its complaint process and keeps touting its dependability while declining to stand behind its goods.

I'm not a cynical person, but I'm getting there.

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Back in February 21, 2008, I wrote about an interesting stock for Cabot Wealth Advisory.  The company was China Digital TV (STV), a maker of hardware and software that control access to digital content on Chinese televisions.

Here's what I wrote at that time.  You can read the whole write-up here: http://www.cabot.net/Issues/CWA/Archives/2008/02/Market-Bottom.aspx

I wrote about the company's great revenue and earnings performance and then said: "The problem is that none of this strong performance has yet shown up in the stock's chart. STV nominally came public at 16 in October 2007 (although it never traded below 26 at its IPO) and then rose as high as 55 in a week. But the end of the year was a rough patch for many stocks, and STV dropped as low as 19 in January before a February rally that has lifted it into the mid-20s."

I didn't recommend putting any money into STV then, but the story was hugely attractive, and I'm intrigued that the company's chart has improved significantly.

On the day I wrote about STV, the stock closed at 23, but was in a pronounced downtrend.  It continued to decline, finally bottoming at 4 in December, along with the rest of the global market.

STV has now recovered significantly, but it's not going to be an easy stock to handle.  In May, it blasted off from 8 to 12 in just a couple of days, then gapped right back down to 8.  Since then it's been much better behaved, rising in an orderly fashion from 8 to 9 with a few good-volume up days to show that institutions may be in the buying mix.  

I know that there are other China advisors who are teasing STV as the next big thing, holding out the promise of huge gains.  And it's possible they're right.  But you should keep in mind that this is a high-volatility issue (both low-priced and thinly traded), and can jump down just as easily as it jumps up.

As I also wrote in February 2008, "STV is a good stock to have on your watch list at this point, a fascinating opportunity with huge potential. It's also a good reminder that story and numbers aren't enough ... you also need the chart."

With the chart finally showing some strength, aggressive investors may enjoy taking a run at this hot issue.

Sincerely,

Paul Goodwin
For Cabot Wealth Advisory

Editor's Note: Cabot China & Emerging Markets Report, under the expert stewardship of Editor Paul Goodwin, was recently named the top-performing newsletter for five years, trumping the market and over 100 other investment advisories. The emerging markets are growing far faster than the U.S., providing ample opportunity for early investors. Let us be your guide to the huge profit opportunities in the emerging markets. Click to get started today!

http://www.cabot.net/info/cem/cemjd00.aspx?source=wc01

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Paul Goodwin can be found on Google Plus.

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