Learning the Rules
All That Glitters ... Sometimes It's Actually Gold
Every January, I track down the list of the top-performing stocks from the previous year. I like to figure out the stories that catapulted these stocks to such strong performances. And yes, I like to torture myself with the possibility that there was an opportunity there that I might have been able to grab a piece of.
The list for 2009 is a powerhouse; just to make the top 15 in performance terms took a price advance of more than 1,000%!
The number one stock of 2009 (the rules require that the stock currently sell for more than $2 and trade more than 50,000 shares a day) was Select Comfort (SCSS), with a price appreciation of 2,508%! Now that's the kind of performance that gets an investor's attention.
But it's not a simple story.
Back in 2006, SCSS was a perfectly healthy stock, reaching a multi-year high of 29 in April of that year. By the beginning of 2008, the stock had fallen to 7 and by the beginning of 2009, it was all the way down to $0.25 a share. The stock ventured even lower in March, falling to as low as $0.20. The stock finally poked its nose above the magic dollar-a-share level in April, but promptly pulled back through June and July after the company got a $35 million cash infusion (and a $70 million line of credit) from a private equity firm in May.
In late July, after a vigorous round of closing underperforming stores and cutting other costs, Select Comfort scored a big coup with a Q2 earnings report that came within an eyelash of profitability. That was enough for investors, who pushed the stock from 1 to 2 in four days, then to 3 in August, 5 in September and 6.5 by the end of the year.
The other stocks that scored advances of more than 2,000% in 2009 had their own stories, but I can't talk about all of them here. You can look them up: China AgriTech (CAGC), Dollar Thrifty Automotive Group (DTG) and Vanda Pharmaceuticals (VNDA). (If you want a list of the entire top 15, reply to this email and I'll send it to you.)
While it's fascinating to torture myself with these stories, since I don't have access to a time machine, I can't make money with them. China AgriTech traded as low as 1.12 on January 2, 2009, and finished the year at 27.95 for a stunning gain, but that won't help me the next time I open my online trading account and try to figure out what to do.
I have two lessons to draw from these tantalizing returns.
The first lesson is that there is no substitute for buying well. The top stocks from any year often start from depressed price levels. And if you can pick a penny stock that makes a big run, it can make your year.
Cabot China & Emerging Markets Report, which I write, won't ordinarily look at a stock that trades under 10 (and prefers them to be trading over 13), because the volatility that can drive huge gains can also lead to enormous losses.
But if you can't luck into a low-priced diamond-in-the-rough or jump into the market right at the bottom, you can buy a good stock on a nice pullback of a few percentage points or move back into stocks soon after a recovery begins. Do this, and you can reap big benefits and boost the odds of long-term success.
The second lesson is that, by contrasting these outsized 2009 returns with the more subdued top performers of 2008 (the year's best return was the 415% bump booked by Emergent BioSolutions (EBS), you can see that there is no substitute for a supportive market environment.
The deluge that produced the Big Bear Market of 2008 didn't sink every stock. But it turned the odds of success heavily against investors and put a serious brick on the head of even the stars for the year. The best performer from 2008 wasn't even close to making the top 15 for 2009.
That's why Cabot growth newsletters like Cabot China & Emerging Markets Report, Cabot Top Ten Report, Cabot Green Investor and Cabot Market Letter (which was just named one of the top 10 market timing advisories for one-, three-, five- and 10-year periods by Timer Digest) all use market-trailing timing techniques to get our readers out of dangerous markets and into cash when conditions deteriorate. They also tell investors when to put their money back to work when markets turn up.
Cabot China & Emerging Markets Report is currently the #1 ranked newsletter for the last five years, according to Hulbert Financial Digest. And market timing is a big part of its success. If you'd like to have a reliable partner to advise when you should be avoiding the market, you can click below for a no-risk trial subscription.
When I was at the Large Boston Investment House where I was initiated into the investment fraternity, I was very much aware--at first--of how little I really knew about investing. (The more I learn, the more I realize that even people who spend their lives studying investing never learn it all, but that's another story.)
My ignorance wasn't really surprising, since nothing in my earlier life had required such knowledge. Like most college teachers, I had just shipped my monthly pittance off to TIAA-CREF and forgotten about it. (When TIAA-CREF used to advertise themselves as serving people "with better things to think about," I thought it was funny, but I also didn't think about it.)
In short, I was a completely naïve and unsophisticated newbie, and I was at the mercy of the last person I talked to.
When I talked to value managers, their strategy made perfect sense to me. I'd hear "find strong companies whose stocks are trading at a substantial discount to their intrinsic worth and look for catalysts for change that will improve investors' perceptions." It's the classic "cheapness and change" mantra, and it made sense to me.
Then I'd talk to technical analysts, and their mastery of reading stock charts made sense to me. They'd talk about support and resistance and volume and cups-with-handles and it sounded like they had the keys to the city. Perfect.
Then the fundamental analysts would get their hooks into me, and that made sense to me too. After all, they'd say, it all comes down to the bottom line, and they'd show me revenue and earnings trends and projections based on market analysis and demographics and analysts' estimates. It's all about the numbers, and numbers don't lie.
I also took a long walk in the world of fixed income securities, but I can't really write about that or I'll have a flashback and have to stop. Bonds are a world unto themselves.
It wasn't until I came to Cabot that the truth finally dawned on me. It wasn't the case that any of those approaches to stock investing was right and the others were wrong. You could make money using any of them.
What was really at issue in the big debate was whether any of the methods of stock analysis could get closer to The Truth than the others.
And The Truth was confidence or certainty or conviction or whatever you want to call it. The real question was whether one method of stock analysis could approach certainty.
But none could.
About the best any analyst could come to predicting whether a particular stock (or industry or sector or country or index) would beat the Wilshire 5000 Index (the Index that represents the entire U.S. equity market) was around 50%.
In fact, we used to say that if any equity manager could pick 51% winners consistently, he (or she) could rule the investment world!
The only truth I've been able to find is that the factors that move stock prices up or down are too various and unpredictable to be reduced to a set of written-in-stone rules. And in the final analysis, a 50-page analysis of every fact in the know universe about a particular company and its stock isn't much better as a guide than a page or two of good solid analysis. If longer were better, stock recommendations would reach book length in no time.
Any stock analysis that gets to 60% validity has done its job. Then it's your turn.
You have to buy well, cut losses short in the ones that don't work and let your winners run. And you need to have the general trend of the market on your side.
Ultimately that's what we preach at Cabot. And if it's more applicable to growth investing than other styles, well, that's where I came down anyway. I'm no thrill seeker, but I get more juice out of the growth style than any other.
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In the spirit of broadening my horizons to beyond strictly growth stocks, I'm going to quasi-recommend a stock that has been correcting since last September. I really admired Fuqi International (FUQI) as it roared from 3 in March 2009 to 33 in September, but I never found the right buy point for the stock.
The story is a good one, as Fuqi International is a Chinese jewelry company that sells mostly gold jewelry to wholesalers, who then retail it within China. The appetite of Chinese consumers for gold is a long-standing taste, as many Chinese families regard gold as a suitable way to safeguard family wealth. Buy when times are good; sell when times are bad.
Times have been quite good for Fuqi, which reported a 135% jump in earnings in Q3 on a 36% gain in revenues. The after-tax profit margin was 14.8%. The roster of institutional investors has climbed from 17 in Q2 to 46 at last count.
I don't usually recommend stocks that are in downtrends, but I've always been fascinated by the Fuqi story. With a P/E ratio of just 8, this looks like a great buy here, with two caveats. First, the stock needs to find some support and build a credible base before it can begin to advance. Second, the company's Q4 earnings report (which hasn't been scheduled yet) needs to show positive results.
If FUQI can stop falling and get support from a good earnings report, it can be a real powerhouse. Just don't forget the "if."
For Cabot Wealth Advisory