Tried and True Investing Lessons and Rules
In Case You Missed It
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This month marks the three-year anniversary of Cabot Small-Cap Confidential and in honor of that, I'm going to be bringing you a multi-part series with Editor Thomas Garrity. Tom will explain how he got interested in small-cap stocks, where he thinks the market is going and some of his time-tested investing rules. I hope you enjoy it!
Question: Tell me how you got into investing, specifically small-caps.
Answer: My curiosity for investments goes back to my grandfather's and my father's influence in my early years. But my passion for investment research took on meaning when I was working part time in college. My grandfather planted the seeds for a strong work ethic in me, as he grew up an orphan and through hard work managed to own a seat on the NYSE. My dad played an equal role, imparting his knowledge by reminiscing about his days working as a chartist. So you might say that stocks are at the core of who I am; they're in my genes.
I began investing in small-cap stocks out of necessity-like most college kids, I was broke-combined with a desire to capitalize on the efficient market theory. I was looking to find a 10-bagger stock in an effort to refute the theorem that all information relevant to security pricing is known. I had a difference of opinion with the philosophy that stocks fully discount the future. But what's a college kid to do, re-write the finance text? My strategy was to take advantage of the information gap and the best place to start was in the small-cap arena.
As an investment, small-capitalization stocks represent an entire class that, over the years, has been entirely overlooked, primarily on the basis of information scarcity, in favor of mid- and large-cap stocks. So I reasoned that investing in small-caps would immediately give me a few extra steps out of the starting gate simply because they were being ignored.
Second, I had limited funds to deploy, so if I could buy 50 shares of XYZ company at 2.00 versus one share of IBM at 100, I'd have some additional price leverage. Finally, I didn't want to risk a lot of money by investing in the wrong horse, I only wanted to make a lot of money. After all, I'd heard stories from my grandfather about the stock market crash in 1929 and I knew that investing in stocks would be a risky enterprise.
Despite the ambiguity that comes from treading into uncertain waters, my first investment in a small-cap stock worked flawlessly and I was able to make a quick 50% gain on my invested capital. I've never forgotten my initial experience investing in small-caps more than a quarter of a century ago. Since then, I've been hooked on small-capitalization investing.
Question: What characteristics are you looking for in the individual stocks you recommend?
Answer: One of my investment hallmarks has always been to give Wall Street's unknown stocks a chance, and I will continue to do that by relying on the metrics that have served me well for decades. I'm forever partial to companies that have monopolistic positions in thriving industries or what I like to call pure plays. A pure play is a company with a product that has created its own category in a large addressable market, it's a company with a highly dedicated research team to develop the product, and a sales staff who will bring that product to market.
Question: What are your tried and true investing lessons and rules?
Answer: I have a lot of investment rules, but two of the most important are: "Stick with it" and "Don't be afraid to take profits." As a small-cap investor, I tend to hunker down in an investment for the long term until institutional investors discover it. I find that sometimes the waiting (which Jesse Livermore described as the way to make money) while anticipating the arrival of institutional investors can be both a little boring and thought provoking.
Let me elaborate. Small caps are thinly traded, which generally means two things: 1) Little trading activity, for the most part it's you and a few other stock research enthusiasts holding the stock; 2) Since few trades occur in these stocks, the shares tend to trade with greater volatility than mid- or large-cap stocks.
A lot of investors will sell out of a position because a stock is not moving favorably or quickly enough. The tragedy is that investors often sell out the moment the stock moves from its slumber past our purchase price, investors often sell out, missing out on tremendous moves in these stocks.
I think you should stick with the investments that you've worked so diligently to research. Know that small-cap stocks can be finicky, but that eventually you'll get paid--in some cases many fold--for your research work and tenacity.
When investors make big gains in their portfolios, they often don't want to sell out their winning stocks. But not taking profits is a foolish mistake. You've got to pay yourself for your work. Whether you're inherently stubborn or you've just acquired a taste for greed, you need to detach yourself from this dangerous trait.
The best advice I can give is, "Collect rent for time well spent." I can't tell you how many times I have had the urge to take the multi-home run stock for just one more at bat. But taking another swing for more gains is risky business and you may well end up losing the lion's share of your profits or worse.
Question: What is your favorite investment book?
Answer: How I Made $2,000,000 in the Stock Market by Nicolas Darvas
In his book, Nicolas Darvas relates how he combined both fundamental and technical analysis to select the best stocks. Darvas realized early on the power of investment themes and knew the importance of finding the next big thing. Darvas knew that having the right idea would attract the most investors to a stock and subsequently boost share price, but he also knew that it was important to leave emotions at the door. Darvas knew the importance of this investing maxim: Don't fall in love with your stocks!
I hope you enjoyed today's Q&A with Tom. I'll be back with more later this month!
To learn more about our special Cabot Small-Cap Confidential anniversary price rollback, please click here.
In case you didn't get a chance to read all the issues of Cabot Wealth Advisory this week and want to catch up on any investing and stock tips you might have missed, I have links below to each issue.
Cabot Wealth Advisory 8/30/10 - An Important Message About Fear and Greed
On Monday, Timothy Lutts wrote about why the biggest obstacle to investing success is emotions-yours and others'. Tim says that today, you should lean toward optimism precisely because so many people are pessimistic, a reason he thinks the market's next major move will be up.
Cabot Wealth Advisory 8/31/10 - Why Net Neutrality is Important
On Tuesday, Chloe Lutts wrote about the current threats to net neutrality (the principle that all Internet traffic should be treated equally, regardless of content or origin) and why it should be protected. Chloe wrote about a company that was recently featured in Dick Davis Digest that specializes in a technology that allows ISPs and others to peek at the content that travels over their networks. Featured stock: Allot Communications (ALLT).
Cabot Wealth Advisory 9/2/10 - The Importance of Sticking to Your System
On Thursday, Michael Cintolo discussed why it's important to find the right investment system for your personality and then to stick to this system, avoiding a phenomenon he calls "system drift." Mike discussed the current market conditions as well as stocks that could be leaders of the next advance. Featured stocks: Netflix (NFLX) and Akami (AKAM).
Until next time,
Editor of Cabot Wealth Advisory
P.S. Don't forgot about our special anniversary price rollback! You can profit with Cabot Small-Cap Confidential for one year for a massive $450 off the regular price. But hurry-this offer won't last long!