The Big Money is in the Big Swing
Aggressive Aggressive investing approach
Dunkin’ Brands (DNKN)
Back on April 12, I wrote a Cabot Wealth Advisory titled “The Conservative Aggressive Investor,” in which I discussed a couple of portfolio management techniques (specifically position sizing and offensive selling) that allow investors to benefit from investing in dynamic growth stocks ... while avoiding some of the tedious drawdowns and painful periods that come when those same stocks go downhill.
Today, as promised in that issue, I am going to switch hats and write about what I call the Aggressive Aggressive approach, which is built around the idea that the goal isn’t to be right—it’s to make big money when you’re right.
The Aggressive Aggressive approach essentially revolves around averaging up in price—that is, adding more shares to your original purchase if and only if the stock goes up, allowing you to build a big position. If it doesn’t go up, you don’t buy any more ... and you might even sell some if the stock stagnates for too long.
There are any number of ways to structure this (I’ll get into a few examples below), but let me give you the gist of it via a conversation I had with Carlton Lutts, Cabot’s founder and a great aggressive investor:
“I like to set up what I call a horserace. When we get a new market buy signal, I might buy small positions in three or four stocks, possibly 5% of my portfolio or even less in each stock. Then, if one of the stocks goes up a few points, I buy another few percent; I might repeat that up to four or five times until I have my full position ... but only if the stock continues to go up! Many of the stocks might go up a little or not at all. Over time, I tend to feed more money into my best performer or two, while paring back on the laggards or selling out altogether. This way I can maximize my best performers.”
In practice, here’s how the Aggressive Aggressive Investor approach usually works: The investor will set a target position size relative to his overall portfolio; it’s often a good-sized amount, say, 15% or 20% of the account. Then he’ll break that total down into two, three or maybe even four pieces—in other words, you want to average up into a large position over three or four purchases. Usually (but not always) the biggest piece will be your initial position, followed by smaller and smaller pieces as the stock advances.
For example, you might target a 20% position on a stock if all goes well. (I am just picking that number out of thin air; it could be 12% or 25%, it really depends on your risk tolerance.) Then you might structure your purchases by buying, say, a 10% position initially, followed by a 6% add-on, with a 4% add-on after that.
As for when to make your add-on purchases, that’s a difficult question; there’s no one-size-fits-all answer because each stock has its own personality and volatility. But the goal is to average up relatively quickly—assuming your original buy point was a good one, you don’t want to wait until a stock is up 10% or 20% before buying more. Usually a few percent in between each buy is enough.
There are countless ways to structure your trades; it’s really up to you to choose the amounts and proportions that work for you. Sticking with the 20% position size example (which is a very aggressive target), maybe you want to do it like Carlton and go 5%-5%-5%-5%. Maybe you want to keep it simpler and do something like 12%-8%, planning on just two purchases. Or maybe you want to do something in between, like mentioned above (10%-6%-4%). There’s no perfect method, it’s really about what works for you.
Important note: Remember that every time you average up, you’re raising your cost basis in the stock ... so you also have to focus on where you’ll place your stops (mental or in the market) and know how much risk you have on the table.
Whatever the details, the Aggressive Aggressive Investor approach has many advantages. The most important is that you’ll have the most money invested in your biggest winners and the least amount invested in your worst choices (those that head south right after your purchase). If you believe that investing in growth stocks is really a game about outliers (big winners and big losers), then this approach seems tailor-made, as you’ll have relatively small initial risk, but the chance to land some outsized winners.
That said, you should also be aware of pitfalls to this approach. Mainly, since your cost basis in a stock will rise every time you buy more, it can be more difficult to hold on to a stock. For example, let’s say you started buying a stock at 100, then bought more at 105 and more still at 110. That means your cost is probably in the 103 to 104 range.
So if the stock pulls back from 110 to 104, you’re basically at breakeven (instead of a four-point profit) ... and that can lead to some tough decisions. You might find yourself knocked out of a stock on normal weakness, only to see it motor higher from there. And, of course, even if you do have a good profit, a sharp drop in a stock in which you have a huge position can rattle the nerves
Hence, this approach requires a lot more thinking and preparation—not only are you going to be more active (buying more than just once) but you’re also going to have to be aware of your new cost basis and how to adjust your stops.
Possibly most important of all, you’re going to have to be mentally tough—this method isn’t geared to take advantage of small-ish winners (5% or 8%), so you might see many of those types of trades actually result in breakeven trades or even small losses. Instead, this method is geared around extra-base hits—finding stocks that can make significant moves over many weeks or, hopefully, months. Be aware that in a choppy or slow-moving market, that can be somewhat difficult to do.
That said, I really do believe that the Aggressive Aggressive approach can yield outstanding longer-term returns ... possibly the best of all trading systems. The gains come in big bunches when you find a few good stocks! Of course, with higher returns comes higher risk, but it’s all about having the proper mental make-up and discipline to execute the plan.
As for the market, bulls finally were able to make a little headway on Wednesday, with the market gapping up and rallying back above the lows it set in mid-May. After such a battering during the past five weeks, it’s good to see—and the fact that investor sentiment is in the ditch (by one measure, investment newsletters are at their most underinvested position since March 2009, and in the bottom 4% of all readings since 2000!) means it’s possible that we’ve seen a sustainable low to this correction.
However, I don’t like to invest on “possible.” The intermediate-term trend is still clearly down, as all the major indexes, even after the bounce, are still 2% to 3% below even their shorter-term (such as the 25-day) moving averages. And, even if the market handles itself well from here, some time will be needed for many stocks and sectors to tighten up again.
All in all, I’m hopeful that the 10% haircut the market has taken means the correction is close to an end, but as always, I need to see far more evidence before starting a new buying spree. Thus, I’m more focused on fine-tuning my watch list (updating potential buy points and stop-loss points, listening to company presentations, etc.).
In compiling my a watch list during a market correction, I like to give stocks long leashes—it’s not just the chart, but the combination of a stock’s movements relative to the market along with the firm’s fundamentals and growth outlook.
One name I keep coming back to is Dunkin’ Brands (DNKN); to be clear, it’s not a fast-moving stock that I expect to be a huge winner. However, don’t let that turn you off—DNKN is a newer stock (public since last July) that has a well-established business and a big international opportunity. Here’s what I wrote about the company in Cabot Top Ten Trader this past Monday:
“National Donut Day was just last Friday (June 1), so Dunkin’ Brands should be on everyone’s mind. With more than 10,000 Dunkin’ Donuts locations and more than 6,700 Baskin Robbins ice cream shops in 56 countries worldwide, Dunkin’ Brands is a giant in the quick service restaurant business. In addition to donuts, Dunkin’ Donuts locations serve bagels, hot and cold coffee and other baked goods, while Baskin Robbins specializes in hard-serve ice cream. The company is nearly all run on a franchise basis, and franchisee sales amounted to about $8.4 billion in 2011. The push for wider distribution has led to the establishment of kiosks and mini-stores within other retail spaces, gas stations, hospitals and airports. Dunkin’ Brands hit a home run with its Q1 earnings report that was headlined by a 213% gain in earnings per share on a 9% increase in revenue. After-tax proﬁt margins topped 20% for the second straight quarter. Baskin Robbins has been making ice cream since 1946, and Dunkin’ Donuts made its ﬁrst donut in 1950. Together, they’re expanding internationally with great success.”
As for the stock, it’s impressively remained above its 50-day moving average for all of this year (excluding a brief shake below it last Friday), and has tightened up between 31 and 34 since late-April. It’s a sign that big investors are accumulating shares during this market maelstrom.
You could buy a little around here with a super-tight stop around 30 or 31, but my advice is to just watch it, and if the market confirms a new uptrend, look for a powerful push above 34 as your signal that the next upleg has begun.
All the best,
Editor of Cabot Market Letter
Editors Note: Mike Cintolo is editor of Cabot Market Letter, which Hulbert Digest (the keeper of the keys of newsletter performance) just announced was the second-best-performing newsletter in the country during the past five years. Mike has produced such returns by fine-tuning Cabot’s time-tested (since 1970!) stock picking, portfolio management and market timing rules to guide the Market Letter’s Model Portfolio—a concentrated portfolio of the market’s most dynamic growth stocks. If you’re tired of being tossed around by the market and want to follow a proven editor with a proven track record, I highly recommend giving the Cabot Market Letter a try today.