If I Had to Pick One Stock…
Let Winners Run; Cut Losers Short
Heavy Metals Stocks with Clean Hands
When I’m talking to subscribers about the stock picks in the various Cabot newsletters, I often hear the same question. After talking about the various stocks that a particular publication is actively recommending, the subscriber will get cagy and ask: “So, if you had to buy just one of these stocks, which one would it be?”
It’s a tough question, but maybe not for the reason you think.
As you probably know, growth investors use concentrated portfolios—as few as five or 10 stocks—to get the maximum boost to results that a big winner can bring. A couple of stocks that go on a tear will usually provide the bulk of your gains for the year. Contrarily, a couple of big losers can turn your yearly results into a big splat of red ink.
Growth investing is the equivalent of a baseball power hitter. You get lots of strikeouts, but when you connect, you put points on the board. The key is getting good pitches to hit and then swinging away.
But there are lots of people who really can’t stand the idea of a stock that they have bought declining in price. It makes them feel miserable, even if a vast majority of their stocks are doing well.
These people want to believe that there is a way to pick stocks that will reduce the risk of suffering a price decline to zero. And they’re willing to accept tiny returns in exchange for losses that are as close to zero as possible. And they think that I must, in my heart of hearts, have some little insight or nugget of information or analysis that I’m not sharing that would allow me to pick the sure winner from a group of attractive candidates.
It’s a natural assumption. After all, I am an expert, so I must be surer about stock picks than the average investor. It’s the same way I feel about an auto mechanic or an appliance repairman. I’m paying them to know more than I do.
So I don’t really blame the people asking for “just my top pick” for asking. But it’s sometimes hard to get them to understand why I can’t really give them a straight answer.
Here’s the best I can do. All of the research in the world can’t produce certainty in the investment world. There are just too many variables, both concrete ones like weather and natural disasters, and big abstract ones like investor confidence, fear and greed and social contagion.
In the centuries that have passed since the first stocks were traded in Amsterdam in 1611, some of the smartest people in the world have spent untold hours, days, weeks, months and years trying to find the key to making big money with no risk.
They’re still looking.
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The cold, uncomfortable fact remains that every investor must make a choice between making small money with no risk (U.S. Treasuries) or scaling the risk ladder in search of higher gains.
The capital markets involve millions of people from the bluest of blue-chip investors to the squirreliest of penny-stock chancers as well as thousands of investment houses, hedge funds, private equity firms, investment banks, endowments and pension funds. And by their inclusion of every level of risk tolerance, from irresponsibly aggressive to totally timid, these markets, collectively, can calculate risk down to more decimal places than you have fingers on your hands.
So the best I think you can do, at least in the kind of individual stock investing that Cabot growth publications address, is to find a group of stocks that look to have a good chance to perform strongly, then limit your downside risk by using strict sell disciplines.
If you buy 10 stocks, some will prosper and some won’t. Let’s say that three of your stocks go into a death spiral and you cut them loose. Then three of them just sit there, and you hold on until the chart tells you that they are lagging the market and then you sell. And three of them may make small advances, and you hold onto those. And then, possibly, one of your ten stocks will catch a real updraft and head for the rafters.
If you had just let your 10 stocks run their course without sell disciplines, your losses would have eaten up your profits and your results would have been dismal.
But if you had cut your losers short—Cabot’s growth disciplines specify a maximum loss limit of 20% from your buy price—and let your winners run, you would have a good chance to make money for the year. And sometimes, when the markets themselves are in a bullish mood, you will make very good money indeed.
So, my advice is to stop looking for the one, perfect stock that is a lead-pipe cinch to make you money. The stock hasn’t been found that can’t go south at a moment’s notice.
And it’s certainly not something that you should ask me for. I make money by following the rules, just like everyone else.
With gold back near new highs, interest in miners is extremely high. Gold mining companies can get a boost from higher prices or unexpected discoveries.
But the downside of mining stocks is also significant. I remember the flooding that took Cameco’s Cigar Lake uranium mine out of production for several years. The fallout (sorry) of this unfortunate occurrence was severe for both Cameco and the price of uranium. And other mines have been hit by labor disputes, cave-ins and cash crunches.
My favorite approach to mining stocks is to find companies that stand to benefit from the rising price of metals without the risks of actually digging in the dirt. I call them clean-fingernail miners, and I know of two.
The first is Royal Gold (RGLD), a Colorado-based company that buys royalty positions in precious metal mines around the world. The company’s 39 producing interests produced an 85% jump in revenue in 2010 and 59% in 2011, when gold prices were appreciating steadily. That revenue growth slowed to 22% in 2012, but a new rally in gold prices that began in August has the potential to kick Royal’s revenue stream significantly higher. In addition to its producing interests, the company has a string of 26 development-stage interests, 40 evaluation-stage interests and 88 exploration-stage interests. Whatever the price of gold, Royal Gold’s lower cost per ounce to acquire its royalty interests will keep its performance ahead of its dirt-digging partners.
The second company is my old friend Silver Wheaton (SLW). The company buys purchase agreements with mining companies, many of whom are happy to have the cash infusion to finance mining operations, and gets the rights to the metal at a discount. Silver moves largely in parallel with gold prices, but the industrial uses of silver give it a longer-term stability. As of the end of 2011, Silver Wheaton owned proven and probably reserves of almost 800 million ounces of silver and 220,000 ounces of gold.
Of the two companies, Silver Wheaton has always been a favorite of mine for the consistency of its management’s skill at negotiating profitable agreements. Silver Wheaton is also larger (market cap of nearly $14 billion versus Royal Gold’s $5.73 billion) and pays a bigger dividend (trailing dividend yield of 0.90%, compared to Royal Gold’s 0.60%).
Personally, precious metal investments involve a little too much crystal ball gazing for me; I don’t think I have much insight into how the global economy is likely affect gold and silver prices. But with price momentum pushing both metals higher right now, a little position in either SLW or RGLD makes good sense.
All the best,
Editor of Cabot China & Emerging Markets Report
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