Small-Cap Confidential FAQ

Q: How should I systematically use Cabot Small-Cap Confidential to invest? (Do I invest a little in every recommended issue, etc.?)

Thomas Garrity: I'm pleased to share the investment management style that I've developed over many years and has helped me capture profits in small company stocks. 

To start, I recommend Investing in stocks that coincide with your risk profile. Not every stock in Cabot Small-Cap Confidential will match your investment objectives nor will every one become a home-run. Read each new stock profile carefully and evaluate its investment in relation to your other stocks. 

Here are some tips for getting the most from your small-cap investments:

  1. Take Partial Profits

    I've found that a key to better performance is to take partial profits on some winners. In the past, a number of my stocks went around the world: a 100% gain turned into a 25% gain—which is something we want to avoid, so I advocate paying yourself.

  2. Follow Advice in the Weekly Updates

    I also advise taking advantage of the timely trade advice mentioned in the weekly updates. Pay attention to phrases like "This is a strong buy", which generally means the stock is set up to possibly make some easy gains. In the event of a price decline, "Accumulate more stock here" may be an attempt to reduce the cost basis (perhaps because the market has overreacted to news or corrected as a result of profit taking or general market action).

  3. Allocate More Funds to Your Strongest Stocks

    In cases when you're comfortable with a company and knowledgeable in their business, build large positions in the stock. Generally, I recommend allocating more funds to stocks that are showing strength (consistency in their price movement).

  4. Selling Some of Your Top Stocks and Laggards

    When a stock goes up say 50% or more, take some profits and redistribute them in your other strong stocks. As for underperforming stocks, make partial sells and re-allocate your funds to stronger candidates.

  5. Write Options

    Lastly, write options against your positions when available to generate income and improve overall yield.

Q: As expected with some of the small caps that I have seen you recommend, the volume is quite light and the bid/ask spread is substantial—especially if the stock is low-priced. If I want to buy $15,000 worth of a 1.50 stock, how do I buy 10,000 shares without dramatically affecting its price?

Thomas Garrity: First, a habit you should get into is buying stocks off the bid versus the ask side of the spread. Second, consider building your position in a stock on days when the share price is under pressure. Third, use multiple buy orders rather than a lump sum. Finally, enter your stock orders with bid limits. Run your trading like your business—on your terms and be diligent.

 

Q: What do you mean by your term, "crossover"?

Thomas Garrity: 99.9% of the time, a crossover means that when the stock breaches that price point, consider adding more stock or initiating a position. So if stock is at 4 and crossover is at 4.20, you should buy the stock when it's price rises over 4.20.

 

Q: What characteristics are you looking for in the individual stocks you recommend?

Thomas Garrity: One of my investment hallmarks has always been to give Wall Street's unknown stocks a chance, and I will continue to do that and rely 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. Second, I seek companies with highly dedicated research teams to develop the products, and sales staffs that will bring the products to market.

 

Q: What advice would you give someone who is ready to start investing in small companies?

Thomas Garrity: Set up some clearly defined investment rules for stock investing, such as

Make certain the company you're considering has enough capital to run its operations for many years and its balance sheet is (for the most part) debt free.

Time your investment with a company-specific event.

Get into a stock before institutional investors become aware of it.

To the best of your ability, ensure that your investment has the highest probability for success. The proof will come from doing research and assessing data. Any company can fail, big or small, you just want to try to avoid being a shareholder when that happens.

Only put capital to work in a stock that correlates with your investment risk tolerance and timeline.

Lastly, become committed to your investment, which means being comfortable with market volatility, and also having the patience to let it succeed.

 

Q: What is Cabot Small-Cap Confidential's sell strategy?

Thomas Garrity: I stick with a position in a stock until A) profit objectives are met or B) the market deteriorates or C) the management of a company gets stupid or greedy.

Here's how I deal with a stock that has appreciated more than historical market returns: If the stock is up 50%, I take one-third to one-half of my original core position to bank profits and hold the rest until A, B or C above.

If a stock exhibits a loss beyond a normal loss threshold, I'll tolerate the loss (on paper) if nothing has changed fundamentally with the company or the markets they address. If the company's balance sheet is strong, and it has key products and good management, the stock will eventually come back into favor. And I also always remain aware that every stock eventually disappoints.

 

Q: Do you use stop-losses?

Thomas Garrity: In certain instances, I recommend stop losses—usually to protect a large profit—but it's important to remember that stop-losses can work both ways. For example, we were stopped out of MAKO and EZCH, only to have share prices go higher. Conversely, stop-losses performed well with other holdings.
 
We expect our stocks to routinely encounter very strong price fluctuations. We are longer-term investors, and so we maintain each position until we're convinced the company or the market it serves will not support our growth expectations. We expect to own a number of stocks that will go up significantly in price and we expect there will be stocks in the portfolio that will show losses (although we also expect our gains to more than cover our losses).
 
To increase our chance of overall success, we take small profits on leading stocks and re-allocate those dollars in stocks just beginning to show price strength and stocks which have fallen deeper into undervalued situations.

Q: How does the economic climate factor into your stock picks and outlook on the market?

Thomas Garrity: I'm a research junkie, so the company and its industry are foremost in my mind when I'm selecting stocks. However, I have an affinity for stocks that are not bound to economic cycles, so the economy isn't a huge factor. Being invested in small-cap stocks doesn't fully protect me from economic swings, but if I've invested in a young company with the right fundamentals, I stand a good chance of avoiding most of the market-based volatility.

One thing I pay close attention to is the IPO market, which gives me an indication of how much money is flowing into stocks with new ideas. What is key with small-cap stocks is that the product and message line up with the market perceptions, despite economic events. Otherwise, the maturation of such investments will be prolonged and investors will be taking a bigger risk. At the end of the day, I do consider the economy as I pick stocks, but I don't let it affect my decisions too much.

 

Q: What sectors are you more interested in? Why?

Thomas Garrity: I've always been interested in technology and medical stocks and more recently, I've been increasingly drawn to alternative energy stocks. Technology stocks have historically had little trouble drawing investors to them, probably because they have a high potential for appreciation. It can be tedious to wait for investors to recognize the value of a technology stock, but once they do, these investments can be very profitable.

If you look at great companies, like Apple and Cisco, you'll see that each started out very small. What enabled them to grow by great leaps and bounds was their inventiveness and vision. In some cases, they designed their products ahead of actual customer demand, defining an industry niche by the time people caught on.

That's the beauty of a small-cap investment; there's a great deal of patience involved waiting for the stocks to appreciate, but when they do, the rewards can be enormous. Putting aside economic woes, technology companies and their products will almost always be in demand, since change is what brings about growth in the overall economy.

Like technology stocks, medical stocks offer the possibility for unusually large upside potential. The same opportunistic characteristics apply, the only difference is that the medical sector is subject to regulation.

The sector I'm most excited about right now is alternative energy. This sector can include such diverse areas as electric vehicles, efficient building materials and lighting and bio-fuels derived from waste. The bottom line here is that these industries are tapping into areas that we as a society need to engage in. They are creating jobs, lowering energy costs and lessening pollution. As an example, building an electric vehicle plant creates jobs, reduces dependence on oil and improves air quality.

Q: You encourage profit taking along the way when stocks bound up.  If your shares of stock X are up 55%, how do you approach a sale? What percent of shares do you sell? Why sell? When people sell under these circumstances, do they turn around and buy a different stock? Is it always a good idea to do this?

Thomas Garrity:
Selling is the hardest thing to do (buying is much easier!). Personally, I'm a scale investor, so I try to build a huge position in a stock before others come to nest. When the stock goes up say 55%, I consider selling a portion of the stock (as the easy money has already been made). I consider several factors to determine how much stock to sell including the strength of the stock’s fundamentals and technicals. (For example, if the story is still great, I may sell a quarter of my original position.) After a profit-taking and/or price consolidation period, I might consider putting those monies back into the stock—or I might decide to put the funds into another stock that’s equally attractive on the fundamental/technical side, but is still undiscovered and/or undervalued.


Stock Picks

Tesla Motors

If Tesla ever begins to cut back on development and innovation costs, earnings will soar.

Alibaba

China seems to be raising up its very own version of Amazon in Alibaba (BABA.

Facebook

Roy Ward uses the PEG ratio to determine if the stock is undervalued or overvalued.

Cabot Wealth Advisory

Three Vital Tips for the Chinese Stock Market

By Paul Goodwin on September 30, 2016

As U.S. stock markets continue to drag, the Chinese stock market is an ideal alternative for growth investors. Here's how to find the best Chinese stocks.Read More >

What Fed Speeches Mean for the Stock Market Today

By Chloe Lutts Jensen on September 29, 2016

Four Fed presidents gave speeches yesterday, and every word was digested by the stock market in an attempt to better predict the Fed’s next move. With odds of a December rate hike now about even, how should stock investors prepare?Read More >

The Emerging Market Stock You Ought to Own

By Paul Goodwin on September 27, 2016

The company I’m talking about (the one that you probably don’t own) is the largest Chinese instant messaging company. It is a giant in its own right, with a market cap of $262 billion and annual sales of over $19 billion. The company grew revenue by 28% in 2015 and routinely boasts after-tax profit margins over 30%.Read More >