I’m not really sure how to use all the info in Cabot Top Ten Trader. How can I get the most out of it?
Michael Cintolo: First, Top Ten is a source of new ideas so don’t feel like you have to grab every stock—it’s about having the ones you own do well, not kissing all the babies.
Second, consider having a Top Ten “portfolio” (could be a separate account or just mentally part of one of your accounts) that has a set
maximum number of stocks—let’s just say 5 to 10, but it could be anything.
Third, focus mostly on the Top Picks each week, and then look for themes (which I try to highlight)—new sectors or industries that are emerging. Also, look for stocks that have shown up recently; if it’s the second time in Top Ten in a couple of months, it’s likely the stock is getting going.
At day’s end, Top Ten is meant to be something where we do the first four or five steps of the process for you: find the strongest stocks, tell you what’s driving the stock, highlight a good buy range and loss limit, etc., and then let the subscribers take it from there. It gives less “hand holding” than our other advisories, but obviously more ideas, and following some simple guidelines like those above can help you focus in.
What are your top investing rules?
Michael Cintolo: Well, my top investing rules are rules that work for me—everybody has their own style, so some of the things I practice may not produce the best results for others.
With that said, cutting losses short is, by far, the #1 rule of investing in growth stocks. Doing this will always keep you in the ballgame, and if you cut them short enough, it will always make sure you never fall too deep into any hole.
Another rule I try to preach is to do some offensive selling—i.e., selling on the way up. When I was learning about the market, I thought that most people liked to sell their winners while holding their losers, a bad idea. But my experience has been a bit different—investors don’t like to sell anything, because doing so means you’re giving up hope of higher prices in the future. And that’s psychologically hard for most.
Thus, I like to take a few chips off the table when I have a good profit and things look overheated. That way, I’m acting, instead of re-acting, like most do by selling after a sharp market correction. But I will hold most of my shares of a winner, giving me a chance to benefit from the occasional home run.
Other rules I believe in: Confine your purchases to the true leading stocks of the day (not low priced, speculative junk), don’t invest too much (risky) or too little (what’s the point?), try to raise your stops to breakeven as soon as you have a decent profit, and, importantly, keep an eye on your portfolio’s total value—you don’t want to track it minute by minute, but too many investors fail to take action when things go awry.
I’ve seen you’re recommending XYZ stock, but I’ve also noticed the directors and management are selling tons of shares. Why should I buy the stock if the top brass is selling?
Michael Cintolo: Simply put, insider selling in fast-growing companies has never proven to be a reliable predictor of stock performance. Sure, sometimes stocks with lots of insider selling top out quickly … but other times, the stocks soar for more than a year before topping out.
Remember, insiders can sell for a variety of reasons—pre-arranged rebalancing of their portfolio, for one, or simply to book some profit since most of their compensation comes in the form of stock options. Insider buying, on the other hand, is more meaningful, as people buy shares because they think the stock is headed higher.
To be honest, we don’t even consider insider transactions when examining a young growth company—there are far more important metrics to follow, such as sales and earnings growth, profit margins, projected growth, sector performance, and whether the firm has a revolutionary product or service.
My stock just crashed after reporting earnings! Why shouldn’t we sell our shares before an earnings report?
Michael Cintolo: You could, if you wanted to, and there’s nothing wrong with that. But remember, there’s good and bad to everything—if you sell every time one of your stocks is going to report, then you’ll never be holding anything longer than three months…and thus you’ll have a hard time landing any really big winners. You’ll miss out on the inevitable couple of stinkers during earnings season, but you’ll also kick yourself for not owning the stock that soars 30% on its report.
I’m definitely sympathetic to those who hate the wild volatility during earnings seasons; Regulation FD (stands for fair disclosure) has prevented any wink-wink, nudge-nudge tactics from management to analysts, leaving investors with little idea how the quarter is really progressing. I don’t like the resulting sharp ups and downs…but as Hyman Roth said in Godfather II, “This is the business we’ve chosen!”
Because there is no great way to predict how a stock will react to its earnings report, your best game plan during earnings season is, well, to have a game plan. Be consistent in your approach. If you want to sell, say, one-third of every stock before it reports earnings, fine—just realize the benefits and the costs of such an approach. As long as you’ve given it some thought, you’ll do fine.
My stock reported good earnings, had a good forecast and beat Wall Street estimates—but it collapsed! Should I buy more?
Michael Cintolo: No! Our studies, especially since Regulation FD came into effect, show that big, big earnings-induced moves up or down tend to continue in the weeks to come. By “big,” we’re talking 15% to 20% or more, up or down, the day after an earnings release. As contrary as it seems, those huge moves have momentum; more often than not, they rocket the stock further in either direction.
I’ll even go so far as to say that big earnings gap ups, in a generally bullish market environment, can be bought the day of the gap. But if you see a huge earnings gap down—especially if the stock’s had a major advance the past few months or longer—you should stay away, or if you own some, sell it.
What about the fundamentals? Don’t get too close to those—it’s good to know the general story and the numbers, but if a stock gets crushed after an earnings report, the market is telling you that the report did not live up to expectations. End of discussion!
Besides, I never hear from subscribers saying, “Gee, that report wasn’t so great, but XYZ stock is up 25%. I should short it here!” Of course not—because people want the stock to go up. So when it goes down, it’s a natural tendency to fight against reality. Don’t do it.
I can’t buy that stock because it’s too expensive; at $200 per share, I can’t buy my normal 100 shares.
Michael Cintolo: I will say this as clearly as possible: The price of a stock means absolutely nothing. Do you think the big institutional investors, who manage billions of dollars and, oh, by the way, are the ones that actually move our stocks up and down, care about how many shares of a stock they own? No!
What they care about is the percentage weighting a stock has in their overall portfolio—they might want to have 2% of their total assets in a given stock. Then, given that information, they tell their trading desk to accumulate that amount of stock (usually in a given price zone) over a period of days and weeks.
If you’re “old school” and you have always bought round lots, get over it. I can tell you personally that I can count my round-lot purchases on one hand; I always figure out how much money I want in a stock, and from there, decide how many shares to purchase.
The company you recommended sounds nice, but it has a P/E ratio of 128! How can you possibly justify owning such a thing?
Michael Cintolo: P/E ratios might have some predictive ability when looking at the broad stock market, or a segment of stocks. But in terms of evaluating growth stocks, they’re not too useful.
Here’s something we read from William O’Neil, founder of Investors Business Daily, that makes sense to us: Elevated P/E ratios are the result of great stock performance, not the cause of it.
Think of it this way: In any market cycle, there are only a few dozen true, institutional-quality leading stocks out there. And thousands of mutual funds, hedge funds and pension funds are trying to accumulate stakes in them! So it’s only natural the valuations of these select stocks get stretched beyond “traditional” comparisons.
In my own history, all of my big winners, and most of my smaller ones, have come in stocks that had huge P/E ratios when I bought them.
The market usually does well in November, so should I buy stocks then?
Michael Cintolo: In my opinion, “usually” is a dangerous word on Wall Street. It gives you a sense of control, a sense that the odds are clearly in your favor … even if they’re not.
Generally speaking, yes, November through January are the three best months of the year for the market. But not always! And sometimes, those exceptions can be painful (year 2000 comes to mind). You’re better off following the trend of the general market and staying in tune with that.
I bought a stock at 50, and within a week, it had gapped down to 40! I stink at investing!
Michael Cintolo: Let me share a secret with you: Even the very best investors, those that churn out great results year after year, buy a large number of losers. I’d say that, if half your picks are winners, you’re going to make an awful lot of money! (I’m assuming you cut losses short while
letting winners run.) And sometimes those losers are bad ones.
Thus, you shouldn’t get down on yourself—investing is very difficult to do successfully. Even the best are often humbled by Mr. Market. You’re not stupid if you pick a stinker…just like you’re not suddenly a genius if you pick a couple of winners. That’s just how the game goes.
The goal is, over time, to put the odds in your favor by learning what actually works in the marketplace. It’s like being a casino—in any given month or even two, you might lose money, but over time, if you follow sound rules and learn from your mistakes, you’ll come out well ahead of the game.