10 Tips for Growth Investors
Are Growth Stocks Coming to Life?
It’s officially mid-August and the overall market is in so-so health, which means a few things-many investors are as concerned about their suntans and BBQ menus as the stock market. I’m inundated with “Out of Office” emails every time we send something to subscribers. And it’s time for our Cabot Investors Conference, which is going on right now!
And that means I’m up to my eyeballs in PowerPoint presentations, speeches, panel discussions and the always-fun schmoozing with subscribers. Thus, for this week’s Cabot Wealth Advisory, I wanted to go back to training camp, presenting some blocking-and-tackling stuff that should be helpful once growth stocks turn decisively up.
Some of these are basic and you’ve surely read them before, but others are more nuanced, derived from some of the dozens of questions I’ve answered in recent months. I hope you get a little morsel or two to chew on while you’re waiting for the BBQ to cook.
It’s the huge winners and, conversely, major losers that count-so let (most) of your winners run, and cut all losses short.
A good trader once said you shouldn’t quit at the 50 yard line-meaning once you get a tiger by the tail, you owe it to yourself to let it run, giving it a chance to do great things for your portfolio. Conversely, you want to make sure no one or two stocks can do great damage to your portfolio.
That doesn’t mean you should always swing for the fences-I advised a ton of partial profit taking in June and July in most winners in Cabot Top Ten Trader, for instance-but grabbing a few big winners over time is key to your results. And, conversely, especially in the tricky environment that has existed for much of 2014, trying to grab 5% here or there often causes more stress than it’s worth.
Buy stocks that are going up.
It doesn’t get any more basic than this but you’d be shocked at how many trades you’ll avoid if you just use a very basic trend filter-say, if a stock is above its 100-day moving average, or is within 20% of its high, etc. Simple stuff like that will keep you in stocks that are being bought by other investors, which is how they go up!
What’s the big idea?
OK, not every stock you buy is going to have a great story that can push the stock up 100-fold. But you want to strive to find those rare firms that are changing the way we work and live. They’re not all that common, and even if you find one there’s no guarantee of success. But nearly all the big winners during the past few decades have had a revolutionary new product with a major benefit
The company is not the stock.
I’ve always liked this one because even among professionals there’s a lot of confusion. Obviously, the stock is generally going to reflect the company’s success, and fundamentals are vitally important. However, what counts more than the fundamentals are investors’ perception of those fundamentals. We see this all the time when a company will post great results for three or four quarters, yet the stock remains in rough shape. It’s the balance between good fundamentals (telling you the stock could do very well) and good technicals (telling you it is actually doing well right now) that’s key. You can’t ignore one or the other.
Of course, this “rule” goes for just about any aspect of life, but in investing, the key is to (a) realize there are going to be some bad weeks, earnings reactions and the like, and (b) size your positions correctly so that the occasional stinker doesn’t ruin you or your confidence. What is the correct position size? Well, that’s the catch-it’s a personal thing. If there were a simple formula, hey, we’d all be in good shape, but that’s not reality.
Usually through experience, you’ll learn how much is “too much” for you; if you’re panicking after every 8% decline in your stock, your position size is too large. Conversely, if you own 63 stocks, your position size is probably too small. It’s something to give thought to if a few bad trades have really put a dent into your portfolio.
Never invest scared.
This is a corollary to what I just wrote about. Every now and then you’re going to get kicked in the teeth by the market-heck, this whole year has been very challenging for growth stock, trend-following types of systems. But one of the unspoken keys is that you never lose your confidence … that you never invest scared, as it’s called. If you do, you’re simply not going to have the discipline to follow the trend, instead getting kicked out days (or even hours) after your initial buy.
One investor I read about had an interesting policy. If he owned 100 shares of a stock but got shaken out, and then wanted to buy back in, he trained himself to buy 110 shares-a little bit more just to keep an offensive mindset. I’m not advising that particular strategy, but the point is that you have to have conviction that every growth stock you buy can do very well for you-and that you’re comfortable with the risk you’re taking. If both of those aren’t there, it rarely goes well.
Buy growth stocks, not potential growth stocks.
Usually after the market’s been hot for a while I’ll start hearing from people about such-and-such a stock that they’ve heard good things about, and I always do some looking for them. Well, what do you know-it’s a $5 stock, and the company has $8 million in revenue, no profits and no growth. But what they do have is some drug in the pipeline or new product that’s just beginning to catch on … maybe.
Now, investing in these pipe dreams can be very profitable, but it’s not growth investing. Growth stocks should have growth now! For example, one of our best historical criteria of future big winners is triple-digit revenue growth-pure and simple, when a company is growing that fast it can often continue for a while, which attracts the big investors.
Stay away from the junk pile.
A century ago it was pools and insiders that would drive stocks up and down. Today, it’s institutions-big mutual funds, pension funds and hedge funds that, yes, can cause day-to-day volatility, but more importantly, can drive stocks up or down over many months as they accumulate (or distribute) shares.
These funds aren’t going to play too much with stocks priced at 3 or 4 (in some cases they are strictly forbidden to do so by the higher ups), and they really don’t want to have anything more than a token position in something that doesn’t trade much volume (because they can’t get in and out of it).
I’m not saying all your positions have to be blue-chips, but I like to stick with stocks that generally trade over $50 million per day (derived by multiplying share price by share volume) average trading volume); going down to $30 million is fine, but if, as a growth investor, your portfolio is loaded with stocks trading less than that, it’s probably full of lottery tickets, few of which will ever pay off.
Plan your trade …
If you’re investing in bonds or sedate value stocks, things tend to happen somewhat slowly. With growth stocks, you’re subject to meaningful upgrades and downgrades, earnings reports, and endless shakeouts and rebounds, never mind big moves when the market has a hiccup. It’s hard to keep your head, especially if you own a few growth stocks and they’re all bobbing and weaving like this.
Pretty much the only way to handle these stocks correctly is to have a plan-not a black-box, mechanical system per se, but to be prepared for all contingencies. You have to know ahead of time how you’ll handle an earnings gap up or down, or what would represent abnormal action. If you like to take profits, you should know where you’ll book some partial profits on the way up. Or maybe you have a plan where you will sell some stock ahead of earnings if you don’t have a profit of at least 10%, etc.
Flexibility is important, but so is having a plan in place ahead of time.
… and trade your plan
This is the hardest part. We all buy a stock with high expectations, and if we’re good, we also have a plan. But it’s one thing to buy a stock at 50 and tell yourself that your loss limit is 42. It’s a whole other deal to see the stock quickly fall to 45 and sit there for four weeks, and to sit tight and give it a chance while your neighbor tells you he bought some other stock that’s up 25% in two weeks.
Again, I’m not pretending that you don’t have to re-evaluate sometimes and that flexibility is important. But more often than not, avoiding the day-to-day wiggles and news items, and instead following a well thought-out plan, will help you make more money.
As for the market, I don’t have a strong feeling at this point, though I’m still leaning cautious as the intermediate-term trend is down, and my measures say the broad market is, at best, not in great health, and at worst, is degrading under the surface.
At the very least, I’m not seeing a ton of stocks racing to new highs, so it’s not like there’s much “risk” in being on the sideline.
What’s interesting, though, is that while many struggled earlier this year, I’m now seeing many taking the recent market struggles in stride. Sure, some have broken down, but many have been forming tight shelves (sideways price areas) during the past three to four weeks.
As always, I’m monitoring all resilient names so I don’t miss out on a potential leader when the market gets going. But I also think there’s value in following these names simply for market timing’s sake-if a bunch of them get going, it will be a good sign that a rally is unfolding.
Instead of highlighting one name, I’ll give you three. One is Tesla Motors (TSLA), which is back near its springtime highs as investors anticipate solid results going ahead with the Model X being released in early 2015. It’s clearly the leading glamour stock out there.
Another is Palo Alto Networks (PANW), which remains in a multi-month, early-stage base. The stock is a leading network security player and has big growth, cash flow and future potential. A burst above 85 on big volume would be bullish here. This is the type of stock that should get going in a growth stock bull move.
The third is Under Armour (UA), which trades north of 70 times this year’s earnings, but institutions love it because of its huge prospects and, recently, accelerating growth. It gapped out of a great-looking base in July and has traded tightly since. If this can rally above 71 on big volume, it would be a sign that highly-valued, institutional-quality growth stocks are back in favor … something we really haven’t seen much of this year. Chipotle Mexican Grill (CMG) is a similar story, FYI.
All of these are stocks I’m watching closely, both for potential purchases but, just as important, as “sentiment signals” for growth stocks. Big rallies from them that coincide with new buy signals from my market timing indicators would be bullish … but major breakdowns in the weeks ahead would confirm the bears are in control.
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Working to make you a better investor,
Chief Analyst, Cabot Market Letter
And Cabot Top Ten Trader