Today, I’m going to tell you about my favorite stock picking criteria, a key metric that hasn’t failed me in my 19 years with Cabot. But first, let me tell you what not to do as an investor.
When growth stocks are acting well, one of the common questions I get involves what to do with a stock that’s just sitting there—it’s not bad, per se, but it’s just flopping around while other stocks rise (and many go to the moon). After all, why have “dead money” tied up? Why not move on?
It sounds logical, but over time “switching” usually isn’t a great idea. And the reason is because of two factors that apply to the market in general and growth stocks in particular: Returns tend to be skewed and streaky.
Skewed means that a good chunk of your gains are going to come from relatively few trades. That’s not surprising when you think about it—sort of the old “80/20” rule applied to trading. But whatever the reason, most trades tend to cancel themselves out, while the big winners and big losers make the real difference.
Streaky means just what it says—the market and stocks tend to do well in somewhat short bursts, and do a lot of sitting around afterwards. It’s not like bonds, in other words, where you’re getting steady payments and little volatility.
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Knowing that returns are skewed and stocks can be streaky tells you to give your laggard a chance—if you’re getting impatient, then tighten your mental stop a point or two, but don’t be too eager to sell a winner that’s just gone quiet for a while.
A perfect example of this was Five Below (FIVE), which I recommended in my Cabot Growth Investor advisory last November; shares had a nice run through year-end before beginning to consolidate. FIVE fell 20% into February, moved out to new highs in April but then again pulled back and went dead, chopping between 70 and 75 while most growth stocks rallied nicely. All told, FIVE made no progress from early January through the end of May.
We should have sold then, right? Well, look at what happened last week:
The stock went ballistic, soaring after an analyst upgrade and then going into outer space following earnings. Clearly, such a move is unusual—many times, the laggard will indeed break down and you’ll give up a few points more than you would have if you sold.
But in my experience, sticking with your stop (maybe tightening it a bit over time) gives you more of a chance to capture those big outliers, which are key to driving your portfolio.
In FIVE’s case, it was the big reason Cabot Growth Investor’s Model Portfolio is outperforming the market so far this year— since the start of last year we’ve nearly doubled the market’s return. In fact, going back way further (I got my start in 2007!), we’ve outdone the S&P 500 by 75% over the past 11-plus years! If you want to join in on our proven methodology and see what I’m buying now, click here.
My Stock Picking Criteria
Though the action in the market has been shaky of late, I’m still looking for new buying opportunities as they emerge—either on powerful breakouts from multi-month ranges, or by playing pullbacks (ideally, the first dip of a few days following a breakout) within up-trending stocks.
That said, I’ve found myself using one of my favorite stock picking criteria more often: Triple-digit revenue growth.
While earnings are very important to me, I was taught (and have seen first-hand) that companies with triple-digit sales growth are so rare and they are expanding so rapidly that it’s hard for analysts and money managers to keep up.
(To be honest, any revenue growth above 75% I’ve found to be unusually good and often a harbinger of a potential big move in the stock. But triple-digit growth is even better.)
When a company is growing that fast, quarterly reports usually crush expectations, the size of the market for the firms’ products or services turns out to be much larger than anticipated, and it doesn’t hurt that these stocks usually attract overeager short sellers, who seem to love to bet against fast-growing companies and then have to cover as the stocks move higher.
Many of our big winners through the years (including Shopify (SHOP) last year) have had triple-digit sales growth when we first bought in.
Of course, firms growing this fast often have stocks that are very volatile, so you have to handle them with care—small positions and looser loss limits make sense. With that caveat thrown in there, here’s one smaller triple-digit grower I’m keeping an eye on.
One Company That Meets My Stock Picking Criteria
Turtle Beach (HEAR), a small-cap firm that’s the clear market share leader in headsets for use with gaming consoles like Xbox and PlayStation. That’s been a mundane business, but a new class of games dubbed Fortnite: Battle Royale (tons of players that search for weapons, battle each other, with a last-man-standing winner at the end), for which headset use is a near-requirement, is causing a sudden boom in business. Q1 sales nearly tripled and earnings crushed expectations, which caused the stock to go vertical in May. It hasn’t slowed since.
HEAR is volatile, but if demand stays strong, there’s no reason sales and earnings can’t mushroom from here.
Both of these companies were featured in Cabot Top Ten Trader. Each week the advisory which I edit features 10 fast-growing momentum stocks that are breaking out on volume and are on track to deliver quick gains in weeks and months to come.