Three Monsters Under Growth Investors’ Beds

Stock Market Video

The Three Monsters Under Growth Investors’ Beds

In Case of Doubt Sound Convincing

In Case You Missed It

In this week’s Cabot Weekly Review video, Cabot Market Letter editor Mike Cintolo reviews his generally positive stance on the market and most leading stocks. He highlights one bullish sector and a couple of buy ideas, and also looks at a handful of names that could help lead the way should the market really kick into gear in September. Stocks discussed include: Lennar (LEN), SolarWinds (SWI) and LinkedIn (LNKD). Click below to watch the video!

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Three Monsters Under Growth Investors’ Beds

If you were looking at a roomful of stock investors and wanted to figure out which ones were growth investors and which preferred the value discipline, it might be pretty easy, especially if the stock markets were open at the time.

All you’d have to do is look for which ones were nervously checking their smartphones to see how their stocks were doing. And then re-checking them 15 minutes later. Then again. And again.

The value investors, in the meantime, would be reading magazines, napping or quietly flipping through annual reports in search of a scrap of useful information about projected market share or free cash flow. 

So why are growth investors jumpier than value investors? 

Well, in general, growth stocks are just more volatile than value stocks, almost by definition. Charts of growth stocks show more movement and their up and downswings cover more ground. Plus, growth investors have more-concentrated portfolios than value investors. The growth investor wants any big win to have a significant effect on his total portfolio, while the value investor aims to spread the risk around so that a big loss will have a negligible effect on performance. 

As a growth investor, I’ve spent years studying the things that drive growth investors crazy, and I have a little list I’d like to share with you. I even have some recommendations for how to keep your blood pressure down while playing the growth game.

Earnings Misses

Four times a year, following requirements set down by the Securities and Exchange Commission, all companies whose stocks trade on U.S. exchanges must tell people how they did during the previous three months. The report must include revenues, earnings and events such as acquisitions that might have affected the results.

Analysts covering the companies predict what those numbers will be, and that sets up a very dramatic event. If analysts’ “consensus” estimate is that the company will earn 30 cents per share on sales of $100,000,000 and the earnings come in at 31 cents and revenue at $101,000,000, it’s a triumph! That’s labeled a “beat” and the stock (generally) goes up. 

If, on the other hand, earnings are only 29 cents per share and/or revenues are only $99,000,000, it’s a “miss,” and the stock (usually) drops significantly.

How can you stay calm during earnings season? 

First, you should know exactly what your loss limits are on each of your stocks. If a stock falls out of bed and hits your maximum loss limit, you sell it. When there is no doubt about what to do, there is no hesitation in doing it. 

Second, you should know exactly when a company is reporting and avoid buying a full position in a stock just ahead of earnings; quarterly reports are too much of a coin flip to make big bets on. And third, you might consider taking a little profit in a big winner ahead of the report.

Bad News

Even outside earnings season, bad news can take a toll on growth stocks. Losing a big contract, being confronted by a new competitor, natural disasters, labor problems … all these can undercut investors’ confidence in a stock. Many industries have built-in opportunities, especially pharmaceutical stocks, which face intense scrutiny when clinical trial results on candidate drugs are announced. 

Then there’s the Bad News that rises to the level of scandal, which can be near-fatal for stocks. Any hint that a company is under investigation for fudging its results or otherwise fiddled with its accounting can send investors toward the exit in a stampede. 

As with earnings season, the best response to bad news lies in how you prepare for it. If your sell disciplines are in good shape, especially your loss limits, you won’t have to worry about controlling losses. When a stock drops below your limit, hit the sell button.

Missing the Big Winner

Often the biggest pain a growth investor feels isn’t caused by a loss; growth investors get used to taking an occasional left hook to the ribs. Some of the most plaintive questions we get from subscribers involve stocks that have run away to the upside. “Is it still buyable?” “Will it pull back to let us in?” The pain of missed opportunity is real for growth investors, who get huge pleasure out of riding a big winner.

Unfortunately, there’s no perfect cure for this problem. Big winners can make astonishing runs while you’re having your second cup of coffee. But remember that a majority of a growth investor’s gains comes from the action of just a few winners every year. So even if you miss a winner, there will be others, especially if the general trend of the market is up. 

Sometimes you can get in on a big gainer after a pullback or consolidation. After all, one of the Cabot rules of growth investing is that trends can go on for much longer than you think. If you need confirmation of this, just take a look at the chart for Apple (AAPL) since the beginning of 2009. Besides soaring from 91 to 660, the stock also presented plenty of dips along the way that represented buying opportunities.

AAPL Chart

The other tip for not missing big winners is, predictably, a subscription to Cabot Top Ten Trader. This publication is legendary for finding big leaders early in their advances and letting subscribers know why they are strong, what the chart tells us and where to buy them. It’s an exciting weekly read for growth investors and you can give it a try with a trial subscription by clicking right here.

Here’s this week’s Contrary Opinion Button. Remember, you can always view all of the buttons by clicking here.

In Case of Doubt Sound Convincing

The original quote, apparently born in the ivory towers of scientific academia, was,  “In case of doubt, make it sound convincing.” That it can work for a salesman is obvious, but how does it work for investors? 

Like this: When everyone knows something about a stock, it’s too late to invest based on that fact; the price of the stock reflects that knowledge. It’s only by investing in things about which there is doubt (like next quarter’s earnings) that you can succeed. To do that, you’ve got to wrestle with doubt, use rational thinking to project the future, and then invest with confidence, whether you talk about it convincingly or not.

Note: This is the only non-circular button in the entire collection.

In case you didn’t get a chance to read all the issues of Cabot Wealth Advisory this week and want to catch up on any investing and stock tips you might have missed, there are links below to each issue.

Cabot Wealth Advisory 8/27/12 — How a Growth Investor Thinks about Valuation

In this issue, Cabot Market Letter editor Mike Cintolo explains why measures of value like P/E ratios aren’t of much use to growth investors, as they don’t predict performance very well. Stock discussed: LinkedIn (LNKD).

Cabot Wealth Advisory 8/30/12 — Eight Stupid Rules That Are A Drag On The U.S. Economy

In this issue, Tim Lutts, who edits the Cabot Stock of the Month letter, lays out an assortment of rules that are keeping the U.S. economy from gathering steam … and he wants your opinions on them, too! Stock discussed: SolarWinds (SWI).

Have a great Labor Day weekend!

Paul Goodwin  
Editor of Cabot Wealth Advisory   
and Cabot China & Emerging Markets Report

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