An Investing “Aha!!” Moment Investing in Liquid Stocks
Oil Service Stocks
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As an investor, you don’t get many serious “Aha!!” moments. The life of a serious investor is usually marked by gradual but sustained improvements, so that when you look back after a few years you might say “What a dope I was for doing such-and-such back in 2010. I would never make that mistake now!” But rarely do you come across something that just sort of changes the way you think about things.
I had one of those rare moments back in the 2003 bull market. At the time, I was still learning my way; I had joined Cabot back in June 1999 and jumped right into the mega-bubble in tech stocks ... which was followed by the mega-bust as the new century began. By 2003, I had pretty much gone through the process of trying to reinvent the wheel—studying on untold number of indicators and systems, trying to find the “perfect” system—before realizing that sticking to tried and true principles was the best course. I learned about investing in liquid stocks.
Anyway, back to that Aha! moment. As the 2003 bull got underway, I was doing my usual buying and selling, looking for strong growth stocks with good numbers and stories. And I did OK. After three years of being banged over the head by the bear market, making money again was certainly pleasant, but I really wasn’t making all that much considering the incredible, straight-up move in the market and dozens of growth stocks that year.
So, after a few months, I did what I always do after a period of blah performance. I went back and studied what I could have done better. What I found has changed the way I’ve invested ever since.
Specifically, I found that I was buying a bunch of smaller stocks and companies that did OK but didn’t really pan out. Or maybe they eventually did have good upmoves, but their volatility was high, which shook me out at an inopportune time.
Meanwhile, I noticed lots of bigger-cap, well-traded growth stocks doing just fine. Up, up, up they marched. I still remember watching eBay just glide higher from March through mid-summer, go sideways for a couple of months, and then move much higher into 2004. Yahoo! was another leader back then, with big sales and earnings growth, good sponsorship and a smooth uptrend. Even the major market exchange traded funds, which weren’t nearly as popular back then as they are today, did just fine.
Now, as a young growth stock investor, I always believed that buying the “obvious” big-cap stocks wasn’t going to produce maximum profits. After all, smaller companies and stocks can grow faster, meaning their stocks have more upside in bull markets! But did they?
I went back and studied the past and found that even while we hit a few home runs with smaller names in the mid- to late-1990s, our big money was made in names like Qualcomm, JDS Uniphase, EMC, Yahoo and Amazon.com—not exactly blue chips back then, but certainly very well-traded, with hundreds of mutual funds (not to mention hedge funds and even some pension funds) snapping up shares.
All of this led me to a major conclusion that’s changed my thinking ever since: You don’t need to invest in small stocks to have great performance. In fact, doing so can even hurt performance! Instead, it’s best to stick with investing in liquid stocks, what I call the liquid leaders.
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Now, when I say liquid leaders, I am not talking about the mega-mega-mega-cap companies that have little growth and whose best days are behind them. Microsoft, Cisco, Intel ... these names were incredible back in their day, and even today, they might have a place in a conservative growth or income portfolio, as all have bumped their dividend payouts in recent years. But the days of these stocks drastically outperforming the market are likely in the past.
Where I had been hunting was the opposite end of the spectrum, looking for the $12 stock that trades 150,000 shares per day that has a good story and good growth. And my results hadn’t been great! Why? Simply put, for a stock to go up, people have to be buying it ... but with stocks like these, trading only $1.8 million in volume every day ($12 per share, multiplied by 150,000 shares), few institutional investors dared touch them.
Thus, while the stock might do well over time, it would be subject to wild gyrations on news, rumors, earnings reports, you name it. Holding on to it for many months was nearly impossible, especially in a relatively concentrated portfolio.
It turns out, though, that there’s an in-between—rapidly-growing companies whose stocks trade lots of volume every day, hence allowing hundreds of institutions to pile in. These days, there’s so much money floating around (thousands of mutual, hedge and pension funds) that when the whales decide to build a position in, say, LinkedIn, the stock can skyrocket! And while there are clearly bumps in the road even in the best stocks, a liquid leader acts far more “under control,” which makes it far easier to hold on through most of the stock’s uptrend.
So how much liquidity is “enough”? There’s no magic figure, but I know in my own trading that with stocks trading less than $50 million per day, my results generally suffer. That doesn’t mean that you can’t find winners that trade $30 or $40 million per day, but they’re tricker to handle, so you might want to buy smaller positions. And I can say that, in every bull market year, there are usually a few dozen very liquid stocks ($100 million per day) that put on great shows.
In fact, I would go so far as to say just that about all of the big winners of the past decade--the stocks most investors think of when they think of huge winners, traded at least $50 million per day at or near the start of their run. There were a few names like Hansen Natural (now Monster Beverage) or Travelzoo that were funky, and I believe First Solar was a bit thinly traded near the start of its run. But even these names “got liquid” by the third or fourth inning of their advance.
Now, just to be clear, if you have a system for picking low-priced stocks or have an edge with your fundamental research and handle the names more like value stocks (i.e., you don’t use tight loss limits or huge position sizes), that’s a whole different story. (I’m thinking especially of Cabot Small-Cap Confidential, where editor Tom Garity does a tremendous job.)
But if you’re a growth stock investor, my main message to you is to consider restricting most, if not all, of your purchases to stocks that not only have a great chart, a great story and great growth numbers, but also have the trading volume that allows the Big Boys to buy in. In my opinion, a portfolio full of smaller, less liquid names carries far more risk, and little (if any) additional reward.
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As for the current market, it remains in great shape, although after a nosebleed run for the major indexes and many leading stocks I can’t say we’re at a pristine buy point. Still, one of the unsung bullish characteristics of this year’s advance has been plenty of healthy rotation—for two or three weeks a couple of sectors will light up the sky, but when those groups pause, others take their place and get going. That’s what has kept the market advance in such good shape.
Thus, for my stock idea in today’s Wealth Advisory, I was looking for stocks and sectors that haven’t run straight up for the past six or seven weeks. Instead, I’m looking for groups that money is just starting to rotate toward after a few weeks of back-and-forth action. And one that fills the bill is oil service stocks. If you examine the S&P Oil & Gas Equipment SPDR (XES), you’ll see a peak in mid-February, followed by a couple of healthy shakeouts during the next two months. But the fund found support at its 40-week moving average and is now working on its fifth straight up week as it tags new-high ground.
Fundamentally, oil prices aren’t advancing, but they’ve generally traded in the $85 to $100 per barrel range for the past year. And, of course, natural gas drilling is going nuts here in the U.S. thanks to the various shale plays. That leads to a healthy environment for the sector.
So how can you play it? One easy way is to just buy XES, or if you prefer, go with the Market Vectors Oil Services Fund (OIH). Both will give you exposure to the group as a whole.
As for individual stocks, a couple that I’m watching include old favorite FMC Technologies (FTI), which is a leader is sub-sea trees and high-pressure valves and fittings—all the stuff that deepwater drillers need. I like that earnings have advanced every year since 2004 (even through the bust period) and, while this year’s bottom line should advance “only” 17%, next year’s is expected to grow 36%. The stock is hitting all-time highs after a sharp shakeout in April.
My other idea, which admittedly is more income oriented, is Seadrill (SDRL), the dominant deepwater driller in the world. It has a huge backlog and tremendous cash flow, and management is looking for big increases in that cash flow in the years ahead as the company adds to its rig fleet. The stock is also punching out toward new high ground, and the dividend (paid quarterly) is north of 8%. The major risk here is that earnings are due out May 28, so you might want to keep the position small ahead of the earnings report.
And, if you’re wondering, both stocks trade plenty of volume, telling you big investors are involved!
Best of luck,
Michael Cintolo
Editor of Cabot Market Letter
and Cabot Top Ten Trader
Editor’s Note: Michael Cintolo is the editor of Cabot Market Letter, which as been uncovering stock market leaders since the 1970s, like American Medical Systems back in the late 1970s: up 1,097%, or Triangle Industries: up more than 150% in the late 1980s, or Yahoo!, Amazon.com and more in the late 1990s! And Mike is using Cabot’s time-tested market timing and growth stock picking system to select the very best stocks of this bull market, like Green Mountain Coffee (GMCR). Don’t miss another issue!
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