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Perception is Reality in the Market

Always use Cabot’s SNaC (Story, Numbers, Chart) approach when evaluating growth stocks

The Company is Not the Stock

Demand the Best

Some Potential Earnings Winners

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I want to write today about something we mention often but never really explain fully: The fact that the company is not the stock. Most people confuse the two—they see a firm with a new product that’s beating earnings estimates and assume it’s a good growth stock. No! It might be a good company, but that doesn’t mean it is (or will be) a good growth stock.

The same thing goes in the other direction; just because a firm is losing money or has had troubles in the past doesn’t mean the stock can’t be a leader or at least earn good profits for investors.

“But Mike,” you say, “I realize a stock can go up or down for a few weeks or even months because of the market or some temporary factors. But long-term, a good company with growing earnings will reward investors.” That would make sense ... but in the market, it isn’t so!

To see real examples of this, all you have to do is take a gander at these charts of solid companies from the last 10 or 12 years of trading. Notice the price bars for the stock, as well as the earnings line— the smoother line with circle markings. The earnings line totals up the company’s earnings per share for the past four quarters.

We’ll start with Amgen (AMGN), one of the leading biotech firms in the world.

Amgen (AMGN) chart

Notice how, back in 2000, shares stretched just over 80 for a time before closing the year near 70. Earnings per share during the year 2000 totaled $1.05. Over the next six years (from 2001-2006), that earnings figure rose 12%, 18%, 37%, 26%, 33% and 22%—six full years of consistent and, for a time, even accelerating growth. Yet take a look at AMGN stock near the end of 2006—it was at 70, unchanged from the end of 2001 and 10 points below its peak in 2000! Now take a look at Amgen’s earnings and stock price today. Amgen’s earnings per share now stand at $5 ... nearly five times that of 11 years ago. But the stock is currently south of 60, off 25% from its peak in 2000.

Another example is Microsoft (MSFT). At the end of 1999, the stock was at 53 and the company had earnings per share of 69 cents. Growth did slow during the next few years, but the earnings line continued to push higher (with a brief dip in 2008), and now stands at all-time highs ... up at $2.70 per share, or nearly four times higher than it was at the turn of the century. Yet the stock is sitting down at 27, about one-half where it was back then!

Microsoft (MSFT) chart

I could go on, as there are dozens of examples of firms with rising earnings over the years that produced nothing but stagnant or losing stock performance. And note this: Neither Amgen nor Microsoft were bubble darlings during the 1990s boom; while both got a boost for sure, they weren’t the Aribas, JDS Uniphases, Broadcoms, Phone.coms or America Onlines of the world. These were large-ish blue chips that had had big advances but continued to expand in the years ahead.

So what happened? Why are the stocks of these companies going nowhere while earnings head north? It’s simple—investor perception of the company’s future potential has lessened significantly. And in the market, perception is reality; if institutional investors don’t believe a firm’s future is as bright as they previously thought, you can be sure they’re unlikely to buy any shares ... and if they own some, they’ll likely pare back during rally phases.

All of this is why the growth investors at Cabot insist on combining fundamental research (which tells you about the state of the company—both current and potential) with technical studies of the stock itself (which clues you in to investor perception of the company).

My fellow editor Paul Goodwin has dubbed this the SNaC approach—to get a truly big winner, you need a unique Story (preferably a new, revolutionary product or service), terrific growth Numbers (rapid sales and earnings growth, big profit margins and big earnings estimates) and a good Chart (with the stock in a major uptrend and outperforming the major indexes).

Getting one or two of these is nice and, frankly, not that hard to do. But combining all three in a bullish market environment really puts the odds in your favor. And that is what you should strive for, especially if the nascent market rally morphs into an honest-to-goodness bull move.

That is, you should strive to find the very best stocks and set-ups out there. Don’t go back to a stock you used to own “just because.” Hey, maybe your old leader still has a great story, terrific numbers and a resilient chart. If so, feel free to take a small position. But be sure to give it an honest evaluation.

As for the current market, I am growing more encouraged that the October 4 panic low represents a sustainable bottom. Now, that doesn’t mean it’s time to load up the truck; in fact, one of the things that few investors grasp is that a new bull move doesn’t start the day a bear move ends. Instead, there’s usually a transition phase of sorts when the market gets ready to make its move. Call it a bottoming out phase if you like.

I think there’s a good chance that is happening now as, just on the face of it, most stocks remain in bad shape. (About 80% of NYSE stocks are still below their longer-term 200-day moving average.) And that means there’s plenty of overhead resistance to chew through, and some time is likely needed for launching pads to form.

My guess is that the rubber will truly meet the road during earnings season, which has just gotten underway this week. If the market can hold or build on its recent gains during the next three weeks, and, importantly, we get some potential leaders to pop higher on huge volume thanks to bullish quarterly reports and forecasts, I think the market has a shot at a year-end run.

So what are some names to watch for during earnings season? I’ll give you three, a couple of which might be surprising.

One is Under Armour (UA), which aims to be the next Nike. The firm has accelerating sales and earnings growth and plenty of irons in the fire, as well as top management. And the stock has formed a cup-with-deep-handle pattern; a move above 81 or so on earnings would be interesting. The earnings report is due out the morning of October 25.

Another name to check out is Tesla Motors (TSLA), which is set to be one of the major players in the electric car industry. Earnings are a long ways off, but revenues are growing nicely (thanks to battery pack supply deals) and all eyes will be on the company’s Model S vehicle, which is set for release in the second half of 2012. We’re intrigued that Fidelity Investments has accumulated a relatively huge position. The quarterly report is likely out during the first week of November, and a big-volume push above 30 would be bullish.

Last but not least is LinkedIn (LNKD), the recent IPO that has settled down in a very quiet, very low-volume range during the past few weeks. We still think its business is unique and could be another “next big thing” when it comes to the Internet. Earnings are likely out during the first week of November, and a push above 90 or so would be a clue that the stock could be ready for a run.

All the best,

Mike Cintolo
Editor of Cabot Market Letter

Editor’s Note: Some investors can make good money in bull markets, and some are good at avoiding damage in bear markets. But to have great returns, you need to do both … like Mike Cintolo (VP of Investments for Cabot) has done as editor of the Cabot Market Letter. Since he took over at the start of 2007, Mike has outperformed the S&P 500 by 13.0% annually thanks to top-notch stock picking and market timing. To benefit from Mike’s advice during these challenging times—and to know when and what to jump on when the bulls re-take control—be sure to give Cabot Market Letter a try today.

A growth stock and market timing expert, Michael Cintolo is Chief Investment Strategist of Cabot Wealth Network and Chief Analyst of Cabot Growth Investor and Cabot Top Ten Trader. Since joining Cabot in 1999, Mike has uncovered exceptional growth stocks and helped to create new tools and rules for buying and selling stocks. Perhaps most notable was his development of the proprietary trend-following market timing system, Cabot Tides, which has helped Cabot place among the top handful of market-timing newsletters numerous times.