Simple Rules for Stock Investing?

Simple Rules for Stock Investing?

The Difficulty of Implementation

A Stock for Your Watch List

Investing in stocks involves a huge number of variables, so many, in fact, that the whole system simply defies complete analysis.

Think about it. Even the most sophisticated organizations (mutual fund houses and hedge funds), with battalions of analysts and rooms full of computers, can’t get the business of making money by investing in stocks down to a science.

That’s why most stock investment strategies are exercises in simplifying, seeking to gain an edge on the market by reducing decisions on buying and selling to a manageable system. And the essence of most systems is that there are only three things (or four, or five, but nowhere near double figures) that you need to pay attention to.

The Cabot growth investing strategy certainly does this. Here are the principles:

1.Invest in stocks whose charts show increasing investor interest.
2. Increase your market exposure when markets are advancing and reduce exposure when markets are declining.
3. Cut losses short, especially in negative market environments.
4. Let winners run.
5. Stick to stocks trading above 14 and that average 400,000 shares traded per day.

That’s about it.

But, the implementation isn’t all that simple. You have to learn at least the rudiments of technical analysis of charts. You need a reliable indicator of the direction of the market, especially when indexes are soaring and swooping like a flock of starlings. And you need to develop guidelines on when to sell.

By contrast, value investors can ignore most of these things and just look for undervalued companies with good prospects.

Of course, the implementation of that, too, is far from simple. You need to learn how to analyze truckloads of data on assets and liabilities. And you must develop techniques for projecting the future of a company’s revenue, earnings, free cash flow, margins and market share, management and competition.

There are stock investment techniques that are simple, dead simple. You can, for instance, buy stocks that your brother-in-law recommends. Or you can only buy stock in the company at which you work. (That’s what my father-in-law did, and his holdings in Amoco–which is now British Petroleum–provided years of dividend income for him.)

You might try to emulate Noel Constant, a character in Kurt Vonnegut’s book The Sirens of Titan. Mr. Constant achieved enormous wealth by buying stocks whose names corresponded to the successive letters of the King James Bible. Although fictional, Mr. Constant’s system is simple and easy to understand. All you need is a massive amount of luck (or divine intervention).

You might also consider the venerable Dogs of the Dow strategy, which involves a once-a-year buy of the 10 top dividend-payers from among the 30 members of the Dow-Jones Industrial average. The strategy beats the performance of the S&P 500 Index in the long run.

But if beating the S&P 500 Index is your benchmark for success, you’re not really aiming very high, are you?

Personally, I find the Cabot growth discipline is just right for my investment personality (that’s my level of aggressiveness, tolerance for risk and need for mental stimulation).

I’ve always enjoyed “Two Out of Three” rules. One favorite says that food can be fast, cheap and nutritious, but you can only have two out of three in any one food. A box of Mallomars, for example, is fast and cheap, but fails miserably at nutrition. You can fill in the other categories.

In investment, I’m not sure what the three categories would be. How about 1) simple, 2) high potential, and 3) consistent. Simple and high-potential might be penny stock investing, where the upside is huge, but the volatility cuts both ways. Simple and consistent would be an index fund, which lacks big upside chances. And high-potential and consistent could, at least in theory, be hedge fund investing, which is anything but simple.

So where would growth investing fit in this scheme? Well, despite the implementation difficulties I ventured above, the principles are indeed simple. And the potential is genuinely high. But growth investing, at least as the Cabot system practices it, looks to make the bulk of its annual returns from a small number of successful stocks that deliver big gains. You have to cut off a lot of losers in pursuit of a few big winners.

In fact, Cabot’s rules for cutting losses short are the key to success in growth investing.

And if you subscribe to our flagship growth publication Cabot Market Letter, implementing a growth strategy can also be simple; you just follow the advice in the advisory.

Sound interesting? You can get a trial subscription to Cabot Market Letter here. And with our generous cancellation policy, if you decide it’s not for you, you can cancel within 60 days and get a full refund. That’s about a low-risk as you can get.

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It’s a basic principle of ecology that when there is a lot of something to eat, nature will see to it that there’s something to eat it. And the same principle holds for economics, as well. And if there is any thing that the global economy is oversupplied with right now, it’s just got to be underperforming mortgages.

Bad mortgages are a major reason the global economy in general, and the U.S. economy in particular, is having such a hard time getting going again.

The U.S. Fed is taking about $40 billion of these mortgages out of circulation every month, but the supply is still enormous. And that’s where Ocwen Financial (OCN) comes into the picture.

Ocwen used to be a pretty standard mortgage lender, but it has shifted its main focus onto mortgage servicing—the collecting of payments and late fees, renegotiating terms, and, if all else fails, conducting foreclosures. Banks are happy to be rid of the responsibility and estimates are that there may be $3 or $4 trillion of mortgage assets that will be subbed out to servicers like Ocwen in the next few years.

Ocwen’s 38% revenue growth in 2011 pales in comparison to the 90% revenue growth it reported in the latest quarter or the 100% growth it booked in Q2. And earnings estimates for the year are estimated to come in at 87%, with 2013 estimates now at a whopping 210%!

OCN went on a strong growth spree from November 2010 to February 2012, roaring from 8 to 17. But after a mild pullback that lasted 10 weeks, the stock really exploded, ripping from 14 last May to 38 at the beginning of October. Since then, OCN has been trading sideways, including five weeks in a tightening consolidation between 34 and 36. That’s the kind of flat base that can produce real sparks when the stock makes a move.

The catch, of course, is that you don’t know which way to move is going to go. So while a sizable buy of OCN might pay off, it could also land you with a sizable loss. My advice is to put OCN on your watch list and monitor it closely for signs (moves either way on increasing volume) of a breakout from this tight trading range.

Ocwen has the story and the numbers, and if the chart signals that it’s time to buy, quick action may give you a great opportunity.


Paul Goodwin

Editor of Cabot China & Emerging Markets Report

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