Thanksgiving wrap-up, CROX and WCG

Thanksgiving was splendid, as always. My wife roasted one turkey in the oven while I smoked one outdoors, using natural charcoal for heat and moist hardwood chips for flavor … and they were both delicious.

The smoked one had an additional layer of flavor and aroma on the outside, while on the inside, they were indistinguishable.

Accompanying them were mashed potatoes, squash, gravy, two kinds of stuffing, green beans, asparagus, two kinds of cranberry sauce, red wine, white wine, water and three kinds of pie. I didn’t eat to bursting. And the youngest person in our group of fourteen was twelve years old (and acting at least fourteen), so there was no jumping up and down to tend to children. All in all, it was fine day, and we were thankful that we were able to enjoy it together.

But somewhere in the slack period between the mashed potatoes and the pies, I overheard this bit of conversation at the other end of the table.

“I don’t think I’ll ever be able to take my kids skiing in Zermatt.”

The speaker was a recent college graduate, a young man whose father (a medical doctor) had treated him to such a trip in the past, but who was lamenting, in general, the high cost of living today. His theme: that individuals of his generation might never be able to live in the manner their parents expected they would. On the other end of the conversation, agreeing with him, was a man from my generation, also a medical doctor, who expressed both sympathy and a little guilt for being a part of the generation that’s been “in charge” in recent years.

So I chimed in and politely disagreed, saying I was confident that their fears were unfounded. But partly because we were at opposite ends of the table, and partly in the interest of maintaining the convivial holiday atmosphere, I didn’t pursue it further.

Still, it’s been on my mind since, so today I’m writing about it to get it off my mind … and to address anyone who feels similarly.

First, this young man’s prospects are bright. Yes, he still has college loans hanging over his head, and the prices of houses in the Boston area, even after the recent decline, are still out of reach. But he’s attending law school in Boston, and my strong belief is that when he graduates he’ll have no trouble finding a job and making plenty of money. I’m confident the demand for lawyers will remain high in the decades ahead.

So the real question is about the prospects for the U.S. Will the next generation live as well as ours has?

Obviously, there are troubles today. Most recently, we’re seen the collapse of the mortgage industry, whose repercussions have in turn brought down well-respected stalwarts like Citigroup and Merrill Lynch. On top of that we have a falling dollar, rising oil prices, an ever-expanding national debt, health care costs that refuse to be reined in … and global warming.

It sounds like a lot when you pile it up like that.

Yet we have always had problems, and we have always surmounted our problems. In fact, my father taught me to call them “challenges” and the first challenge lies in putting these in perspective.

And how do we get perspective? First, as John Prine advised, “Turn off your TV. Throw away your paper.” Then stand back and look at the long-term trends.

The long-term trend of this country is still up, as reflected by its growing GDP. The long-term trend of the stock market, which tends to track the value of our corporate assets, is up, too. I have a 100-year chart on the wall of my office that reminds me off this regularly.

And I don’t believe those trends are finished.

Now, admittedly, we don’t have the double-digit growth rates enjoyed by the people of China, Kazakhstan, Estonia, and Latvia. But they don’t have our standard of living! And as long as our growth rate is positive, it’s reasonable to assume that a young man’s standard of living will exceed his father’s at the same age … and that this young man will be able to take his son skiing in Europe.

As for the “challenges,” they will be dealt with, just as those that beleaguered us in every previous decade were dealt with.

The problem of high oil will be solved in time by the growing use of new alternate energy technologies, as well as conservation through more efficient use of energy.

The mortgage/credit issue will pass, and if in the end we end up with a couple hundred fewer banks, no problem; there are still far too many banks in the world, and the ongoing consolidation of banks should bring more efficiencies to the industry when this has passed.

As for the falling dollar and our rising national debt, they’re connected, and I blame the folks in Washington for acting so irresponsibly. Nevertheless, I’m optimistic that there’s a bottom for the dollar somewhere, and as with any asset that bottoms, once the trend turns up, bargain-hunters will be eager to accumulate it again.

And then there’s the escalating cost of health care. The root of the problem, in my opinion, is that we confuse the right to decent health care for everyone – which we as a country can afford, with the right to the very best health care – which we as a country absolutely cannot afford. And with the consumer insulated from the actual costs of health care, the mechanism that regulates demand in other industries is lacking. So we continually use more health care than we can afford, and then fail to notice that our insatiable demand is the reason for the ever-increasing costs. The solution won’t be pretty, but it looks like it will involve increasing government control over health care expenditures for everyone except people who can afford to pay their own way.

And global warming? Short-term, I have no doubt that public perception of the problem is at a temporary high and will fade as the news gets old. Such is the news/attention cycle. But long-term, I’m confident that mankind, armed with big brains and technology, will adapt in time to “save” both the world and our species. Along the way there will be some major changes, some bad and some good. But we will adapt, and when you take a long perspective, you realize that adapting is what humans do best.

Bottom line: I’m confident, even optimistic, that today’s troubles will pass and that both the U.S. economy and stock market will continue to advance.

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And one reason I’m so optimistic is Sir John Marks Templeton, who’s celebrating his 95th birthday today. Sir John was born to a poor family in Tennessee in 1912, but attended Yale University, earned a Rhodes scholarship to Oxford and an M.A. in law. He began his career on Wall Street in 1937, founded the Templeton Growth Fund in 1954, and in 1992 sold his company to Franklin Resources for $440 million.

I heard Sir John speak some fifteen years ago and I still remember this thin, distinguished man expounding on the fact that the world at the time was a far better place than it had ever been before, spouting statistics about advances in longevity and infant mortality, the eradication of disease, the increase in leisure time, the increases in living standards throughout the globe … and then telling us that we were nowhere near the end of the trend!

He was right, of course. In the brief 15 years since he spoke we’ve been blessed with Google, YouTube, the iPod, and the Toyota Prius. We’ve seen the Chinese people begin to enjoy the fruits of capitalism and the comforts of middle-class life. We’ve cracked the human genome and are just beginning to reap the benefits of that breakthrough. And more. So Happy Birthday, Sir John!

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Moving on, I received this email yesterday from a loyal subscriber in Vermont:

“During this quiet buying period, would it be helpful to put out a few words on WCG and CROX? They both made somewhat unexpected cliff-charts, for very different reasons. Any wisdom from you would probably be enjoyed by the flock!

Thanks for all you do!

WR Jr.”

Very well. To clarify, the “quiet buying period” referred to is the current market phase where we’re advocating that growth-oriented investors favor cash over aggressive investing.

And the “cliff-charts” (not a phrase I’ve used before, but I like it) refer to prices that suddenly plummet for a few days before bottoming well below their peaks. Note: it’s very rare that we experience two cliff-charts so close together.

WCG is Wellcare Group, a leading provider of Medicare and Medicaid-sponsored health plans. It was held in the Cabot Market Letter’s Model Portfolio from October 2006 until May 1, 2007; we sold at 80 for a 36% profit. Following that, the stock rallied, earning a recommendation in Cabot Top Ten Report in August when it was selling at 105. After that the stock climbed all the way to 128 in mid-October. But then the bottom fell out; the stock lost 84% of its value in one week, bottoming at 21; today it’s back up to 37.

The news that sparked the selling was simple; the FBI, Department of Health and Human Services and the Florida Attorney General’s Medicare fraud division raided the company’s Tampa headquarters, without saying why the company was being targeted. A day later, the Securities and Exchange Commission joined the party.

So investors assumed the worst, and jumped ship. Weeks later, it was reported that the raid was stimulated by an ex-employee’s whistleblower lawsuit, claiming the company overstated medical care costs. But as I write, the authorities are still analyzing their findings and plotting their course.

Analyzing the company today as a growth investor, the plainest statement I can make is that this stock is heavily damaged … and we don’t like damaged stocks.

When the selling pressures in WCG peaked, the stock was deeply oversold. But in the four weeks since then, the stock rebounded 89% (21 to 49, still 62% off its high), and I think that rebound is over. Every rally from here will simply provide an opportunity for someone who bought higher to get out, so selling pressures are likely to weigh on the stock for long time. On Tuesday and Wednesday of this week, in fact, when the market soared, WCG declined. The rebound has taken the stock up exactly to its now-declining 50-day moving average, and I think this is a perfect place to sell the stock if you still own it.

As to the fundamentals, they’re a minor part of my analysis.

Wellcare had a great growth business, and I assume it will have one in the future, too. And by some measures, the stock is cheap; WCG’s market capitalization is now just $1.5 billion, approximately a third of the company’s annual revenues. But the class-action lawyers are now circling, and they’ll get a bite of the company when the authorities are done.

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So on to Crocs (CROX), the maker of funny-looking shoes.

CROX was added to Cabot Market Letter’s Model Portfolio in October 2006 at 17, and recommended as a Cabot Stock of the Month on April 25 of this year at 27. It was a strong stock and the company’s numbers were superb, reflecting triple-digit growth of both revenues and earnings as well as profit margins approaching 20%. I particularly liked the fact that the unusual shoes were viewed skeptically by so many experts; it’s the improvement in perception, remember, that is truly responsible for a stock’s advance and I saw a lot of room for perceptions to improve.

But by June CROX had become an uncomfortably large part of the Model Portfolio, and detecting a short-term overbought condition in the stock’s chart, we sold a third at 45 for a profit of 160%. Nine weeks later, the stock was trading at the same level. But the good numbers kept coming, so buyers returned, and pushed the stock up to a high of 75 in October.

And then the third quarter results were released, and while they were terrific, they were not quite as terrific as expected, so the uptrend ended and the sellers took over, knocking the stock down 55% in one week. The Cabot Market Letter sold immediately at 47, for a final profit of 176%, while Cabot Stock of the Month waited a week and got out at 42. The stock eventually bottomed at 34, and the bounce in the three weeks since then has been poor indeed. The stock is still below all its moving averages.

Now, unlike Wellcare Group, Crocs still has an excellent growth business, and we still have high expectations for the company.

But we don’t confuse the stock with the company, and we never argue with the stock. CROX, like WCG, is heavily damaged. Every rally from here will be met with selling pressures from investors who bought higher who will now be content to “get out even.” And thus it’s highly unlikely that this stock will return to its winning ways in the near term. So we say sell.

Bottom line, the odds of success in the months ahead are better in leading stocks than in either CROX or WCG.

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Editor’s Note:

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Yours in pursuit of wisdom and wealth,

Timothy Lutts
Publisher
Cabot Wealth Advisory

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