Daring to be Cautious

Daring to be Cautious

Explaining Growth Investing to Academics

An Old Friend for Your Watch List

With the global economic recovery showing spotty results and equity markets trying to cough up a fur-ball, it’s a ticklish time for investors.

Basically, we have to make decisions about what to do with our money based on incomplete and contradictory data and conflicting predictions.

Cabot’s position on the question of what to do when markets are bearish is clear.

• Reduce or eliminate buying.
• Purge your portfolio of any weak or losing stocks and hold the cash.
• Put the stocks that are still performing well on a short leash.

These steps have one huge good effect; they will preserve your capital. And the money you don’t lose in a down market can be put to work when the bull wakes up again.

But true growth investors—although they can be quite disciplined when doing their due diligence and preparing their buys—have a bias for action that makes it hard to just sit on a wad of cash. Like the vultures in the cartoon, growth people are likely to look at one another and say, “Patience, hell! I’m going to go kill something.”

It’s true that this market has a fair number of stocks that are holding up well—or even advancing—during this spell of weakness. The Model Portfolio of the Cabot Market Letter is about 50% invested and is recommending a little buying for investors who are similarly cash-heavy.

The Cabot China & Emerging Markets Report’s portfolio is about 60% in cash, with only two stocks still rated buy. I think this is great, because it’s like watching a thunderstorm from behind the safety of a nice, big picture window.

So what should you be doing if you have the proverbial “bias for action” and don’t like the idea of just sitting in cash while the market makes up its mind which way to jump?

Well, if you’re a thrill seeker, the kind of person who doesn’t wear a seat belt in a car or knee pads on a skateboard, I say just go for it. Not because I think that’s the right thing to do, but because pain and loss are the only things that are likely to convince you. As I’ve always said, the market is a tough teacher because it tests first and teaches afterward.

But if you’re sane enough that you’re already heavily in cash and just want to make a few bets to keep your hand in, there are a couple of things you can do to take the sting out of being wrong.

First, keep your bets small. One classic growth investor buying pattern is to take a half a position (that’s half of your usual dollar amount, assuming that you use equal-dollar positions for each stock), then follow it with a one-third position if the stock confirms your buy by rising in price, then taking a final one-sixth to finish the position.

If the stock doesn’t go up after your initial buy, you don’t ever make the second or third buys.

The second thing is to keep your loss limits tight. In this kind of a market, any stock that closes a trading session 15% under your buy price should be sold. Period. End of story. (And, really, anything down 10% from your buy point should be looked at very skeptically.)

Mostly, though, I think it’s a time to conquer your aggressive impulses and savor the flavor of cash as the best holding to get you through a bear market.

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Timing is Everything

From the bear market bottom in 2003 to the bear market bottom in
March 2009, subscribers to Cabot Market Letter made a stunning 94%.
Compare that to the S&P, which LOST 18% over the same period!

If you’re a Cabot Market Letter subscriber, this will not be
surprising. You know how Michael Cintolo helps readers conserve cash
when the market is unsupportive and to invest aggressively when the
market trend is up. But if you’re not a subscriber yet, you owe it to
yourself to take a look at the Cabot Market Letter.

http://www.cabot.net/info/cml/cmlkb02.aspx?source=wc01

I used to teach at the college level, and many of my friends still do, which can be a slight problem when it comes to talking shop. These people, including many from English Departments, are the ones that TIAA-CREF talks about as “people with better things to think about” than mere money.

My friends have mostly gotten the picture, but when I try to explain what I do to strangers from the Groves of Academe, I have to resort to metaphor.

Here’s my latest effort.

I tell people that following stocks is like doing a critical analysis of a novel. You have to think of the stocks not as companies, but as narratives. Like the people in a novel, companies have personalities and characters. Some are solid pillars of the community and some are fly-by-night wastrels who will never amount to anything.

There are even a few villains.

Like the fictional folks who inhabit books, stocks have histories, including past triumphs and tragedies, marriages and divorces and either good or bad luck. When they are challenged by the world (and their competitors), they either grow into heroes or they fall by the wayside like flawed characters.

Sometimes the company has a CEO (like, say, Steve Jobs) who embodies both the strengths and weaknesses of the enterprise. Jobs is brilliant, but he’s also touchy and maybe just the slightest bit arrogant, which is fine, as long as he can keep pulling profitable iRabbits out of hats. Apple is a heroic character if I’ve ever seen one.

On the other side, there’s Blockbuster, which used to own the movie rental business. But the company was arrogant, even a little mean, and charged late fees when tapes (remember tapes?) weren’t returned. So when DVDs showed up and dynamic, young Netflix made it easy to get them through the mail, WITH NO LATE FEES!, Blockbuster was like the classic bully who loses his power. Then, just to nail the coffin lid down, down-market Coinstar began the Redbox rental kiosk business with fresh flicks for a buck a night. It’s the kind of narrative an English professor could write books about.

My academic friends probably won’t ever take to growth stock investing the way I have. But at least I’m able to talk their language for a while, which makes it easier when old acquaintances ask what I’m doing now. And I see the light come on behind a few eyes every now and then. I’ll get through to them eventually.

Obviously any stock recommendation I make today will come with a list of warnings attached. There’s nothing in a good combination of revenue and earnings growth and a strong chart that can reverse the trend of the market. Stocks that resist the downward pull of the market are worth studying and make great additions to watch lists.

But a market that’s trending down puts pressure on all stocks, even those that are going up.

So my pick today is a stock for your watch list that’s an old friend of the Cabot China & Emerging Markets Report. We made excellent money on this stock back in 2006, but the company has been through the mill recently and could represent a good value here.

Focus Media Holdings (FMCN) was a pioneer in the out-of-home advertising business in China, sticking flat-panel video screens in elevator lobbies, malls, buses, chain stores and other high-traffic areas and then selling screen time to advertisers. It was a brilliant strategy, and it spawned a host of imitators in China, most of whom have struck deals with different transportation systems and locations to display content and ads.

The company hasn’t recorded a quarterly loss in years, but experienced four quarters of declining earnings starting in Q4 2008. On the good side, there’s no debt and the stock is perfectly liquid.

But the price is a problem. FMCN took an unusually large hit during the Great Recession, plummeting from 66 in late 2007 to 5 in March 2009. The recovery since then has been substantial, but the stock’s price recovered only to a peak of 19 on March 17, and is now trading in a tightening wedge at 15.

It may be that Focus Media was a one-trick pony and just reaped the benefits of being the first on the scene in an untapped industry. But I’m keeping FMCN, which has an attractive P/E ratio of 15 on my Watch List. I’m especially interested in seeing what happens when that wedge on the stock’s chart makes its move — if the move is to the upside, it could be explosive.

If you’d like to keep track of the latest and greatest in the world of emerging market stocks, I think a subscription to Cabot China & Emerging Markets Report would be a great first step. In every issue I give subscribers some perspective on what’s happening in China and elsewhere, and the advice that accompanies each issue and update has kept my subscribers safely on the sidelines for much of this cranky market’s worst tantrums. A click on the link will get you started.

Sincerely,

Paul Goodwin
For Cabot Wealth Advisory

Editor’s Note: Paul Goodwin is the editor of Cabot China & Emerging
Markets Report, the #1 newsletter for the last five years, according to
Hulbert Financial Digest. The Report is up 244% for the last five years
versus a 14% gain in the market. Don’t miss out on the next five years of
monster growth! Join us today.

http://www.cabot.net/info/cem/cemkj06.aspx?source=wc01

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