You Ask, We Answer
The FAQ Edition
Send Us Your Questions
Every few months I like to do a frequently asked question (FAQ) issue for Cabot Wealth Advisory. The reason I’m able to do this is that I’m available to subscribers–every editor answers many emails each week, so we have a pretty good idea of what’s on subscribers’ minds.
I find the FAQ both makes for a good read (I usually get a bunch of positive feedback after FAQ issues … so be sure to let me know what you think, good or bad, about this one) and helps me think through some of the most common and intriguing questions out there. A quick note before I start, the answers to these questions are from my growth stock and market-timing perspective. If you want to know more about where I’m coming from, see my Editor Profile here: http://www.cabot.net/Editors/MichaelCintolo.aspx
So without further ado, on with the show.
Question: I like your stock picks and newsletter, but I’ve noticed that most of your recommendations have already rallied greatly during the past few months. Why can’t you bring them to our attention a few months earlier, at lower prices?
Answer: The reason is this: when all these stocks were on the ground and were acting terribly, no one knew which among them would turn into leaders. Today, we’re bringing you the stocks that are under strong accumulation, but we’re not showing you the dozens of stocks that fell hard during the bear market (just like these) and have barely been able to rally during the past few months.
Said another way, guessing which stocks will successfully rally off their lows is a low-odds play–for every stock that comes back nicely, many more just sit there, or actually decline. Believe it or not, waiting for the wheat to separate from the chaff allows you to pinpoint leading stocks and avoid the thousands of laggards and mediocre performers in the market.
Of course, that doesn’t mean you go out and buy any strong stock at any price. The best time to buy a growth stock is usually after a normal 10% or 15% pullback, or after a strong stock has consolidated for many weeks and then breaks out powerfully to new-high ground. Many stocks did the latter in recent weeks, boding well for the market.
Question: You said in one of your online seminars that proper portfolio management can make the difference between having a good year and a great year. What exactly did you mean by that, and if it’s true, what are your handful of top portfolio management rules?
Answer: I did say that, and yes, it’s very true. Here’s what I meant: While finding the best stocks in the market is a very important aspect to making big money (obviously), it’s just as important to know how to handle these stocks. Those who do can made big money; those who don’t can make decent money.
For instance, you may have owned Cisco Systems sometime in the 1990s–it was the bellwether technology stock. But did you buy it at the right time? Did you buy more at proper points? Did you have a large percentage of your portfolio in the stock during its advance? And did you sell it when it began to break down? Investors who did made a killing, while those who didn’t probably made a little money, but nothing great.
Anyway, broadly speaking, my top portfolio management rules are
(2) Let at least some of your winners run–it’s OK to take some chips off the table on the way up, but you want to give yourself a chance to benefit from a huge winner.
(3) Don’t risk too much–you shouldn’t be risking more than 2% (preferably less than 1%) per trade. If you buy something at 50 and cut your loss at, say, 44 (a 12% loss)–a normal occurrence which is going to happen from time to time–you shouldn’t lose a huge chunk (5% or 10%) of your total portfolio. If you don’t cut your losses short, you can quickly go bust during a rough patch in the market.
(4) Don’t risk too little–while you don’t want to risk too much, part of your goal is to make good money when you do land a big winner. If you only have 2% of your total portfolio in a stock, why bother? You’re not running a mutual fund.
(5) Follow the bottom line–too many investors fail to track their accounts. Big mistake! You don’t need to follow things on a daily basis (in fact, that’s probably counterproductive), but weekly or monthly tracking will help you stay on track and know when things go amiss.
Question: You’ve written about the importance of earnings gaps, but what do you make of the many reversals we’ve seen of late–stocks opening down a few points on earnings, but then rallying strongly? Don’t big down gap openings usually lead to lower, not higher, prices?
Answer: Yes, we have seen recent gap reversals in many stocks, including Green Mountain Coffee Roasters (GMCR) last week, and Chipotle Mexican Grill (CMG) the week before. In general, big down openings followed by higher closes are bullish, which bodes well for the stocks.
But the bigger thing to remember is that decisive, powerful earnings gaps (up or down)–i.e., a 10% to 15% move through support or resistance on humongous volume are meaningful. In the case of GMCR and CMG, both gapped down, but the damage in each case was less than 10%, and even at their worst levels, both stocks were safely above their 50-day moving averages.
The most meaningful earnings gaps are the most obvious; if you see a stock move 20%, 25% or more on earnings, that move is likely to continue. We’ve seen a handful of these already, including American Superconductor (AMSC) and Intuitive Surgical (ISRG) to the good, and Riverbed Technology (RVBD) to the bad.
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Question: How do you handle buying growth stocks in the current environment, when most leaders have already enjoyed some powerful upmoves … yet they refuse to pull back and even continue to move up? Should I wait for a pullback or buy now?
Answer: Every stock is different, of course, but right now, many of the best stocks have recently broken out of a five-, six- or seven-week consolidation areas, so while they’ve enjoyed a good couple of weeks, they aren’t extended to the upside. Thus, for the most part, I think you can basically buy these stocks right here, or on minor (2% to 5%) pullbacks. (One caveat: Don’t load up right ahead of an earnings report, as that’s more like gambling than investing.)
With that said, however, I do think the market will retreat at some point, and it’s foolish to think the leaders won’t be affected. Over the long run, waiting for pullbacks is your better option, so don’t get in the habit of chasing stocks higher. Doing so almost always leads to losses.
Q: How do you balance the fact that many of your stocks have great sales and earnings growth, but also have very high P/E ratios? Isn’t their growth priced in at some point?
A: I learned long ago that for growth stocks, P/E ratios are simply not an important factor in determining future performance. Rapid growth and (most important) a revolutionary product or service are better predictors.
Eventually, valuation will matter, but you should let the stock tell you when it does–its own topping action will let you know it’s time to move on. Just remember that a valuation is the result of good performance, not the cause of it.
Q: What do you do when you buy a stock and get stopped out because it trips your loss limit, only to see the stock quickly reverse course and begin advancing again?
A: This is a good question to think about because, frankly, such a scenario is going to happen a few times–that’s life in the stock market. Here’s what I would suggest:
First, make sure you’re buying properly; if you’re buying a stock in the stratosphere, you’re more likely to get shaken out on normal pullbacks.
Beyond that, you should consider buying the stock back if it knocks you out but turns tail POWERFULLY. Remember, if you got shaken out, the odds are that many others did, too … eliminating lots of potential resistance. So if the stock turns around, it could be ready for a nice upmove. I know it’s psychologically difficult to do, but oftentimes, buying after a shakeout is one of the higher-odds investments you can make. So keep an open mind to it.
Q: How do you handle stocks that announce new share offerings?
A: Usually it’s just best to watch the chart. More often than not, a strong leading stock will not break down because of a share offering, although such stocks usually decline on the news. And these stocks will often be “capped” in the short-term, until their offerings are out of the way.
Just make sure you’re buying because the stock truly merits your support, not because you’re trying to get even.
Really, though, like I just wrote, it’s best to just watch the chart. If a stock announces a big follow-on offering and it breaks below its 50-day line, that’s bearish. But if it pulls back but remains above support, it’s usually worth holding.
That’s all for today. I hope you enjoyed reading the FAQ issue as much as I enjoyed writing it. Do you still have a burning question that you want answered by me or one of the other editors? Then send us an email or comment on our blog, http://www.iconoclast-investor.com!
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Editor’s Note: Do you want to read more of Michael Cintolo’s expert advice on buying stocks and timing the market? Then you should try Cabot Market Letter, THE place to find out Mike’s latest thoughts on the market’s action, what stocks he’s currently buying (and which to avoid) and whether the time is right to invest. Right now, our market timing indicators are all bullish, telling us it’s time to BUY! Let Mike be your guide to this new bull market and start by filling your portfolio with the market leading stocks he’s buying right now. Get started today!