Bidding Your Inner Chump Goodbye

First, let me say that I don’t think you, the person reading this commentary, are a chump. This is addressed to all those other investors who act like chumps. But not you. You’re fine. Really.

But you have to admit, there are a lot of chumps out there. They’re the people who stand on the sidelines while a market rally is going on and get more and more excited and finally just can’t stand it any more and throw their money into the hottest of the hot stocks … which is the signal for the rally to be over. The leaders correct sharply and the professionals quickly hop off, landing lightly on their feet, while the chumps watch in uncomprehending horror as their stocks drop like Wile E. Coyote into the canyon of steep losses.

But it doesn’t stop there. Sustained by hope, chumps hold on to those losing stocks while they continue to decline, working their way toward a messy and protracted bottom. Then, fueled by denial, they hold on, reasoning that a stock that once sold for X certainly must be worth more than ½ X or even 1/3 X.

And finally, after all hope has been crushed and a dull resignation takes hold, the chumps sullenly unload their losers … which is the signal for those stocks to begin rising again!

This may sound like a load of cheap irony, like the people who delight in telling us that the grocery line they choose (after a diligent search for the shortest queue) is the one that will be hit by a change of checkers, a need for a new roll of paper for the register and a call of “Price check on register three!” This is a common feeling, although rarely accurate.

But the phenomenon of chumps buying near a stock’s (or a market’s) top and selling at the bottom is very real. When you think about it, a stock tops out only when it reaches a price so high that the sellers outnumber the buyers. Value-oriented professionals think it’s overvalued. Technical analysts see a climax top or a decline in buying volume. The final push for a stock comes because it has momentum and the chumps finally want in.

That doesn’t mean that, by definition, the last people to buy a stock after a long rally are chumps. Aggressive growth investors will often buy stocks at what turn out to be their highs. What makes investors chumps is that they 1) refuse to cut their losses short, or 2) make the same mistake over and over, or 3) conclude that the stock market is a fool’s game and never invest again. As we like to say, in investing it’s okay to be wrong, but it’s a sin to stay wrong.

But this section is called “How to Stop Being a Chump.” And since it doesn’t apply to you, you’ll want to be thinking about someone to whom you’d like to send it.

A person stops being a chump by finding a successful investing system that makes sense to them and then following it! It’s that simple. And if you’re wondering what an investing system looks like, you should go back to Mike’s CWA from October 13, which is about as good a free introduction to finding a system as I’ve ever read. Here’s a link.

Having a system is vital because it gives you a framework for finding, buying and selling stocks. Without a system, a potential investor gets stock ideas from anywhere and everywhere. Ideas come from familiar names, news stories, television (including the entertaining cult guru Cramer and the systemic overload of CNBC), friends and relatives, or, worst of all, from e-mail or snail-mail stock touts.

Without a system, you might get one idea from a portfolio manager on television who describes a company as having excellent growth prospects and a reasonable valuation, then another from Cramer, then a final one from your brother-in-law. Congratulations, you now have one lumbering blue chip that won’t go anywhere for years, one high-flying tech stock that will streak to a climax top in a week and a pink-slip pharma that will jump around like a monkey on speed.

What this gives you isn’t a portfolio … it’s the dog’s dinner. These stocks have no theme, no common style, nothing that will let you compare them in a meaningful way so you can manage them responsibly. And because the portfolio has no style, the investor has no rules or tools to give advice on when to sell. You can make money as a value investor. You can also make money using the growth style or a sector strategy or as a swing trader. But you probably can’t do all of them successfully at the same time.

Personally, I think growth investing is a great style because it’s interesting. You can dial your risk level up or down until you find a level of aggressiveness that keeps you interested but still lets you sleep at night. And there are newsletters (like many of Cabot’s) that will supply stock ideas, tips on market timing and trends, and commentary that will let you develop your style and hone your skills. In other words, they can help that friend of yours (or even you) to stop being a chump.

At about 9:30 in the morning on November 20, I got a call from a guy at CNBC, asking me to appear on one of their shows. The Cabot China & Emerging Markets Report had just reported a bearish signal from our market timing indicators, and they thought this was an interesting story. I’m proud of the Report’s #1 ranking and I wanted to do the show. The only problem was, they wanted me to appear that afternoon!

I don’t want to puncture anyone’s illusions, but the dress code at Cabot Heritage doesn’t really include suits and ties, and the very casual shirt I was wearing that day wasn’t likely to produce an impressive television image. And since I wasn’t eager to race back to my home in New Hampshire to grab a more formal outfit, it was power shopping to the rescue! I made a daring daylight raid at a local mall, and soon had a spiffy new shirt and tie so I could appear credible (at least from the waist up) as a talking head on CNBC’s Street Signs.

After a rainy drive into the heart of Boston’s financial district and a sumptuous business lunch (yogurt cup and power bar), I went to the same tiny studio that many financial heavy hitters use when they make such appearances. I asked the single technician — the only employee in the studio — to powder my head to reduce the glare. (Needless to say, the sunny image of the Boston skyline that appeared behind me was just a projection.) And after talking to Michelle Lee (on a disorienting seven-second delay) for a quick three minutes of generalities about what a technical sell signal in emerging markets stocks means and a couple of stock ideas, my moment of glory was over.

As I walked back out into the Boston rain in my new shirt and tie, it occurred to me that they hadn’t even powdered my head. If it weren’t for the glamour, I don’t think I would have bothered. But if you’d like to see a video of my short time on the national stage, you can click on the link.

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My investing idea in this issue is FLIR Systems, a global leader in thermal imaging. The company’s name is an acronym for Forward Looking Infrared, a kind of imaging technology that allows military aircraft and vehicles to see through darkness (and also daytime fog and smoke). Government Systems applications may be FLIR’s calling card, but they’re a small part of the whole story. The company also has a Thermography division that designs and manufactures temperature sensing technologies that can spot overheating machinery, leaks, flaws in buildings and gradients in scientific experiments. There is also a Commercial Vision Systems division that enables functions like perimeter security, night vision, news gathering and law enforcement.

In 2006, revenues from the Commercial Vision area were 65% of the year’s total, with Thermography contributing 30% and Government just 5%. Revenues from U.S. sources were 55% of total, with Europe contributing 29% and 16% coming from elsewhere. And those revenues have been growing at a good pace; after recording four quarters of single-digit growth from Q3 2005 through Q2 2006, revenue growth has increased steadily, peaking with 43% in the latest quarter.

The stock formed a long, descending base during the low-growth quarters, but took off when revenue growth turned positive in Q3 2006, bouncing from a low of 21 to around 70 in recent days.

Flir Systems isn’t a story that depends on one line of business or one earnings report. The company is diversified across business segments, which lowers the risk that, for instance, the loss of a big government contract might undercut the stock. That’s not likely anyway, as the company announced on November 7 that it had won a $17.4 million contract from the U.S. Army for a long-range imaging system to be used by the Army and Marine Corps. It probably also doesn’t hurt that a lawsuit alleging backdating of stock options was dismissed by an Oregon court on November 13.


Editors Note: Paul Goodwin is the editor of Cabot China & Emerging Markets

The recent pullback in Chinese stocks is another great opportunity, not
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