What Do Your Stocks Know About You?

Forget Regret

What Do Your Stocks Know About You?

Another Bite of the Apple

The stock market is always trying to separate you from your money.  Everybody knows that.

What some people may not know is that the market is equally good at separating you from your sanity.

My favorite crazy-making tactic on the part of individual stocks is the issue that trades sideways for weeks and then breaks out with a 10% gain in one day.  I tell myself that I can’t buy it now because it’s too extended.  So I figure I’ll buy it when it corrects tomorrow.

Tomorrow comes and the stock continues to soar.  Now I really can’t buy it.  

And when the stock finally corrects for a day or two, it’s so high above its moving averages that only a fool would buy it.  

This isn’t just a random rueful comment.  This has actually happened to me more than once.

And it seems to me to be one of a matched set of frustrating regrets that can take the sun right out of the sky for growth investors.

The first regret is: “The stock has gone up, I can’t buy it.”  The second regret is: “The stock has gone down, I can’t sell it.”

If you’ve been following the advice and stories that Cabot’s growth analysts tell in these wealth advisories, you know that the second regret is not only not true, it’s actually dangerous to your portfolio.  

Psychologically, of course, it makes a lot of sense.  If you own a stock that has gone down in price, it’s hard to do the right thing and just sell it when it triggers your sell discipline.  Selling at a loss forces you to admit to failure, and that’s tough on both your pocket book and your ego.

But, as we’ve said here time and time again, if you can’t set and stick to a sell discipline, you might just as well throw your money into the back yard and let the birds make nests out of it.  A portfolio without a sell discipline is like a bucket with a hole in it.

The first regret is a little less common, but it’s a good one for growth investors to spend some time with.  I took a long, long look at Baidu (BIDU) back in January when it dipped to 105, but it was just completing a retest of its November/December lows.  But at the time, the Cabot China-Timer was flashing a red light and then, when BIDU began its new run, there were stronger stocks available.  But now that I’ve watched it go all the way up to 246, I’m still regretting every day that it went up and I didn’t own it.  

At 246 BIDU may still be a good stock.  The Chinese market–especially the Chinese Internet market–is very strong and still has amazing growth potential, which means BIDU may be a great buy here.  But the memory of that 105 low sticks in my craw and keeps me from looking at Baidu as just another growth company.

I know there are lots more growth stocks out there.  With the bulls firmly in charge of the rudder, it’s a target-rich environment.  But regret isn’t rational.  I looked at BIDU at 105, and regret can chafe for a long time.

The cure?

As usual, a dose of tough love is the ticket.  If you can’t sell your stocks when you should, you’re going to have a tough time as a growth investor.  If you can’t find buy points for stocks that make sense to you, same thing.  There’s a kind of personality that is shared by every successful growth investor I know, and it is optimistic, forward-looking and able to shed disappointments like a meter maid sheds abuse.  Good traits to emulate … if you can.

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Stocks don’t know you own them.  That’s the standard reply to anyone who’s feeling paranoid because a stock they bought immediately fell on its nose.  Similarly, the sports team you’re watching on television doesn’t know when you leave the room, turn your hat around in “rally cap” position, or give the evil eye to the shooter, kicker or passer.

At least that’s what they tell me.  

The truth is, though, that while the stock may not know you’ve bought it, the stock market does.  Or, rather, the market knows when a bunch of people have bought a stock because the chart reflects the rising tide of buyers.

Growth investors are used to buying stocks on the way up.  In fact, a rising chart is one of the things we screen for when we’re looking for growth stocks.  

A rising stock can gather momentum as more and more people buy in to try for a piece of the action, and the rate of appreciation can steepen dramatically as a run continues.  And if you’re one of the investors who jumps on the bandwagon just as a stock is getting ready for its big correction, then you can say the stock knows you own it.  

The moral is to watch the climb rate and volume of a stock after a big run.  If the price line starts heading for vertical and volume is waning, it’s probably time to take some profit if you own it or keep your hands in your pocket if you don’t.  

Its great that the stock market is healthy enough that people need to be warned about climax tops.  It’s a good problem to have because it’s so easy to avoid and it says so much about the overall tone of the market.  If you’re in a market that’s strong enough to pull money off the sidelines and build stocks up to the danger point, you’re in an environment that can make you some money.  

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I once bought Apple (AAPL) on a pullback just before it reported earnings.  It was a stupid move, but it paid off because nobody had anticipated just how many iPods Apple was selling.  

One of our rules for evaluating growth stocks is that the leaders of a previous bull market are seldom the leaders of the next one.  In fact, the odds are about four-to-one against it.

But Apple is apparently beating those odds.  The stock, which peaked at 203 during the last days of 2007 and completed a kind of double top at 192 about a year ago (with a dip to 115 in between), is now coming off a new base after bottoming at 78 in January.

It’s not just the run from 78 to 138 that makes AAPL attractive.  And it’s not just the boost the stock will get when (and if) Steve Jobs reports for duty again.

No, it’s the flood of sales for the iPhone and all the apps for the iPhone flowing together with the billions of songs purchased from iTunes and the still substantial sales of iMacs and PowerBooks to make a river of revenue.  So far, analysts haven’t been able to get their minds around the money you can make by offering consumers “insanely great” products.  And we’re not even talking about the possibility of getting the iPhone into the hands of Chinese consumers.

Apple’s revenues during the fourth quarter of 2008–the lowest point of a very low period for the market–were still up 6%, which improved to 9% in Q1.  Earnings were up 1% in Q4 and have improved to a respectable 15% in Q1.  AAPL isn’t cheap (P/E ratio of 23) and isn’t unknown (857 institutional supporters).  But it’s pretty much broken every rule in the book, and if it wants to be a leader in this new bull market, I’m not going to say no to it.  

Sincerely,

Paul Goodwin
For Cabot Wealth Advisory

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