Editor Educates Investors of All Kinds

Tonight (June 2), while everyone else on the Eastern seaboard is watching Antiques Roadshow, I will be talking to the Boston chapter of the Investors Business Daily investing group, an experience that will, I hope, bring me face to face with a bunch of hard-headed Yankee investment veterans. I’m looking forward to explaining how I pick emerging markets stocks for the subscribers of the Cabot China & Emerging Markets Report.

I’ve been told that the group, despite coming together under the banner of the growth-oriented IBD newspaper, includes investors of every stripe, from hard-core, buy-and-hold value investors to day and swing traders.

To me, their investing style isn’t all that important. (I’ve always said that it’s possible to make money using any investment style, as long as you follow sound rules.) No, the most important thing is that these people are all actively trying to understand and profit from the stock market.

My bet is that I will come away from the meeting with at least a couple of good investing ideas that I’d never even thought of, maybe a new way of finding good charts or a different approach to buying.

Whatever it is, I’m ready to hear it.

Keep on Learning

Every successful investor who writes a book on how he/she brought the market to its knees always talks about how important it is to keep on learning. As soon as a technique becomes widely known, it starts to lose some of its efficiency. The first people who started using the Dogs of the Dow or the Santa Claus Rally or the January Effect probably did very well … until the whole market got wind of the pattern and priced it into every trading program and every strategy. Once everybody knows about an edge, it’s not an edge any more.

I’ll also be glad to be talking to a dedicated investing crowd because, frankly, most of my friends just aren’t interested in buying individual stocks. For most of them, just moving their money around among their mutual funds is so daunting that they just throw up their hands and leave it where it is.

I’m sympathetic, of course. After all, that’s the same way I feel about fixing a car engine or higher math. But it’s frustrating, when I have a really interesting stock to talk about and people look at me like I’m discussing shoe construction or historical styles in venetian blinds.

It will be good to be among my peeps.

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SNaC: Story, Numbers and Chart

At Cabot, we believe education is a key component of successful investing. Today I’m going to review my system for picking growth stocks, which I’ve discussed in this space before. I call it SNaC, for Story, Numbers and Chart, and it’s the method I use to choose stocks for the Cabot China & Emerging Markets Report. There’s nothing complicated about it, but it can be very powerful. Just because it’s simple, that doesn’t mean it’s easy to do. Here are the basic principles.

Story includes the basic market proposition of a company, including its products, its target consumers, its potential for huge sales growth, its barriers to entry, its competition, its intellectual property, its management and all the other stuff that you can put into words. When someone buttonholes you at a party and tells you about a penny stock they’ve found that just can’t miss … what you will probably hear is the power of a stock’s story at work.

Story is an attractive way to look at stocks because we’re all trained to react to stories. We like books and movies about people who have great ideas and struggle (against apathy, short-sightedness and malevolence) to gain acceptance (and make a pot-load of money). And we’re attracted to the same things in stocks.

But there are lots of stocks with great stories that don’t do a thing. I also want good numbers, which are a factual record of a company’s (and thus, management’s) success. I look for stocks that have been growing revenues and earnings for a number of quarters, ideally with earnings (profits) rising faster than revenues (sales). I like to see the rate of growth for both categories accelerating. It’s also nice to have an increasing number of institutional investors and an after-tax profit margin that’s high and rising. And finally, I want a stock that’s liquid-trading at 400,000 shares a day or more–so Cabot subscribers can trade without being worried that the stock will get deep-sixed by one money manager who wants out.

Numbers can be comforting because they give you a sense that more and more consumers and businesses are buying a company’s products, and that management knows how to grow profits. Plus, it’s a fact that most of history’s greatest growth stock winners had huge numbers before they catapulted higher.

Charts are where the rubber meets the road in growth stock investing. Some highly technical investors don’t even care what a company’s product is or how much money it’s been making. They think they can tell everything they need just from a stock’s chart. I’m not that confident, but I know that a stock with a rising price and good volume support must be doing something right. When I screen my emerging markets investment universe for candidates to recommend, I’m really looking for stocks that are in demand. And that’s what’s a chart can tell you.

Charts also tell you about a stock’s momentum–whether its rate of appreciation is rising or falling, whether it’s shaping itself into any of the classic patterns of consolidation, reversal or base-building. I’ve sold stocks that were going up steeply because the chart told me it was a climax top. And I’ve bought stocks that had advanced sharply and then corrected into a tight pattern that indicated steady accumulation.

Like almost everyone, of the three components of the SNaC strategy I guess I like story the best. But there is value in all three, and having all three parts–Story, Numbers and Chart–can help to shift the odds in favor of a stock’s success. The best stocks have great stories, strong numbers and technically attractive charts. In an enterprise that requires you to use every advantage at your disposal to get the odds on your side, it just makes sense to go for the complete package.

Flir Systems

My stock idea for today is a pretty big company (market cap $5.3 billion) that specializes in infrared imaging. The company is Flir Systems (FLIR is the stock’s symbol and it trades on the Nasdaq Exchange), an industry leader in military and commercial infrared sensing.

(I’ve written about Flir before, in the September 17, 2007 CWA. At the time, the stock was trading at 25. Today, after a correction, it’s trading above 38.)

The company made its name (literally: Flir comes from the acronym for its first headline-making product, the Forward-Looking Infrared Radar sensing system) in the military equipment business, and this remains the most important segment of its business.

But it’s not the only market for Flir’s instruments and systems. The company also has a Commercial Vision Systems division that sells to law enforcement and aviation entities and a Thermography division that addresses the needs of industrial and scientific organizations.

Flir’s systems have been instrumental in allowing soldiers to see through the darkness and the smoke of battle. They have also been used in pilotless drones, on ships and in factories where they can detect hot spots in equipment.

All in all, it’s a very useful technology, and Flir has been making good money at it. The latest quarterly report showed earnings up 33% on a 47% increase in revenues, resulting in a 15.8% after-tax profit margin. Support from institutional investors just reached a new all-time high, reflecting confidence in the company’s long-term profitability.

FLIR had a nice run in 2006-07, rising from 11 to 36. The winter bear dragged the stock back to 24, which is where the markets recovery and an excellent earnings report got it moving again. Just last week, the stock pushed over 40 for the first time, and it has now corrected back toward 38. With its 25-day moving average between 35 and 36, this correction has made the stock a better buy.

Paul Goodwin

Editor’s note: FLIR looks like a good idea, but it’s just an idea. For stocks that have the full support of Cabot’s editors and analysts, you should consider a no-risk trial subscription to one of our growth investment newsletters. Paul edits the Cabot China & Emerging Markets Report, the top-rated investment newsletter for the past couple of years. You can take a look at it and the other Cabot newsletters by clicking on this link.



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