Simplicity is the Ultimate Sophistication

Simplicity is the Ultimate Sophistication

Avoid Temptation

Fracking Sand

I’m not a neat freak, but I like to have things pretty clean. I put away my dishes as soon as I finish eating. I put the laundry in the laundry basket instead of throwing everything on the floor. And I like to keep the family room and my daughter’s playroom (where we spend a good chunk of time, especially in the winter) tidy.

But, to balance my general cleanliness, there are a few spaces in my life where I “concentrate” all of my sloppiness. My garage is a mess, though as a guy, I almost consider that normal. My car is also amazingly messy—home to various grocery bags, a couple of cleaned-out tupperware containers, a variety of kids’ toys, receipts and the like. Even when my wife takes the car for a nice cleaning once or twice a year, it inevitably attracts the usual amount of trash within a few weeks. It’s like a magnet.

Another spot that’s a bit messy is my desk at work … but it’s messy in a different way. I’m not one to have papers spread out all over the place like some co-workers I know (cough, cough, Paul Goodwin, cough); my marked up charts and research notes are all in a neat pile on one side of my desk, easily accessible pile. There are a few coffee marks, but I clean those up nearly every day. And any books are placed in the shelves by my desk (a perk of working in an old library building).

But what is messy is a big and growing pile of sticky notes I have stuck to the bottom of my computer screen and generally scattered on my desk. Almost all the notes have something to do with the market. Some are heads-up levels for certain stocks, or average volume amounts for names I’m watching. But many of the notes are actually quotes, sayings and truisms that I’ve learned to love over the years.

For example, one sticky note simply says “Careful with Turnarounds,” meaning turnaround stocks. Frankly, my record when buying non-growth, turnaround situations is spotty; I think last year’s solid profit in Lennar, which we owned from January 2012 through February 2013, was one of the first major wins I’ve had in the turnaround space. Most of my others died on the vine.

Some of the sticky notes are quotes that pertain to the growth investment style we practice. One of my favorites is “Only fools and egotists pick tops and bottoms. Which one are you?,” which, when I read it, always gets me back to focusing on the evidence in the market itself, not some prediction or forecast I just read about. It really applies well to our trend-following approach.

But then there are the quotes that pertain to investing or life in general. The two that I refer to the most: “It’s Hardest to Keep Things Simplest,” and, from Leonardo DaVinci, “Simplicity is the Ultimate Sophistication.” I’ve been thinking of these two a lot during the past couple of weeks, even pondering them over my week off during Thanksgiving.

This has been a good year for stocks; the major indexes are up nicely, most sectors have enjoyed great runs and, while the ride hasn’t been totally smooth, it hasn’t been anywhere near as choppy as 2011 and 2012.

However, after many months of profits, I’m seeing many investors start to make things more complicated for themselves. Some are worried about taxes; they’ve made good short-term gains (less than 12 months) and they’re hesitant to book profits in these stocks before 2014. Some don’t want to buy leading stocks that trade at high prices, so they’re looking at call options instead of just buying the shares. And others, after having some success using charts for perhaps the first time, are now exploring the arcane, looking at all sorts of different indicators like MACD, ADX, Bollinger Bands and more.

Now, absolutely none of the above is “bad.” I don’t pretend to have the only investing system—I’m open to all sorts of different ways of making money.

The problem is when people get sloppy with their investing systems and make investing more difficult than it has to be. Instead of sticking with, say, a trailing stop, they start diving into analyst reports and basing decisions on fundamentals, or using the aforementioned indicators. Or maybe, instead of focusing on growth stocks as they usually do, “style drift” takes hold, causing them to look at turnaround stories or low-priced lottery ticket types of stocks. It’s not as much about letting the profits go to their head as it is inventing new rules and tools that they have no experience with.

Believe it or not, this phenomenon happens during two opposite extremes: after a long losing streak and after a long winning streak. After a long losing streak, investors are eager to try something new to change their results. After a long winning streak, like now, many try new methods out of greed (or, at least, lack of fear), thinking that more money can be made (or kept) by using new indicators or techniques.

Again, there’s nothing wrong with trying new things—I’m all for it! My point today is that investing, while not easy, is not as difficult as most make it. (That’s actually another quote, from trader Dave Landry.) You don’t see a football team that’s up by 17 points thanks to a great running game come out and start throwing the ball every down in the second half. No, they stick to what’s working. And if you’ve been following one (or more) of our advisories and have had a good year, I say stick with what’s working.

As for the current market, my thoughts are best summed up by the title of my Cabot Market Letter last week: “Trends are Up, But …” There’s not enough evidence to say the overall bull market is in rough shape; the major indexes are trending up, as are most stocks and sectors, though the broad market has weakened of late.

But … as the weeks go on, more and more growth stocks have been acting funky, trading widely and loosely after big advances (often a sign of distribution), lagging the market in a big way, and showing volume distribution every time they approach new high ground. Basically, since the start of October, it’s been hard for growth stock investors to make much money; for every winner there’s another stock that gets hit for one reason or another.

Thus, I’ve been slowly paring back in recent weeks; if and when the evidence improves, I’ll be more than happy to jump back in with both feet. In the meantime, I’m advising investors to be selective, hold some cash, and when buying, look for stocks with real signs of accumulation and good entry points.

One name I’ve been watching closely for a couple of months is U.S. Silica (SLCA), a leading provider of sand for the fracking of oil and natural gas wells. It doesn’t sound exciting, but there are big barriers to entry here, and not only is the number of wells being fracked rising nicely, but so is the amount of sand used per well, which results in more output.

Here’s what I wrote about the company in Cabot Top Ten Trader on November 18:

“We remain impressed with both the stock action and the fundamental outlook for U.S. Silica, which is one of the dominant suppliers of fracking sand (which is very specialized, with only a few players in the market) to the energy industry; not only does the company have the product but management has shown great ability to ink transportation deals with various railroads, giving U.S. Silica exposure to every major shale area in the U.S. The company still gets over a third of its revenues from sand used in industrial products like glass, but that segment is basically stagnant. By contrast, its oil & gas-related revenues make up two-thirds of revenues and rose 37% in the third quarter (prices were flat, but tons sold increased 36%), and more than half of those sales were delivered via its rail deals. As fracking activity continues to rise, even more exciting is that the amount of sand used per well is greatly increasing; many drillers are boosting results by increasing the number of fracking stages and sand usage per well. Management has a goal of doubling profits by 2016, but we think that could prove conservative as long as energy prices hold up. Combine the gradually accelerating sales and earnings growth (see table below), the buoyant earnings estimates ($2.17 per share next year, up 37%), the reasonable valuation (21 times trailing earnings) and the modest 1.5% dividend, and there’s a lot to like here.”

Chart-wise, I like how SLCA broke out of a first-stage base (its first real base since coming public in February 2012) and rose a whopping 40% in just three weeks. Such an initial burst is often a precursor of bigger and better things.

Since that rally, the stock has consolidated nicely, trading in a wide, but sideways, range for six weeks. The 50-day moving average has nearly caught up, and I think the stock could be nibbled at here, with a stop near 30. And a big push above 37 would be reason to buy a little more.

For more updates on SLCA as well as additional momentum stocks recommended in Cabot Top Ten Trade, click here now.

Working to making you a better investor,

Michael Cintolo
Chief Analyst of Cabot Market Letter
and Cabot Top Ten Trader

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