Don’t be the Guy Who Buys at the Top and Sells at the Bottom
When a Stock Proves You Wrong, Sell
Look for the Next Big Thing
Today I’m not going to beat around the bush. I’m jumping right into investing, because I think the market is at a critical point here.
On the one hand, the world is a mess. Arab governments are being overrun by crowds whose actions threaten to throw a monkey wrench into our oil-addicted economy.
And here in the U.S., where only one new deep-water drilling permit has been issued since the moratorium was lifted last October (!), it’s becoming clearer day by day that our debts are excessive, and that we simply cannot continue to spend as we did in previous decades. Individuals and corporations, to their credit, have cut back. But governments at all levels are finding it far more difficult to cut spending, and the longer they delay, the more likely we are to see the word “bankruptcy” in stories about towns, cities, even states.
On the other hand, those Arab crowds are taking steps toward democracy, which in the long run means they’ll be more productive members of the global economy.
And here in the U.S., auto sales are up, unemployment is down, productivity is up and foreclosures are down.
Faced with conflicting information like this, do you invest defensively, because things might get so much worse? Do you invest aggressively because the future has so much potential for improvement. Flip a coin? Go with your gut? Ask Nouriel Roubini or Ben Bernanke?
No, you consult the one oracle that is always right … the omnipotent stock market itself.
The market has recently completed a crackerjack five-month run that added 25% to the Dow Industrials and 29% to the S&P 500. It was quite profitable for Cabot investors, and even fun, as breadth was superb and the leading stocks were far stronger than the broad market, helping us to pile up profits fast.
But now some cracks have begun to appear. It’s nothing major, mind you, but it does appear to be the start of the inevitable top-building process. Volatility is increasing. Leadership is growing more selective. And this follows a notable increase in the level of investor sentiment, which contrarians know can be dangerous.
Thus, the odds are very good that the next five months won’t be as profitable as the past five. The odds are that the market will be substantially more selective, and that the most successful investors will be those who manage their portfolios wisely, selling their weakest stocks and shifting into stronger ones.
Finally, the odds are very good—no, the odds guarantee—that at the very top of the bull market, there will be buying by investors getting into the market for the very first time … or just getting back in after selling in disgust near the bottom in 2008-2009.
So here’s my first piece of advice today.
Don’t be the guy who buys at the top and sells at the bottom.
Now, obviously, no one wants to be that guy. We all want to buy low and sell high. But the only way to do that is to think independently—to work hard to avoid the groupthink that is so prevalent at market bottoms and tops—and to listen carefully to the messages broadcast daily by each stock you’re interested in.
The fact is that the market is a two-way street … and in the heat of the moment, some people forget that. In strong bear markets, like the end of 2008, many people lose hope, ignoring the fact that all bear markets eventual turn into bulls. And in strong bull markets, like the one that’s floated virtually all boats over the past five months, many people forget that stocks can go down quickly too.
As a result, they put caution aside when buying. They buy stocks that are overextended, stocks that have low liquidity, and stocks that, frankly, have simply come too far, too fast. Don’t be one of them.
And if, despite all your best efforts, you find yourself holding a loser that’s headed down, don’t hold on in blind faith, watching your losses escalate. Sell! There’s no shame in being wrong. I expect to be wrong many times in the year ahead. The sin lies in staying wrong, and in ignoring the message of the market.
So that’s the second piece of advice today.
When a stock proves you wrong, sell.
Remember that the goal, particularly after great bull markets, is not to keep piling on profits. It’s to preserve profits, so you have plenty of ammunition to use when you want to buy the leading stocks of the next uptrend!
And which stocks will you buy?
Not the winners of yesteryear!
Sure, conservative investors can sit with stodgy dividend-paying companies like Johnson & Johnson, General Electric or Wal-Mart. But growth-oriented investors need to keep switching mounts, shifting to the fastest horses in the current race … ideally backing high-potential stocks that aren’t well known yet.
Consider the computer industry, particularly since it remains a fertile breeding ground for great growth stocks.
Back in the 1970s, the big winners included Computervision, Data General, Hewlett-Packard, Intel, Loral and Prime Computer.
In the 1980s, the winners included Circuit City, Compaq Computer, Computer Associates, Cray Research and Novell.
The 1990s were especially profitable … until the whole sector exploded in 2000. Big winners included Cisco, Dell, Intel, JDS Uniphase, Microsoft, Network Appliance and Sun Microsystems.
And in the past decade, the market made millionaires out of investors in Apple, Baidu, Google, Research in Motion and Sina.
The message: If you want to own the top-performing stocks, you’ve got to adapt to the times; you’ve got to always be looking for the emergence of the next big thing.
Look for the next big thing.
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Today, the action is in cloud computing, social networks, smart phones and tablets. Which brings me to the Apple iPad, a device that is changing the world faster than anyone—except perhaps Steve Jobs—thought possible.
Apple sold more than 15 million iPads in the nine months of 2010 the device was available. This year it may sell 45 million.
And while Apple (AAPL) has been a fine stock, even more profitable have been some of the relatively unknown companies supplying the guts of the device.
One of these is Polypore (PPO), which I’ve mentioned here four times since August. The company makes precision-engineered polymer membranes that regulate the flow of electrons between the anode and cathode in batteries. Some of these are traditional lead/acid batteries that go into automobiles; the U.S. market is rather dull, but the Chinese market is booming. But the real growth lies in the lithium battery business, which is hot, in part because of smart phones, but above all because of the Apple iPad. Polypore keeps beating estimates and expanding capacity, and subscribers to Cabot Stock of the Month, who bought when I first recommended the stock last year, have seen their investment grow 140%! And the stock is still chugging upward!
Another attractive stock is a fast-growing little company that designs high-speed digital interface technologies, and licenses them—frequently as emerging standards—to major manufacturers. Because it doesn’t actually manufacture, its profit margins can be plump. And because it’s still relatively small, with annual revenues less than $200 million, it can grow very fast. The chips are believed to be in the iPad (which explains the company’s rapid growth), and the stock is strong right now, trading just under $10.
But I can’t reveal its name here because it’s currently recommended by Cabot Small-Cap Confidential (our limited-circulation service), and broadcasting its name to all the readers of this Cabot Wealth Advisory email might disrupt orderly trading … which helps no-one.
Yours in pursuit of wisdom and wealth,
Cabot Wealth Advisory