Milking the Chinese Market

Three Reasons to Own Individual Stocks

Never try to Catch a Falling Knife

Milking the Chinese Market

In 2002, the Investment Company Institute, the industry group for mutual fund companies, found that just about half (52.7 million or 49.5%) of all U.S. households owned stock in some way.  But just 21 million households (fewer than 20%) owned individual stocks outside their 401(k) plans and other mutual funds.

I know that much has changed since 2002, but I’m betting that those figures are still in the ballpark.

And that’s because owning mutual funds is easy.

If you own a chunk of a fund that owns a basket of stocks, you don’t have to watch the daily movements of stocks and make decisions about buying and selling.  (The mutual fund companies certainly work hard enough to discourage you from taking much initiative with your investments.)  Plus, if you have a tax-deferred mutual fund, you don’t have to consider the tax consequences of capital gains.

Personally, I have the bulk of my retirement savings–what’s left of it anyway–in exactly the same kind of mutual funds as most people.  They are mostly a legacy from my days with earlier employers, and I mostly just let them be.

But I also own individual stocks.  And I think there are some really good reasons for taking on that role.  Here they are.

1) Owning stocks is real.  

Facebook, Twitter, YouTube, Second Life, chat rooms, massively multiplayer online role-playing games and every game console joint ever made may be fun, even addictive.  But life online doesn’t make or lose a thing.

But if you own a stock, you’re joined at the wallet to the fortunes of the company that issued it.  It’s real money, and you can make actual money with it.  You can also lose money, but that’s part of being real.  You can’t hit restart or (command/option/escape) and make it go away.  Real risk, real opportunity.  There’s nothing like making a decision and having it lead to real consequences.

2) Owning stocks gives you a chance to test yourself.

It’s one thing to watch the markets in a general way.  And you may find yourself making some interesting adjustments to your mutual fund allocations during the open enrollment at the end of your company’s plan year.

But owning stocks allows you to test yourself against Warren Buffett, Gordon Gekko and Jesse Livermore, the Speculator King.

How good are you at picking the nuggets out of the gravel?  Do you have the nerves to wait out a market correction and the gumption to follow a sell discipline?  If you’re willing to pay for the class, the market will be more than happy to give you exactly the grade you deserve.  It can be a humbling experience at times, but also personally rewarding.

3) Owning stocks is fun.  

It amazes me all the time that people go to Las Vegas knowing that they’re probably going to lose money … and yet they enjoy themselves.  But then that’s what huge fountains, famous headline acts and billions of dollars of advertising and fantasy architecture will do for you.

The stock market, on the other hand, just has the boring old ticker.  Stocks and indexes go up and they go down.  You have to supply the fireworks.

But if you’ve ever talked to an investor who owns a stock that has just doubled in six weeks, you’ve probably seen something akin to real joy.  (Yeah, I know that it’s nothing compared to parenthood, finding true love and sinking a hole in one, but you have to work with me here.)

I also know that it may not be fun if you’re desperately playing catch-up, trying to get your retirement funds back up to where they should be so you can quit a job you don’t like and head for the ivy-covered cottage in which you hope to live out your years.  I’m not saying it’s fun for everyone.  But for people who prefer investing to woodworking or collecting Pez dispensers, it can be a hugely enjoyable thing to do.

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The steep market correction of the past week or so has dropped lots of stocks back to their 25-day moving averages and more than a few back to their 50-day moving averages and below.  So, since Cabot’s market timing indicators are still positive, this must be a great chance to pick up some real bargains on some great stocks, right?

Well, not so fast.

It’s one thing to buy an individual stock that has just undergone an orderly pullback on reasonable volume.  But it’s another thing entirely to buy into a significant market correction that has yet to put in a convincing bottom.  Investor sentiment is a little sour, and every down day is only increasing the acid reflux level of equity investors and their eagerness to unload more stocks.

I subscribe to the old stock market saying that you never try to catch a falling knife.  The probability of cut fingers is just too great.

So stick to your sell disciplines on the stocks that you already own.  Watch to direction of the market’s movements and the volume trends that tell you which way the momentum is shifting.  But let caution be your guide in this kind of unsettled situation.  This bearish mood may pass in a few days and we’ll be back on the yellow brick road again.  You never know.

But for now, dare to be cautious.

My stock recommendation today is American Dairy (ADY), a Chinese producer of milk powder, soybean milk powder, walnut products and other dairy stuff.

China isn’t known as a big consumer of dairy goods.  Many Chinese find cheese distasteful and just don’t enjoy yogurt, buttermilk and the rest of the milk-based foods that delight Westerners.  But that’s changing … a little.  

You can’t call a company with $266 million in annual sales a major trend, but it’s a start.  The Chinese are finding a place in their child-rearing regimen for milk-based infant formula, and the potential is enormous.

The company has been around since 1985, and its product mix–where do walnuts fit in with milk products, you might ask–reflects a kind of opportunistic management style that takes opportunities where it finds them.

It took two successive quarters of amazing results to put ADY on investors’ radar screens.  In Q4 2008, the company turned in an astonishing 1,550% jump in earnings on just a 25% gain in revenues.  Then, just to prove that that wasn’t a fluke, the company’s Q1 report revealed a 278% earnings jump on a 191% boost in revenues.  After-tax profit margin for Q1 was a respectable 24.4%.

The milk business in China has had to do a lot of fence mending following last year’s melamine-tainting scandal.  American Dairy came through that with its record clean as a whistle and growth has been excellent since then.

The stock bottomed at 9 in March, and since then has gone off like a rocket, soaring to 44 two weeks ago.  ADY has been correcting with the market, but it’s holding above its 25-day moving average, which is right at 38.  The stock will need to settle down a little and build a new base for further advances.  But you don’t find many stocks that turn in nearly five-bagger performance in less than six weeks.  It’s worth a look.


Paul Goodwin
Editor of Cabot Wealth Advisory

Editor’s Note: Paul Goodwin is the editor of Cabot China & Emerging Markets Report, which was recently named the top-performing newsletter for five years by Hulbert Financial Digest. The Report gained a whopping 22.2% for the five years ended May 31, 2009, beating out more than 140 newsletters for the top spot. Let Paul be your guide to the enormous profit opportunities in China and the emerging markets. Click here now to get started today!


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