An Unbalanced SNaC is No Way to Pick Stocks

The Appeal of Story

Warning: Earnings Season Ahead

The Logic of Emerging Markets

Housing, Benjamin, Housing

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In trying to explain the Cabot approach to picking growth stocks–especially the approach I use in the Cabot China & Emerging Markets Report–I’ve come up with an acronym.  If you have a system, you need to have an acronym!

I call it the SNaC approach.

That means that a great growth stock must have a compelling Story, excellent Numbers and a technically supportive Chart.  Story, Numbers and Chart.  Cute, ain’t it?

But it’s more than cute; I think it really makes sense.  And using it can make you a better stock picker for one big reason: it forces you to look beyond a stock’s story.

The stock’s story is just that.  It’s all about the company’s product or service and why the world needs it, or how people have been wanting it without even knowing it.  A story is about benefits, whether it’s a lower price for familiar goods, saving lives or making them healthier, or offering opportunities for new experiences in games or style or communication.  Stories are appealing, even compelling, but it’s not good to stop there.

Numbers are the fundamentals of a company, including profit and loss, assets and liabilities.  People who screen stocks for consistent earnings growth or valuation or their ability to beat analysts’ expectations are fundamentalists.

Charts are a graphic representation of a stock’s reception in the market, and a skilled chart reader–a technical analyst or technician–can get an astonishingly detailed read on a stock’s momentum and likely future action from the patterns of price and volume that charts lay out.

But it’s story that I’m concentrating on today, because I think humans are trained from birth to appreciate and react to stories.  From the moment we graduate from “Goodnight Moon” to the stories that begin “Once upon a time” and end “and they lived happily ever after,” we’re hooked.  We become connoisseurs of the rise of underappreciated heroes and the downfall of overbearing villains.

So, when we discover a company with an appealing story, especially if the company’s stock has been ignored or punished by the market, we can sometimes get swept away by sympathetic enthusiasm.  Only later will the market teach us that story isn’t enough.

A few years ago, one of my favorite stock stories concerned a small manufacturer called Capstone Turbine (CPST).  The company makes efficient, environmentally friendly MicroTurbines that burn almost any kind of fuel and generate electricity (from 30 to 200 kilowatts) and heat, which can both heat or cool facilities.

Two elements of Capstone’s story stand out.  First, its product has just one moving part, the turbine rotor itself, that’s turned by the combustion of fuel.  The vertical turbine rotates at 96,000 revs per minute, turning the generator rotor, which is on one end of the one moving part.  The rotor can turn that fast because it rides on patented air bearings that use no grease or oil.  Since they have virtually no friction and don’t get gunked up with grease, the turbines can be used in remote settings where maintenance is difficult.

The second standout element of Capstone’s story is its fuel versatility.  The company’s Web site says that its MicroTurbines can run on low- or high-pressure natural gas, biogas generated by landfills or sewage treatment plants, flare gas from oil wells, diesel fuel, propane or kerosene.  Basically, whatever hydrocarbon you have, the turbine can burn it.

I’m not writing about Capstone Turbine in order to recommend the stock.  But doesn’t it sound great?!  It’s exactly the kind of story that you could tell a friend about at a cocktail party or over lunch.  It’s easy to be enthusiastic because the story is simple and compelling; it looks like a can’t-miss proposition.

Unfortunately, the numbers and the chart aren’t quite so attractive.  Capstone has a record of yearly losses that goes back as far as 2000, and maybe farther.  And the company isn’t projecting a profit at least through 2010.  Without profits, there are no valuation metrics to work with.

The chart is similarly ambiguous.  CPST has made some monster moves in the past, including a big run when the company participated in a pilot program with Wal-Mart to determine whether Capstone MicroTurbines might be useful in heating and cooling the company’s stores that litter the American landscape.  If that had worked out …

But no.  It’s a long way down from 98, which is where the stock was trading back in 2000.  Even as recently as June 2008, the stock was at a respectable 4.4.  Unfortunately, it took a big move on April 2 to boost the stock nearly 10% … all the way to 78 cents.

This is obviously a cautionary tale.  The moral is that really appealing stock stories have the power to knock your judgment off balance.  All great stocks have great stories; but not all great stories are great stocks.

In stocks, as in life, you need a fully balanced SNaC to give you real nutrition.

In any big sports event, there’s always a pound of hype, analysis, trash talk and odds-making for every ounce of actual play.  I’m thinking particularly of Monday’s NCAA Basketball Championship Game that crowned the University of North Carolina Tarheels and brought an end to the Final Four and March (April) Madness.  The game itself didn’t live up to the build-up.  But then, nothing short of a triple-overtime squeaker with Magic Johnson and Michael Jordan bounding out of the stands for a tie-breaking game of H*O*R*S*E would have paid off the anticipation.

Championship games are often disappointments, and the game between the Spartans and the Tar Heels was over almost as soon as it began.  There had been lots of talk about what Michigan State had to do to beat UNC, but it sure didn’t happen.  There’s something heartless about the ability of sports to crush hope and give the victory to the superior team despite the character, grit and determination of the underdog.

There hasn’t been quite as much hype about it, but the stock market is steaming into the heart of its quarterly earnings season.  After a nice rally like the one we’ve been enjoying on U.S. exchanges, the approach of quarterlies sends shivers of fear down the spines of investors.  It’s that reality check thing again.  Stocks can rise on hope, but a bad earnings report can do a Hindenburg on an individual stock and a spate of disappointing results can crush the market’s momentum like a grape.

If you own a stock that misses on earnings, you have a dilemma.  You can always put in a tight stop, leaving enough wiggle room so you don’t get stopped out of a stock that then takes off.  But when the news is bad, your little stop will often be swamped in the flood of selling, resulting in a much bigger loss.   

So keep your stop-losses in place and watch the news closely when your companies’ stocks are due to report.  If you’re not sure when that report is scheduled, you can find it at  Go to the main page for your stock and click on the “Analyst Estimates” heading on the left side of the page.  If your company has announced the date for its earnings report, it will show up there.  

Good luck.  It’s going to be a bumpy ride.

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So, I have a stock for you, but first I want to explain what I do here at Cabot.  

I write the Cabot China & Emerging Markets Report.  My investment universe includes every emerging market stock that trades on a U.S. exchange as an ADR (an American Depositary Receipt).  Sticking to ADRs is a risk-control measure, since it guarantees that the companies whose stocks are listed have met the reporting requirements of the major U.S. exchanges, including those pesky Sarbanes-Oxley standards that U.S. companies complain about (but that give investors in foreign companies so much comfort).

Cabot China & Emerging Markets Report used to focus only on China.  But the Chinese economic miracle, which shoved China through the transition from a rural-agrarian society into an urban-manufacturing one like a DVD on fast-forward, is being copied around the world as consuming nations seek out new sources of low-priced labor.

So we widened the focus to include the so-called BRIC stocks, those from Brazil, Russia, India and China.  (I was tempted to add Korea so I could spell BRICK correctly, but I suspected that Korea would be making the transition to developed nation status soon.)  These four countries had the capitalization, the infrastructure and the relative political stability to spawn some monster stock stories.

(The political stability part of the equation has gotten a little stickier in Russia in the past year or so, with the situation there, scaring many otherwise fearless investors worse than a letter from the IRS.)

The Report has made money in Chinese stocks, in Russian Stocks, in Brazilian stocks, even in the few Indian stocks that offer ADRs.  

Of course emerging markets are more volatile than developed markets, which means that they go down faster than their developed-world counterparts when trouble is brewing and investors start scrambling for the comfort of cash and T-bills.  

But they also go up faster than developed markets.  Check out these MSCI performance numbers from the end of March:

MSCI Index

Trailing 12 Months (%)

First Quarter (%)

March (%)













Emerging Markets




The story looks clear to me: Equity performance was totally crappy in the last year, but improved around the world in the first quarter and took a real jump–especially in China–in the past month.  The emerging markets were the clear global leader in the first quarter and even outperformed the U.S. and the world for the year!

It seems to me that anyone who cares about making money in the stock market–I know, that’s so 2008–should have some emerging markets exposure.  As the wise race-track veteran said, “The race is not always to the swift, but that’s where the smart money is.”

But enough about me, how about an example of these Chinese opportunities I’ve been talking about?

My idea for today is E-House Holdings (EJ), a leader in the Chinese real-estate market.

Chinese real estate experienced its own bubble in 2007-2008, with massive development in both the residential and commercial sectors and rapidly inflating prices.  With most housing sales in China still being made mostly in new housing to first-time buyers, E-House has been more of a marketing agency for newly completed developments than a real-estate agency as we think of it in the U.S.  The bursting of the Chinese bubble has left a huge backlog of housing on the market, and there won’t be much price movement until demand can chew its way through that inventory.

But E-House is holding its own today, and when the market returns to a normal balance of supply and demand, the company’s wholly owned exclusive housing and commercial real estate database will become a vital (and marketable) tool for all agents.  It’s as if E-House had exclusive rights to the Multiple Listing Service in the U.S.

EJ has been through a horrendous dive, falling from its high of 36 in late 2007 to a low of 4 last November.  Since then, it has fought its way back to 8, then spent three months building a new base between 6 and 8.  It has broken above 8 on good volume and should put in a little time under 10 to recharge its batteries.  It looks good to me.  


Paul Goodwin
For Cabot Wealth Advisory

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