4 Common Investing Mistakes

4 Common Investing Mistakes

10 Revolutionary Stocks

Best Revolutionary Stock # 6

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First, in recognition of the fact that it is Martin Luther King, Jr. Day and our country is still working on achieving his goals, here’s a quote.

“Cowardice asks the question, ‘Is it safe?’ Expediency asks the question, ‘Is it politic?’ Vanity asks the question, ‘Is it popular?’ But, conscience asks the question, ‘Is it right?’ And there comes a time when one must take a position that is neither safe, nor politic, nor popular but one must take it because one’s conscience tells one that it is right.”-Martin Luther King, Jr.

4 Common Investing Mistakes

One of the eternal truths of our business is that every day we get to hear from readers who are just starting out as investors and have a lot to learn.

For example, last week, after I recommended Illumina (ILMN) here as a Revolutionary Stock that had great long-term potential because of its dominance in the genetic-analysis equipment market, I received the following response:

“WHO THE HELL CAN AFFORD TO BUY THE STOCK ILMN AT $200 A SHARE? HOW RIDICULOUS.”

This writer is guilty of-

Mistake #1
Thinking Price Matters

Many inexperienced investors make the mistake of equating price with value, thinking that low-priced stocks are a better bet than high-priced stocks. This is wrong.

Many beginners also like the thought of buying equal amounts of all their stocks-a hundred shares of each, say.

My correspondent is probably making that mistake as well.

But the fact is, it’s not how many shares you own that matters; it’s how much you invest. And if one stock is priced at $2 and another is priced at $200, that doesn’t mean the latter is too high to buy; it just means that if you buy it, you should buy fewer shares.

In the end, there’s no difference between owning a thousand shares of a stock priced at $2 and owning 10 shares of a stock priced at $200. The result is exactly the same. You own stock that’s worth $2,000.

Another note about price: The amateur may think that the $2 stock could easily climb to $4 and thus double his money (a common goal of amateurs), while he imagines it will be difficult for the $200 stock to climb to $400. But he’s wrong. And he underestimates the probability that the lower-priced stock will fall well below his purchase price.

Remember-low-priced stocks are low for a reason. On the whole, they are lower quality and they bring higher risk. High-priced stocks, conversely, achieved their high prices because investors approved of the company’s prospects.

In fact, over the past decade or so, thanks to the smart people at Google (GOOG now trades around 500), Apple (AAPL now trades around 100) and Netflix (NFLX now trades around 300), to name a few, there have been far fewer stock splits than in previous decades, and thus there are far more high-priced stocks than previously. This doesn’t bother professional investors in the least, and if it doesn’t bother you, you’re no longer a beginner!

Bottom line: The experienced investor looks beyond price.

Mistake #2
Ignoring Charts

Human beings like stories. From an early age, they resonate with us. And when we become investors, stories matter, too. Whether they’re stories about visionary managers like Tesla’s Elon Musk, stories about inventions like GoPro’s cameras or stories about emerging markets like Cuba, they are typically easy to understand, and “buy into” or not, as the case may be.

But charts are more difficult. We don’t learn to read stock charts at home, no one teaches us about them in school, and some investors never learn to use charts.

Yet charts have great value for those who learn how to use them. Charts are a visual representation of the consensus of all investors regarding a particular stock, and thus a very efficient “shortcut” to understanding how all those other investors are thinking about that stock at every moment.

When I prepare to visit a foreign country, I study maps beforehand so I know the lay of the land. And when I investigate a stock, I study its chart. To ignore either resource is simply foolish.

Mistake #3
Holding Losers

As human beings (once again), it’s natural that we defend territory we’ve already claimed, whether it’s a homestead on the prairie, a Boston parking space that we’ve shoveled out, or a lounge chair by the swimming pool.

We defend our ideas similarly, and the longer we’ve held a position, the more likely we are to argue vehemently for it.

And we do the same thing with stocks! Having chosen to invest in a stock and internalized visions of the profits that will accrue as the stock rises, we have a hard time accepting the opposite when it occurs. And it does occur; in fact, you should expect that it will occur-often.

The only time you should ignore a losing stock and simply hold patiently is when it’s a value stock you’ve bought using a proven system, like the one used by Roy Ward in Cabot Benjamin Graham Value Investor. Learn more here. 

In all other cases, especially cases involving hot growth stocks and popular stocks (which therefore have many potential sellers), you should take losses seriously, recognize that the stock is telling you that you were wrong, and consider taking action.

The rough guide for Cabot’s growth-oriented advisories is to limit losses to 20% in a bull market and 15% in bear markets. In most cases, however, our advisors are able to sell earlier by applying other disciplines.

And speaking of the market …

Mistake #4
Ignoring the broad market

“A Rising Tide Float All Boats” is a fine market maxim, and you can imagine the corollary. This is why you should understand the market’s main trend when you invest. When the market is ripe for a pullback, consider taking partial profits or delaying new buying. And when the market is ripe for a bounce, start buying (or prepare to do so).

Market timing is a science and an art, and it can never be perfected, but by respecting the market’s main trends, you can improve your own investing results substantially.

Among Cabot’s offerings, the best place to get a read on the market’s current health is our flagship Cabot Market Letter, where every week analyst Mike Cintolo updates his loyal readers on both the short- and long-term trends of the market. 

10 Revolutionary Stocks

Rule #1 when hunting for revolutionary stocks is to ignore valuation. Wall Street likes to count things, and price/earnings ratios are one of their favorite measurements. But investors who focused on P/E ratios missed the greatest growth years of Amazon, Google, Microsoft and Qualcomm.

Rule #2 is to use your imagination. This is difficult for most investors. It’s much easier to look back than look ahead. But ahead is where the big profits are. In the case of Amazon, having the imagination to see that the little company might actually put Borders out of business was key.

Rule #3 is to pay attention to management. It’s my contention that the best revolutionary stocks are those of companies led by visionaries. In fact, just off the top of my head, I listed these revolutionary stocks of my lifetime. Most-perhaps all-were led by exceptional managers: Apple, Blockbuster, eBay, Green Mountain Coffee Roasters, Home Depot, IBM, McDonalds, Netflix, Oracle, Research in Motion, Starbucks, Tesla Motors, Teva Pharmaceuticals, Walmart, Whole Foods, Yahoo! and Xerox.

Rule #4 is to invest only when there’s potential for a major increase in perception. If you invested in Amazon (AMZN) when Jeff Bezos was on the cover of Time, you lost money. Similarly, if you bought Apple (AAPL) when it made headlines as being the most valuable company in the world, you lost money. To make big money, you’ve got to invest when skepticism is high (or at least when a stock is little-known).

To find the current crop of revolutionary stocks, I asked all the Cabot analysts to send me candidates. After studying them all, I narrowed the list down to 10, and I’ve been presenting them in alphabetical order.

So here’s Number Six!

LinkedIn (LNKD)

LinkedIn is the leading professional social networking platform in the world, with more than 277 million members in more than 200 countries who access the website in 20 different languages.

Founded in 2003, the company turned solidly profitable in 2009 and revenues and earnings have grown healthily since.

In 2013, revenues grew 57% to $1.53 million, while earnings grew 81% to $1.61 per share.

In 2014 (final numbers will be released February 5), revenues grew roughly 43% to $2.19 billion, while earnings grew roughly 20% to $1.94 per share.

And in 2015, analysts are looking for earnings growth of 42%.

So while the company is big, it still has plenty of growth ahead. And because it dominates its niche, it’s unlikely that any competitor will get in its way for years to come!

Thus, the odds are very good that LinkedIn will be far larger and far more profitable, years down the road.

LinkedIn has three main sources of revenue.

Talent Solutions, which accounts for 56% of revenue, is used by recruiters and corporations, who build branded corporate pages with careers sections, offer pay-per-click ads that are shown to LinkedIn users that match the job profile, and get access to the LinkedIn database of users and resumes.

Marketing Solutions, which accounts for 24% of revenues, consists of pay-per-click ads placed by advertisers.

Premium Subscriptions, which accounts for 20% of revenues, provides a variety of job-offering and job-finding services to businesses and job hunters.

All together, they make up a complete solution for matching professional workers to jobs, a solution that’s revolutionary because it didn’t exist before, and it replaces the antiquated paper-based systems of centuries before.

And because it’s digital, it’s global. Already, 40% of the company’s revenues come from outside the U.S.

But we can’t invest without looking at the chart (Mistake #2 above).

LNKD came public in May of 2011 at 45, and hit 122 within a week (!!!), a clear sign that the stock was red-hot. Trouble is, red-hot stocks are seldom held for long, and sure enough, seven months later, LNKD was down to 56 (a drop of 54%).

That set the stage for the stock’s main advance, which took it all the way to 257 in September 2013 (an advance of 359%).

But once again, the stock was too hot, and the selling that followed took it down to 136 (a drop of 47%) last April as the market corrected. 3 And now it’s trending up again. Most recently, LNKD hit resistance at 240 and pulled back to 215, and this is probably a good entry point for long-term investors, Almost certainly, the maximum correction from 240 will be less than the previous correction (47%), simply because the stock is maturing and being held by growing numbers of institutional investors.

Still, there’s a fair possibility that the stock could fall as far as 190, which is where it found support in October.

So, you could simply buy here, close your eyes, grit your teeth and hope it’s higher next time you look.

Or, you could listen to the master, Mike Cintolo, chief analyst of Cabot Market Letter, whose readers receive updates on LNKD every week so they know exactly what do-with LNKD and every other high-quality growth stock in Mike’s portfolio.

For details, click here. 

Yours in pursuit of wisdom and wealth,

Timothy Lutts
Chief Analyst, Cabot Market Letter and
Publisher, Cabot Wealth Advisory

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