Thinking Big

#1 Reason Most Investors Don’t Make Big Money

My (brief) Take on the Fiscal Cliff

Keep Your Eyes on Facebook (FB)

Cabot has been around for 42 years now, and so you can imagine we’ve built up quite an investing library. In fact, our building used to be a Salem library branch, so we have shelves galore around the walls. And on our side (where the editors sit), they’re filled with investment books! Many of these titles are forgettable, and many others are well-known classics.

But a few are rare gems–books that we found tremendous value in, but few to this day know about them.

One of those is called 100-to-1 In the Stock Market, by Tom Phelps, written in 1972. The book’s main goal was to illustrate how often stocks actually advance 100-fold over many decades. Granted, a lot of these comparisons were based off the Great Depression lows from either 1932 or 1937, to their peaks in the late 1960s and early 1970s, near the top of the secular (long-term) bull market. But Phelps’ point was there really are amazing possibilities in the stock market for those who look for them

I wouldn’t say the book kept my eyes glued to the page the whole way through; there are many tables and slow parts. However, there’s one chapter past the halfway mark that has always left a mark, where the author talks about the benefit of investing in growth stocks with no visible ceiling to their growth, allowing you to benefit from “the unforeseeable and incalculable” as these companies expand and prosper. We see this all the time—Apple, for instance, had a hit on its hands with the iPad back in 2004, but few could have foreseen how it would basically invent two new industries after that (touch-screen smartphones and tablets), which pushed earnings through the roof.

However, to me, there’s an even more meaningful message in that chapter, bigger than just describing the benefits of looking for firms with big growth potential; after all, many investors do just that. The most telling line is when Phelps talks about why these same investors never score gigantic gains—they don’t try! And, while that’s always been the case, it’s doubly true these days, when investor expectations have been beaten down; honestly, I don’t know many investors even looking for 40% or 50% gains. As a matter of fact, a 4% dividend yield is about all it takes to get investors’ attention these days.

Now, don’t get me wrong; I’m not saying people are being irrational in aiming low. The last couple of years have been very challenging for any growth investor, and it’s not like the past 13 years have been great, either. Heck, I’ll even go so far as to say that those who have booked profits quickly during the past couple of years have probably done better than investors who have generally aimed for bigger winners. That continues today, with the market’s trend being clearly down and any profits coming from relatively quick in-and-out trades.

But, historically, such prolonged trend-less periods are rare! My bet is that 2013 is going to be a lot “trendier” than 2011 and 2012, and longer-term, I’ve written a few times (both here and in our paid newsletters) that I think we’re in the seventh or eighth inning of this long-term bear market (since March 2000). That means we’re likely not that far away from a real, honest-to-goodness bull market that persists for many years.

In other words, if you’ve been mentally beaten down by all the negative headlines and choppy market action, now is the time to remember to think and aim big. It might not seem like it, but there are almost certainly many stocks that will rise 10-, 20- or even 100-fold from today’s prices during the next decade or two! That doesn’t mean you should be plowing money into stocks here, but it is a reminder that truly big things are possible in the stock market. Remember that.

Switching gears, I want to touch on the so-called Fiscal Cliff, which has been receiving saturation coverage from every news source since the election. I figured I’d throw in my two cents, at least as I see it from an investment point of view.

My main thought is that, right after a major election, it would be rare for our fearless leaders in Washington to simply sink the economy; politicians have many faults, but being so openly against what the public wants (in this case, not to go over the edge) usually isn’t one of them.

Thus, this whole deal will really come down to what kind of deal gets made, and how much of the can gets kicked into next year. So how, with so many variables (tax rates on income, dividends and capital gains, limitations on deductions, thresholds on tax hikes, spending cuts, etc.) can you figure out what’s going to happen?

Well … you can’t. But that’s not a reason to throw up your hands, take your ball and go home. Instead, in my view, you should do what I always preach—follow the market.

While I’m not naive enough to believe the market will magically discount the final outcome weeks ahead of time, I do think the market will be the first to discount whatever deal is likely to take shape; as leaks and rumors swirl, smart investors (including those with reliable connections and big portfolios) will begin to buy this and sell that in response. And I’ll be able to see that on the tape.

Above all, I think what the market really wants is some permanency. Between bailouts, temporary tax credits, debt ceilings and various expiring provisions, not to mention some long-term imbalances, it seems like Washington is spending most of its time chasing its own tail. The Capitol has been in the headlines way too much since things turned down way back in 2007. That’s not a political, left-vs.-right statement; I’m just saying constant uncertainty isn’t a great environment for the market.

So, hopefully, whatever comes out of these Fiscal Cliff talks will be fruitful and positive for the economy, partially by adding some certainty to the equation. But instead of hoping, my advice is to keep your eyes on the market itself, and not the talking heads from D.C.

Finally we come to the market, which, to be frank, looks terrible. What started as a mild correction in mid-September picked up some steam in October. Things then chopped around for a week before the election but have cascaded since, with many sacred cows (including Apple, which is down on huge volume for eight weeks in a row) falling hard.

Despite Friday’s mild rebound and today’s gap higher, my main trend-following indicators are currently negative, so it’s best to be defensive here, holding lots of cash and limiting new buying. If anything, I think this bounce will provide an opportunity to sell any broken stocks you still own.

That said, I don’t think the market is so far gone that a new uptrend is going to take months to develop; it’s not 2008 out there. And for that reason, I’m busy building my watch list. When doing so, I’m focusing on stocks with three main characteristics.

First, I want stocks that are holding up well; sure, something that’s fallen 30% can and probably will bounce, but such a decline will take time to heal.

Second, I want stocks that have shown some type of major buying volume during the past month, whether it’s because of good earnings or something else. This tells me that, despite the poor market, institutional investors are accumulating shares at opportune times.

And third, of course, I want something that has a good growth story—a company with a unique competitive advantage that could propel the stock higher when the bulls return.

Right now, there aren’t too many stocks that fit these criteria, but one that does is Facebook (FB), the well known but much-hated (at least in stock market circles) social media leader. Obviously, the company’s IPO was a mess, and to be honest, I’m worried that the stock’s huge float (about one billion shares!) could keep the stock waterlogged for a long time.

But there are plenty of things to like, too. First, the firm had a very encouraging third-quarter earnings report; CEO Mark Zuckerberg dispelled the notion that the company’s mobile business is sputtering, as mobile made up 14% of all ad sales in the quarter (about $150 million), and accelerated as the quarter went on. One analyst said that mobile ad revenue was at a $1 billion run rate by quarter’s end!

All told, revenue was up 32% for the second straight quarter, and analysts are looking for 28% growth for all of 2013, a sign that the firm’s deceleration is over. And other metrics were equally encouraging—I liked that daily active users rose 6% sequentially in the third quarter, a slight pick-up from the prior quarter.

I have little doubt the company can continue to grow and much of that will fall to the bottom line. And, impressively, even though the stock’s “lock-up” expired last week (millions of closely-held shares were finally eligible to be dumped), FB ramped on its biggest volume since its IPO! But it’s more than just that one clue—this stock bottomed out 11 weeks ago and reacted very well to earnings in late-October.

If you really want in, a small position (no more than half of what you’d normally buy) on a dip of a point or two is possible, or just keep it on your watch list—the longer FB can hold up and show signs of accumulation, the better the chance it can be an institutional favorite of the next major market upturn.

All the best,

Michael Cintolo
Editor of Cabot Market Letter

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