The Connectedness of Stocks
How Fast Do You Want to Go?
One Hot Chinese Stock
“When one tugs at a single thing in nature, he finds it attached to the rest of the world.”—John Muir
This is a sentiment that I’ve seen written many different ways, but I’ve always liked John Muir’s version best.
As I see it, Muir is just commenting on the connectedness of things. If you really want to understand a topic, you will probably find that you can keep researching in just about every direction. Not only is the research interesting, all the new information you find just keeps giving you a deeper appreciation of your original subject.
I recently saw a short video on how the re-introduction of wolves into Yellowstone National Park changed the park more profoundly than anyone imagined. It all started with the deer. Without a top predator around, the deer and elk population had increased, creating a horde of grazing mouths that stripped grass and other vegetation right down to the dirt and trees up as high as they could go.
When the wolves returned to the park, the deer immediately withdrew to safer areas, allowing meadows to recover and new trees to grow. More trees meant more places for birds, beavers, small mammals and the things that eat them. Even the rivers ran straighter and deeper, as reduced soil erosion led to strengthened banks.
I know this isn’t an ecology newsletter, but I also know that stocks represent the same kind of challenge to someone trying to view them in isolation. If you try to do complete due diligence on one company, you probably start with fundamentals like trends in revenue, earnings and margins and then move on to valuation measures like price/earnings or price/book ratios. Maybe you look at a company’s management team, starting with education and qualifications and moving on to history.
At some point, of course, you will want to assess the macro- and micro-economic environment, including taxation policy, economic growth and the political and regulatory climate. And you certainly don’t want to ignore consumer trends and projections, competitors and barriers to entry for potential competitors, intellectual capital (including patents and proprietary processes) and competing technologies that might change the competitive landscape.
And I haven’t even started on the current state of the company’s stock, whether it’s in an uptrend, downtrend or sideways movement. Are there any technical patterns in the price and volume that suggest future movements: Advance/decline, Bollinger Bands, RSI, MACD, Ichimoku Cloud or the Ulcer Index?
In reality, however, very few investors try to look at everything. In fact, investing style is best defined by what we decide to pay attention to and what we choose to ignore.
Of the Cabot advisories, the one that ignores the least is Cabot Small-Cap Confidential, the limited-enrollment service written by Chief Analyst Tom Garrity.
Tom is a legendary researcher with a talent for discovering small companies with products or services that have the potential to dominate a market space.
It sounds easy, but of course it’s not. The key to this kind of analysis is a deep understanding of a product and the problem it addresses.
Tom looks for ideas that address potential mass markets, that have a compelling advantage over competitors and that haven’t been fully appreciated by investors. And he finds these ideas in a variety of industries, from pharmaceuticals and medical devices that can transform treatments to electronic hardware and software that solve problems most investors don’t even know exist.
Cabot Small-Cap Confidential, in other words, concentrates on the story, looking for the Big Idea that has the potential to fuel a major advance in a stock’s price.
These stories don’t pay off immediately (and a few don’t pay off at all), but the upside opportunity is enormous. And Tom’s history is pretty phenomenal when you consider that each month he sets himself the task of researching a brand new industry, company and product.
And Tom’s research is exhaustive. He gets to know medical problems down to the molecular level, all the ins and outs of computer displays and the challenges of mobile banking software. In essence, he turns himself into a new kind of expert every month, and masters new fields with apparent ease. He’s that kind of guy.
My bet is that if Tom had been in charge of figuring out what would happen once wolves were reintroduced into Yellowstone, he would have predicted that the rivers would straighten out and run deeper. He’s just that kind of researcher.
How Fast Do You Want to Go?
Over the years, I’ve had a few friends who liked to go fast, really fast. One of them satisfied that need every year by taking her Porsche to a driving school, where she learned how to motor with the masters.
But many of these speed addicts weren’t so refined. They just liked to get on the Interstate and put the hammer down. For these people, a six-liter V-8 engine was a ticket to a good time.
My commute from New Hampshire to Cabot’s offices in Salem, Massachusetts, takes me a little over an hour each way, so I get to see a lot of how people drive on Interstate 95 in all kinds of conditions. Generally, most people respond well to changing weather; I’d say that average speeds come down by about 10 miles per hour in the rain, and more in snow and ice.
Not everybody slows down, however. There are some people (from my experience, mostly drivers of big pickup trucks and big SUVs) who just don’t give a rip about conditions.
Maybe they think that four-wheel drive will get them out of anything. Or maybe they’re counting on their superior driving skills to pull them ahead of the incompetent dawdlers in the slow lanes.
Or, maybe they’re just crazy? That’s certainly the case with the people I see texting, knitting or reading while they drive.
Whatever the reason, I see more pickups and SUVs stranded in the snow in the median and having slid off the shoulder to the right than any other kinds of vehicles.
Thinking about this phenomenon got me to thinking about risk tolerance in stock investors. Personally, I’m a fairly aggressive growth investor, but my level of investment varies a lot based on what markets are doing at any given time. My personal portfolio is based on a maximum of 10 stocks, but I will sell some and go to cash when it rains (the market goes down), and even more so when it’s icy (the market goes down a lot).
Risk in the stock market is almost exactly like risk in driving. The faster you go, the higher the risk, whether it’s from spinouts, crashes and rollovers (or State Police) in driving or big draw-downs in portfolio value in stock investing.
If you want to go really fast, you have to pay very close attention all the time. Good luck. Drive safely.
My stock pick for this issue is a Chinese online marketplace that’s helping businesses and customers find each other in the localized Chinese economy. Here’s what Chief Analyst Mike Cintolo had to say about it in the most-recent issue of Cabot Top Ten Trader, an advisory that looks at the 10 strongest stocks of the previous week.
“Why the Strength
With the IPO of Alibaba now imminent, investors are enthusiastic about stocks that give them access to the fragmented Chinese consumer landscape, and 58.com has caught their eye. The company is an online marketplace that gives local merchants (China is virtually without big retail chains) a place to meet customers and customers a place to shop for (and get information on) housing, jobs, automobiles, second-hand goods, pets, tickets and yellow pages information. Beijing-based 58.com was founded in 2005 and has many similarities with Craigslist and a few with eBay. But it’s really a unique hybrid, a Chinese response to a problem of getting merchants and consumers together. It’s worth noting that Tencent Holdings, a Chinese online giant, has grabbed a nearly 20% stake in 58.com in return for an investment of $736 million. This alliance will give 58.com potential access to Tencent’s hugely popular WeChat platform, which could substantially boost 58.com’s mobile device penetration. 58.com enjoyed 67% revenue growth in 2013 and has booked four profitable quarters in a row leading to EPS of 25 cents in 2013, which is forecast to rise to 46 cents per share in 2014. Add in the continuing rumors that 58.com is an attractive takeover candidate and you have a nicely positioned Chinese online commerce play.
WUBA (literally “five eight” in Chinese) came public in October 2013 at 17, but has never traded under 21. The stock advanced and corrected up to 58 in March, then began a nicely shaped cup correction that has likely ended with a handle at around 55 over the last week. News of the Tencent buy-in caused a high-volume spike in WUBA on June 26 and 27 and last week’s action represents a consolidation of those gains. WUBA looks like a good buy anywhere under 54. The stock’s 25-day moving average is at 46.5, and that’s a pretty good stop.”
Personally, I like to confine my stock analysis to Story, Number and Chart, which I call the SNaC approach. I’ll write more about it in a future issue. But I think this writeup of 58.com shows how much of a stock’s strength and appeal can be expressed in just a few paragraphs.
Your guide to the best Chinese and emerging markets stocks,
Chief Analyst, Cabot China & Emerging Markets Report
And Editor of Cabot Wealth Advisory