Contingency Plans
The Meaning of “Late-Stage”
Boring Business, Exciting Prospects
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Here at Cabot, we make it a point to be available to subscribers, mostly via email but sometimes over the phone. Providing the service takes time, but we think it differentiates us from most investment advisors that send you a newsletter and then turn the other way.
Not only does our being available boost customer satisfaction, it also gives us an insight into how most subscribers are feeling at any given time. Carlton Lutts, Cabot’s founder, used to call this the Telephone Indicator (this was way before email). When the market rallied for a few weeks but the phones were silent, he knew most people had yet to get excited ... meaning the market likely had further to run. Most of the time, it worked.
Anyway, I’m not going to write about market timing here; for what it’s worth, I think most people are generally optimistic about the market ... but are watching the door in case the bears suddenly take control. Take from that whatever you want.
What I want to focus on instead is something that happens every time the market has a few bad days, like we saw early last week: I get inundated with emails and phone calls, 80% of which ask me something like “What do I do with XYZ stock now that it’s down 5 points?” It’s like clockwork-a bad couple of days and I have a couple dozen emails all asking generally the same thing.
Now, such questions aren’t necessarily “bad"; you should care about your stocks and what they’re doing. And I’m happy to answer these questions whenever they come in.
But if you’re someone who often wonders “What should I do?!?,” my conclusion is that you’re not doing enough planning ahead of time-before the market or your stocks go against you.
It’s really just simple human nature. When things are going your way (in this case, when your stocks are heading north), there’s no urge to think about negative outcomes; we all like to bask in the glow of the profits we’re accumulating. But the great investor does think about what could go wrong ... and more importantly, what s/he will do if something bad happens.
Having such contingency plans is important for a few reasons-the most important is that you’ll be following a plan that was made when the market was quiet and your emotions were on an even keel. Contrast that to most investors, who wait for things to hit the fan ... and then react (or, more likely, overreact) based on how they’re feeling at that second.
The bottom line is that, after six months of a great market rally, we’re going to run into a serious correction someday. But success doesn’t come from predicting when the market will pull back, how much it will eventually fall, etc.-those are unknowable things. Instead, you should start thinking now about how you’ll handle the inevitable down period-what you’ll sell or buy, where you’ll sell or buy, and how much you’ll sell or buy.
Your plan doesn’t have to be exact to the penny, but it should give you a roadmap to follow whenever the storm clouds gather. Doing this will improve your results-I can guarantee it!
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Switching gears, I’ve been writing in my publications (Cabot Market Letter and Cabot Top Ten Weekly) about many stocks-especially the popular leaders like Netflix, Baidu, F5 Networks, etc.-being “late-stage.” And, as in the example above, I usually get a few emails pertaining to that comment.
“Why would you say XYZ stock is late-stage if its story is so good and its earnings growth (even its earnings estimates) is so strong?” The answer is relatively simple-history tells us that, no matter how good the story or earnings, growth stocks tend to have a shelf life. Usually their greatest performance comes in a 12- to 24-month period.
“But wait!,” says the skeptic. “What about Apple this decade or Cisco during the 1990s, both of which rose (or, in Apple’s case, is still rising) for years?”
Even with those exceptional stocks, there were usually one or two major, prolonged corrections that took the stock down in a big way, knocking out all the weak holders ... and effectively giving the stock a new lease on life. Looking back at it today, yes, those stocks had multi-year runs. But I actually consider them having as separate advances, split up by some harrowing corrections.
Cisco, for instance, had a huge three-year run into early 1994 ... and then fell 54% over a five-month period! Then the stock spiked into 1998 before suffering a three-month, 41% retreat. Apple did something very similar this decade-despite strong sales and earnings growth, the stock cascaded 42% from January through July of 2006, yes, even as the overall market was generally healthy. And then shares took another 61% haircut during the 2008 bear market.
There are no sure things in the stock market, but history tells us that, at first, a growth stock and story are relatively undiscovered. As time goes on, more people discover the story and buy the stock, driving it up. But after a year or two, pretty much everyone knows the story ... and thus, most investors have already bought their position! For example, does anyone not know that Netflix has a great streaming video business? Does anyone not know that Baidu is strong because it’s the leading online search player in China?
In other words, these names become relatively obvious ... and in the stock market, the obvious rarely works for long. There have recently been numerous breakdowns among these later-stage stocks, such as F5 Networks, Amazon, Salesforce.com and possibly Netflix, which is looking very heavy.
Now, with that said, I am still a trend-follower at heart, so I need to see a decisive breakdown in a stock to really get negative toward it. In Cabot Market Letter, we’re still holding on to some shares of Baidu, which we originally purchased back in July 2009 (around 32).
But the market is an odds game, so when looking for stocks that can make major upmoves in the months ahead, it’s usually best to hunt for newer merchandise-possibly a stock or sector that just lifted off a few months ago, or one that has already passed through a major, multi-month correction and base-building phase to get rid of all the weak hands. Assuming these stocks also have a great story and outstanding growth, these “fresher” names often have more upside potential.
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With that in mind, my stock idea this week is Manitowoc (MTW), which is in the exciting business of ... cranes. Seriously! The big idea here isn’t that the company has something terribly new and exciting, but that, as one of the largest crane operators in the world, Manitowoc is highly, highly leveraged to the business cycle-when business is good, it’s very good.
Unfortunately, the company’s business was in tatters for much of the past couple of years, but that changed in the fourth quarter. Earnings, while still at low levels, beat estimates by a wide margin, and more importantly, Manitowoc’s backlog for its crane business soared 28% from the previous quarter. Combine that with optimistic words from the firm’s top brass on the conference call, and institutional investors took it as a sign the upturn had begun.
And so these big fish bought shares ... a lot of them! MTW soared nearly 40% five weeks ago on volume that was more than triple average. Better yet, this move took the stock out of a nine-month basing formation-really, the stock’s first major launching pad of the bull market. Said another way, MTW is not “overowned” by the institutional crowd or overly obvious to the retail crowd; if anything, we think many big fish will be trying to build positions over time, as it’s a relatively sure bet that this company’s earnings have bottomed and will head significantly higher in the quarters to come.
During the market’s recent bout of indigestion, MTW fell from nearly 22 to 18.5, but has held up well since, still meandering just south of 20. Shares might need a few more days or weeks to consolidate, but I think buying in this area, or on weakness into the 18 range, will work out over time. MTW is likely still in the early stages of a big-picture advance that should play out over months.
All the best,
Mike Cintolo
For Cabot Wealth Advisory
Editor’s Note: Mike Cintolo is VP of Investments for Cabot, as well as editor of Cabot Market Letter, a Model Portfolio-based newsletter of the best leading growth stocks in the market. It’s been 50 months (just over four years) since Mike took over the Market Letter, and if you invested $10,000 when he started, you’d be sitting on north of $16,000 today ... compared to just $9,200 if you’d invested in the S&P 500! He’s beaten the market by 14% annually thanks to top-notch stock picking and market timing. If you want to own the top leaders in every market cycle, be sure to give Cabot Market Letter a try by clicking HERE.
