Simple Rules for Stock Investing?
The Difficulty of Implementation
A Stock for Your Watch List
---
Investing in stocks involves a huge number of variables, so
many, in fact, that the whole system simply defies complete
analysis.
Think about it. Even the most sophisticated organizations
(mutual fund houses and hedge funds), with battalions of analysts
and rooms full of computers, can't get the business of making
money by investing in stocks down to a science.
That's why most stock investment strategies are exercises in
simplifying, seeking to gain an edge on the market by reducing
decisions on buying and selling to a manageable system. And the
essence of most systems is that there are only three things (or
four, or five, but nowhere near double figures) that you need to
pay attention to.
The Cabot growth investing strategy certainly does this. Here
are the principles:
1.Invest in stocks whose charts show increasing investor
interest.
2. Increase your market exposure when markets are advancing and
reduce exposure when markets are declining.
3. Cut losses short, especially in negative market environments.
4. Let winners run.
5. Stick to stocks trading above 14 and that average 400,000
shares traded per day.
That's about it.
But, the implementation isn't all that simple. You have to
learn at least the rudiments of technical analysis of charts. You
need a reliable indicator of the direction of the market,
especially when indexes are soaring and swooping like a flock of
starlings. And you need to develop guidelines on when to
sell.
By contrast, value investors can ignore most of these things
and just look for undervalued companies with good prospects.
Of course, the implementation of that, too, is far from
simple. You need to learn how to analyze truckloads of data on
assets and liabilities. And you must develop techniques for
projecting the future of a company's revenue, earnings, free cash
flow, margins and market share, management and competition.
There are stock investment techniques that are simple, dead
simple. You can, for instance, buy stocks that your
brother-in-law recommends. Or you can only buy stock in the
company at which you work. (That's what my father-in-law did, and
his holdings in Amoco--which is now British Petroleum--provided
years of dividend income for him.)
You might try to emulate Noel Constant, a character in Kurt
Vonnegut's book The Sirens of Titan. Mr. Constant achieved
enormous wealth by buying stocks whose names corresponded to the
successive letters of the King James Bible. Although fictional,
Mr. Constant's system is simple and easy to understand. All you
need is a massive amount of luck (or divine intervention).
You might also consider the venerable Dogs of the Dow
strategy, which involves a once-a-year buy of the 10 top
dividend-payers from among the 30 members of the Dow-Jones
Industrial average. The strategy beats the performance of the
S&P 500 Index in the long run.
But if beating the S&P 500 Index is your benchmark for
success, you're not really aiming very high, are you?
Personally, I find the Cabot growth discipline is just right
for my investment personality (that's my level of aggressiveness,
tolerance for risk and need for mental stimulation).
I've always enjoyed "Two Out of Three" rules. One favorite
says that food can be fast, cheap and nutritious, but you can
only have two out of three in any one food. A box of Mallomars,
for example, is fast and cheap, but fails miserably at nutrition.
You can fill in the other categories.
In investment, I'm not sure what the three categories would
be. How about 1) simple, 2) high potential, and 3) consistent.
Simple and high-potential might be penny stock investing, where
the upside is huge, but the volatility cuts both ways. Simple and
consistent would be an index fund, which lacks big upside
chances. And high-potential and consistent could, at least in
theory, be hedge fund investing, which is anything but
simple.
So where would growth investing fit in this scheme? Well,
despite the implementation difficulties I ventured above, the
principles are indeed simple. And the potential is genuinely
high. But growth investing, at least as the Cabot system
practices it, looks to make the bulk of its annual returns from a
small number of successful stocks that deliver big gains. You
have to cut off a lot of losers in pursuit of a few big
winners.
In fact, Cabot's rules for cutting losses short are the key to
success in growth investing.
And if you subscribe to our flagship growth publication
Cabot Market Letter,
implementing a growth strategy can also be simple; you just
follow the advice in the advisory.
---
It's a basic principle of ecology that when there is a lot of
something to eat, nature will see to it that there's something to
eat it. And the same principle holds for economics, as well. And
if there is any thing that the global economy is oversupplied
with right now, it's just got to be underperforming
mortgages.
Bad mortgages are a major reason the global economy in
general, and the U.S. economy in particular, is having such a
hard time getting going again.
The U.S. Fed is taking about $40 billion of these mortgages
out of circulation every month, but the supply is still enormous.
And that's where
Ocwen Financial (
OCN
)
comes into the picture.
Ocwen used to be a pretty standard mortgage lender, but it has
shifted its main focus onto mortgage servicing-the collecting of
payments and late fees, renegotiating terms, and, if all else
fails, conducting foreclosures. Banks are happy to be rid of the
responsibility and estimates are that there may be $3 or $4
trillion of mortgage assets that will be subbed out to servicers
like Ocwen in the next few years.
Ocwen's 38% revenue growth in 2011 pales in comparison to the
90% revenue growth it reported in the latest quarter or the 100%
growth it booked in Q2. And earnings estimates for the year are
estimated to come in at 87%, with 2013 estimates now at a
whopping 210%!
OCN went on a strong growth spree from November 2010 to
February 2012, roaring from 8 to 17. But after a mild pullback
that lasted 10 weeks, the stock really exploded, ripping from 14
last May to 38 at the beginning of October. Since then, OCN has
been trading sideways, including five weeks in a tightening
consolidation between 34 and 36. That's the kind of flat base
that can produce real sparks when the stock makes a move.
The catch, of course, is that you don't know which way to move
is going to go. So while a sizable buy of OCN might pay off, it
could also land you with a sizable loss. My advice is to put OCN
on your watch list and monitor it closely for signs (moves either
way on increasing volume) of a breakout from this tight trading
range.
Ocwen has the story and the numbers, and if the chart signals
that it's time to buy, quick action may give you a great
opportunity.
Sincerely,
Paul Goodwin
Editor of
Cabot China & Emerging Markets Report
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