The Big Money is in the Big Swing
Aggressive Aggressive investing approach
Dunkin' Brands (
DNKN
)
---
Back on April 12, I wrote a
Cabot Wealth Advisory
titled "
The Conservative Aggressive Investor
," in which I discussed a couple of portfolio management techniques
(specifically position sizing and offensive selling) that allow
investors to benefit from investing in dynamic growth stocks ...
while avoiding some of the tedious drawdowns and painful periods
that come when those same stocks go downhill.
Today, as promised in that issue, I am going to switch hats and
write about what I call the
Aggressive
Aggressive approach, which is built around the idea that the goal
isn't to be right-
it's to make big money when you're right.
The Aggressive Aggressive approach essentially revolves around
averaging up in price-that is, adding more shares to your original
purchase if and only if the stock goes up, allowing you to build a
big position. If it doesn't go up, you don't buy any more ... and
you might even sell some if the stock stagnates for too long.
There are any number of ways to structure this (I'll get into a few
examples below), but let me give you the gist of it via a
conversation I had with
Carlton Lutts
, Cabot's founder and a great aggressive investor:
"I like to set up what I call a horserace. When we get a new market
buy signal, I might buy small positions in three or four stocks,
possibly 5% of my portfolio or even less in each stock. Then, if
one of the stocks goes up a few points, I buy another few percent;
I might repeat that up to four or five times until I have my full
position ... but only if the stock continues to go up! Many of the
stocks might go up a little or not at all. Over time, I tend to
feed more money into my best performer or two, while paring back on
the laggards or selling out altogether. This way I can maximize my
best performers."
In practice, here's how the Aggressive Aggressive approach usually
works: The investor will set a target position size relative to his
overall portfolio; it's often a good-sized amount, say, 15% or 20%
of the account. Then he'll break that total down into two, three or
maybe even four pieces-in other words, you want to average up into
a large position over three or four purchases. Usually (but not
always) the biggest piece will be your initial position, followed
by smaller and smaller pieces as the stock advances.
For example, you might target a 20% position on a stock if all goes
well. (I am just picking that number out of thin air; it could be
12% or 25%, it really depends on your risk tolerance.) Then you
might structure your purchases by buying, say, a 10% position
initially, followed by a 6% add-on, with a 4% add-on after that.
As for when to make your add-on purchases, that's a difficult
question; there's no one-size-fits-all answer because each stock
has its own personality and volatility. But the goal is to average
up relatively quickly-assuming your original buy point was a good
one, you don't want to wait until a stock is up 10% or 20% before
buying more. Usually a few percent in between each buy is enough.
There are countless ways to structure your trades; it's really up
to you to choose the amounts and proportions that work for you.
Sticking with the 20% position size example (which is a very
aggressive target), maybe you want to do it like Carlton and go
5%-5%-5%-5%. Maybe you want to keep it simpler and do something
like 12%-8%, planning on just two purchases. Or maybe you want to
do something in between, like mentioned above (10%-6%-4%). There's
no perfect method, it's really about what works for you.
Important note: Remember that every time you average up, you're
raising your cost basis in the stock ... so you also have to focus
on where you'll place your stops (mental or in the market) and know
how much risk you have on the table.
Whatever the details, the
Aggressive
Aggressive approach has many advantages. The most important is that
you'll have the most money invested in your biggest winners and the
least amount invested in your worst choices (those that head south
right after your purchase). If you believe that investing in growth
stocks is really a game about outliers (big winners and big
losers), then this approach seems tailor-made, as you'll have
relatively small initial risk, but the chance to land some outsized
winners.
That said, you should also be aware of pitfalls to this approach.
Mainly, since your cost basis in a stock will rise every time you
buy more, it can be more difficult to hold on to a stock. For
example, let's say you started buying a stock at 100, then bought
more at 105 and more still at 110. That means your cost is
probably in the 103 to 104 range.
So if the stock pulls back from 110 to 104, you're basically at
breakeven (instead of a four-point profit) ... and that can lead to
some tough decisions. You might find yourself knocked out of a
stock on normal weakness, only to see it motor higher from
there. And, of course, even if you do have a good profit, a
sharp drop in a stock in which you have a huge position can rattle
the nerves
Hence, this approach requires a lot more thinking and
preparation-not only are you going to be more active (buying more
than just once) but you're also going to have to be aware of your
new cost basis and how to adjust your stops.
Possibly most important of all, you're going to have to be mentally
tough-this method isn't geared to take advantage of small-ish
winners (5% or 8%), so you might see many of those types of trades
actually result in breakeven trades or even small losses. Instead,
this method is geared around extra-base hits-finding stocks that
can make significant moves over many weeks or, hopefully, months.
Be aware that in a choppy or slow-moving market, that can be
somewhat difficult to do.
That said, I really do believe that the Aggressive Aggressive
approach can yield outstanding longer-term returns ... possibly the
best of all trading systems. The gains come in big bunches when you
find a few good stocks! Of course, with higher returns comes higher
risk, but it's all about having the proper mental make-up and
discipline to execute the plan.
---
As for the market, bulls finally were able to make a little headway
on Wednesday, with the market gapping up and rallying back above
the lows it set in mid-May. After such a battering during the past
five weeks, it's good to see-and the fact that investor sentiment
is in the ditch (by one measure, investment newsletters are at
their most underinvested position since March 2009, and in the
bottom 4% of all readings since 2000!) means it's possible that
we've seen a sustainable low to this correction.
However, I don't like to invest on "possible." The
intermediate-term trend is still clearly down, as all the major
indexes, even after the bounce, are still 2% to 3% below even their
shorter-term (such as the 25-day) moving averages. And, even if the
market handles itself well from here, some time will be needed for
many stocks and sectors to tighten up again.
All in all, I'm hopeful that the 10% haircut the market has taken
means the correction is close to an end, but as always, I need to
see far more evidence before starting a new buying spree. Thus, I'm
more focused on fine-tuning my watch list (updating potential buy
points and stop-loss points, listening to company presentations,
etc.).
In compiling my a watch list during a market correction, I like to
give stocks long leashes-it's not just the chart, but the
combination of a stock's movements relative to the market along
with the firm's fundamentals and growth outlook.
---
One name I keep coming back to is
Dunkin' Brands (
DNKN
)
; to be clear, it's not a fast-moving stock that I expect to be a
huge winner. However, don't let that turn you off-DNKN is a
newer stock (public since last July) that has a well-established
business and a big international opportunity. Here's what I
wrote about the company in
Cabot Top Ten Trader
this past Monday:
"National Donut Day was just last Friday (June 1), so Dunkin'
Brands should be on everyone's mind. With more than 10,000 Dunkin'
Donuts locations and more than 6,700 Baskin Robbins ice cream shops
in 56 countries worldwide, Dunkin' Brands is a giant in the quick
service restaurant business. In addition to donuts, Dunkin' Donuts
locations serve bagels, hot and cold coffee and other baked goods,
while Baskin Robbins specializes in hard-serve ice cream. The
company is nearly all run on a franchise basis, and franchisee
sales amounted to about $8.4 billion in 2011. The push for wider
distribution has led to the establishment of kiosks and mini-stores
within other retail spaces, gas stations, hospitals and airports.
Dunkin' Brands hit a home run with its Q1 earnings report that was
headlined by a 213% gain in earnings per share on a 9% increase in
revenue. After-tax profit margins topped 20% for the
second straight quarter. Baskin Robbins has been making ice cream
since 1946, and Dunkin' Donuts made its first donut in
1950. Together, they're expanding internationally with great
success."
As for the stock, it's impressively remained above its 50-day
moving average for all of this year (excluding a brief shake below
it last Friday), and has tightened up between 31 and 34 since
late-April. It's a sign that big investors are accumulating
shares during this market maelstrom.
You could buy a little around here with a super-tight stop around
30 or 31, but my advice is to just watch it, and if the market
confirms a new uptrend, look for a powerful push above 34 as your
signal that the next upleg has begun.
All the best,
Michael Cintolo
Editor of
Cabot Market Letter