Tailor Your Portfolio of Growth Stocks to Your Size
Position Sizing and Offensive Selling
LinkedIn (
LNKD
)
---
Editor's Note: Matt here. Before you read Mike's fascinating piece
about tailoring your portfolio, I'd like to ask that you read all
the way to the end today for a special announcement. And now here's
Mike:
After the sharp decline that we've seen recently in the market,
it's inevitable that most investors feel blindsided by the
market--the speed of the decline, and in particular in leading
stocks, can make your head spin.
And the fears fueled by these declines mean many investors who want
to invest in potentially big-winning stocks find themselves scared
out of most winners. So, today, I want to talk about an
investment style that I've been thinking about for a while--I call
it the Conservative Aggressive style.
To explain it, let's consider two systems, the first of which
gains, say, 18% per year over three years, while the second system
has 15% returns over three years. Clearly everyone would want
the first system, right? Well, maybe not.
Imagine we dug further and found that the three years of returns
for the first system were +11%, -15% and +74%. On the other
hand, the year-by-year returns of the second system were +10%, +15%
and +20%. From my back-and-forth with thousands of
subscribers over the years, I believe that most investors would
prefer the results of the second system because of the steadiness
and persistent gain in wealth--especially after they've gone
through a few jaw-dropping corrections or sour earnings seasons.
In the real world, the more volatile your results, the more faith
you're going to need to stick with a system. It's easy to stick
with the plan when all your stocks are going up; but it's
infinitely more difficult when a falling market and some bad
earnings results are gashing your portfolio, especially when the
pain continues for many months.
Thus, many investors are searching for a system that (a) invests in
cutting-edge leading stocks with dynamic new products or services,
and in turn, allows them to hit the occasional home run ... but (b)
they don't want to see their portfolio take enormous drawdowns
during the occasional sour earnings season.
Can you have both? To some extent, I believe you can. To get
there, all you need to consider are two simple portfolio management
techniques.
The first is good old-fashioned
position sizing
. If you want to own the fastest-moving stocks but don't want
to live and die with every tick, then buy smaller amounts,
dollarwise, of the stock at the outset.
I know that some investors get an ice-cream headache when presented
with any math, but calculating a "proper" position size is
important. There's nothing wrong with owning a smaller dollar
amount of a very volatile stock.
The second method is something few investors do--
take partial profits
at pre-defined levels. This way, you don't have to take a
small initial position ... but you will have to take some profits
on the way up (dubbed offensive selling) when things are good.
There are a million ways to do this, none necessarily better than
the other. But the point of partial selling isn't really to
book a quick profit (that's all about trading, which isn't my
thing). Instead, booking a relatively small initial profit
changes your mindset, and actually gives you leeway to hold on to
your remaining shares through deeper corrections (because you know
the overall trade will show a gain).
For example, you might buy a stock at 50, and place a loss limit at
45 (that's 5 points of risk). If the stock rises, say, 7 to
10 points (1.5 to 2 times your initial risk), you might sell a
chunk--not more than half your shares, but enough to take a
worthwhile profit.
With the rest of your shares, you'd place your new stop-loss
(mental or in the market) at breakeven (in this case, 50), so even
if you get stopped out, the overall trade was a profitable
one. With that in mind, you can then give your remaining
shares room to breathe, sitting through earnings reports and some
adverse moves, hoping to ride out a big winning stock.
As I wrote a couple of
Cabot Wealth Advisories
ago, the key in the stock market is really the outliers--your big
losers and your big winners. To get the big winners, you must
invest in fast-growing leaders ... but you also need a position you
can hold on to for months without panicking, because big moves play
out over time. The above methods can help you do that.
Next time, I'll write about a strategy for the "Aggressive
Aggressive Investor," giving you the viewpoint from the other end
of the spectrum.
Back to the current market. We're in a correction, there's no doubt
about that--selling began cropping up a couple of weeks ago and
really accelerated on Tuesday of this week, when volume exploded
and many leaders went over the falls.
That said, I am not overly defensive here ... in fact, I wouldn't
say I am defensive at all. I did advise subscribers to raise
some cash, mainly by selling a couple of stocks that had broken
down.
And that's what I think is your best move--let the stocks you own
tell their own stories. If you own some that show abnormal
weakness (big-volume breaks off the 50-day line, especially after
lagging the market for a few weeks, etc.), then punt them.
But I don't advise wholesale selling at this point because, while
the short-term is likely to bring some more pain and choppiness, I
do think the odds favor higher prices down the road. Thus, if
you have a good-sized winner or own a few resilient stocks, I would
advise giving them a chance to breathe here (though taking partial
profits is fine).
As for new buying, I'm not eager to do much here; again, I think
the short-term could be rocky, and earnings season is just getting
going, layering more uncertainty. Still, when putting
together my watch list, I'm focusing on names with great growth
that are still acting properly.
One of them is
LinkedIn (
LNKD
)
, the fast-growing professional social networking site that sports
a sky-high valuation ... but also has huge sales and earnings
growth and even bigger potential down the road. Here's what I
wrote about the stock in
Cabot Top Ten Trader
back on March 26:
"LinkedIn is a leader in the new wave of social media Internet
stocks. The company is basically Facebook with a suit and
tie--the company's 150 million-plus members use LinkedIn as an
online Rolodex, and because of that, it's emerging as one of the
best ways for companies to find the talent they're looking
for. Thus, the whole job-seeking industry is being turned on
its head--instead of companies advertising job openings and
individuals having to make the first move, companies can now take
the lead, finding the people that could fit best ... even if
they're not looking for a new job! LinkedIn's largest and
fastest-growing revenue source is from its hiring solutions
segment, where companies pay for the tools to successfully mine its
database. Advertising and paid subscriptions make up the rest
of revenues, and both of those are growing rapidly, too; efforts by
the company to make itself something of a professional portal,
where relevant business articles and ideas are presented on a
user's page, have resulted in vastly increased traffic. Of
course, investors are already excited about the concept--LinkedIn
has a lofty valuation (about $10 billion, compared to just $522
million in revenue during the past year), but the triple-digit
revenue growth and healthy earnings estimates (up 80% this year,
and another 73% in 2013) make this one of the top "glamour" stocks
in the market. If management continues to make the right
moves, this company could go far."
At that time, LNKD was hovering just over 100 per share after a
jazzy analyst upgrade on the shares. It then pulled back into
the high 90s on very light volume ... impressively light
considering the market's wobbles. And then it surged higher
today on some positive analyst commentary
However, after a terrific advance in recent months (60 to 106!)
this stock has earned a breather and my guess is that shares won't
simply explode higher from here. It might even build out a new
base. I think LNKD is one to keep on your watch list, though,
as the huge-volume accumulation during the stock's
January-through-March advance, the quiet retreat in recent weeks
and the huge potential for its business all suggest the stock could
be a big winner.
If you really want to nibble, try to get shares around 100 or
below, but keep a stop around 89 if you do so. For me, I'm
content to just watch it for now, giving it room to wear out some
weak hands.
All the best,
Michael Cintolo
Editor of
Cabot Market Letter