The Next Baidu?

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Now that the market has come under some pressure, I'm starting to hear from many fellow investors, including a few professionals, who are mentally reviewing the good, bad and ugly of their trading during the first few months of the year. It's not that everyone's bailed and is heading to the beach, but most have pared back some and are not doing nearly as much buying as earlier this year (when many stocks were going bananas).

I think these "war stories" are helpful to talk about. They help me sort through my trading subconscious, reviewing what I did right or wrong but hadn't thought too deeply about because I'd been so busy. And it also helps to hear other investors' stories, as I sometimes pick up helpful hints from their successes and mistakes. It's like a five-minute phone therapy session for all involved.

I've had these sorts of talks for years with my closest trading buddies. The talk of winners is always fun-usually we chat about identifying the characteristics of the stocks that made up our biggest winners. (It often involves a liquid leader that gapped up on earnings, etc.) But I find it much more valuable to talk about the mistakes-it's usually easy to identify the missteps you've made, and once you do that, you can avoid them going ahead.

So what are the common mistakes? Stuff like holding a laggard or loser too long, buying some thinner, lower-quality stocks (usually because they have an enticing story or amazing chart pattern) that get blown out of the water, buying stocks that are too extended, buying stocks that look good but are part of a struggling group that holds them back, and, of course, buying stocks just before the market pulls in sharply and takes everything with it. These are all good "don'ts" to remember, and I have them jotted down on various sticky notes at my desk. However, there's one silent performance killer that few people mention-many don't even realize it's a weight on their results.

So what is it? It's anything that serves to cut your winners short or lessen their influence on your portfolio. Sometimes it means selling out on the way up, even as the stock continues to act great. Sometimes it means panicking out of a winner during a bout of weakness. And sometimes it means simply not owning much of a stock that does very well.

Of course, none of these actions ever cause an investor to wake up with the sweats at night, but in my experience, these types of hidden mistakes cost you more than the obvious goofs we all make from time to time.

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One of the best lines I've ever read about investors (really, about humans in general) is that we all naturally tend to act in a way that will maximize the chance of us being correct (or minimize the chance of being wrong)-in investing terms, that's the chance that we make money. That doesn't sound so bad ... and, for the most part, it's not. But it can lead you to do things that, in the long run, hurt your results.

One classic example that used to bog me down was getting stopped out of a stock that wasn't even a winner yet (or, if it was, it was a small winner) because I kept my stops too close to the current price-in my desire to minimize being wrong.

I specifically remember buying some Salesforce.com ( CRM ) in August 2009 after it gapped up on earnings. I bought the stock because I loved the gap, the story and the numbers.

But wanting to keep risk in check, I placed a super-tight stop around the low of that gap. Often, such a stop works perfectly-but not that time! CRM pulled back normally during the next couple of weeks and stopped me out. It was a very small loss, so, on the surface, it didn't hurt my results too much.

But, of course, it represented a missed opportunity. CRM ramped from there; while there were a couple of tedious pullbacks, the stock didn't break its 50-day moving average until January, about 33% higher than where I sold.

Now, a 33% gain isn't the biggest in the world, but if you had a 10% position in the stock, that's a net 3.3% gain in your portfolio. Three mistakes like that in a year would be the difference between being up 8%, or 18%. Not a tiny difference. A much more common occurrence that all of us have lived through is owning a stock that's a decent winner (say, up 10% to 20%), but then it gets dragged down by a brief market retreat. Even though the stock doesn't actually break down, we bail for a 5% gain-locking in a profit and eliminating a chance of a decent gain turning into a loss. The stock might even head lower from our sell point, but a month later, it begins to get going, eventually zooming higher.

So how do you avoid these issues?

It all really comes down to planning ahead of time where you'll force yourself to sell the stock-and being comfortable with that amount of risk. That alone with help you avoid panicking out of a winner just because there's some adversity for a few days. It's also important to remember that, when you look back over your trades for the year, it's the big winners and losers that count; most of your other trades will cancel each other out. Thus, if you have a small winner that you can afford to give a looser leash, do it.

All of the above is simply to remind you that-while avoiding big losses is key to good performance-so is developing a few bigger winners. So if you think you've found one, do your best to give it every chance to keep advancing.

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As I mentioned at the outset, the market is finally taking a breather after a terrific advance in recent months. Indeed, for the first time since the mid-November low, I'm seeing some real fatigue in the market and many sectors-anything interest rate-sensitive has been crushed, and most stocks have joined in on the downside this week.

It's not the end of the world, and I'm not going to predict exactly how deep this retreat will be or how long it will last. I do think there's a chance the market can hold up around these levels, but as I wrote in both Cabot Market Letter and Cabot Top Ten Trader this week, I believe there's been enough evidence to take a couple of steps back and see what comes.

That means I've pared back buying, raised some cash and I'm watching my stocks closely. It also means I'm focused on building a watch list of stocks that are holding up well.

One neat trick (albeit very short-term in nature) is to look for leading stocks that have formed higher lows during the past couple of weeks, even as the S&P 500 and other indexes have etched lower lows. It's not any type of buy signal, but it is a heads-up of emerging resilience.

One such stock I'm watching closely is Qihoo 360 ( QIHU ) , a Chinese company that's making inroads into that country's search market. It's a market I'm familiar with from our investment in Baidu from 2009 through 2011-it was a huge winner for us because it basically had the market to itself.

Now, though, Baidu is struggling; growth has vanished (earnings are projected to be flat this year) and the stock is acting horribly, now below 100 compared to its all-time peak of 166 in July 2011. I don't think that stock is heading to zero, but its best days are likely behind it.

And one reason is Qihoo, which has always done a good advertising business by having very popular Web browsers (used by a whopping 332 million people in March 2013, up from 273 million a year ago) and by having a huge audience for its 360 Start Up page (94 million in March, up from 77 million last year).

But in recent months, Qihoo's been developing its own search platform and taking share rapidly-on average, 1% of market share per month. And the company is just now starting to monetize those efforts-search made up just 5% of revenue last quarter but most analysts see it possibly doubling in the second quarter and expanding quickly beyond that. Plus, the company, which runs the large Android app store in China, is seeing its mobile gaming business boom, up 119% in the recent quarter.

Put all of that together and management came out with a very bullish forecast for the second quarter: while revenues have grown 77%, 65% and 59% during the past three quarters, it expects the current quarter to produce 95% growth. Analysts see earnings up 31% this year and 60% in 2014, but we think those could prove conservative if the search business really takes off.

As for the chart, QIHU came public in March 2011 and was a big nothing through the middle of last year when it made its search efforts known. The stock boomed on that news, and then chopped its way higher in the months that followed. Then, after a three-month pause just below its IPO price, the stock broke out powerfully on the upside last month, running up more than 20% in just two weeks.

Moreover, despite a shakeout during the market's initial wobbles two weeks ago, QIHU remained in good shape. This is still a relatively speculative stock (just 130 mutual funds own shares), but it seems to be "growing up" (attracting new sponsors) and could be a follow-on opportunity to Baidu, should it continue to take market share in search. You could nibble here, but I'll just keep it near the top of my own watch list.

Best of luck,

Michael Cintolo
Editor of Cabot Market letter
and Cabot Top Ten Trader



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Stocks

Referenced Stocks: CRM , QIHU

Cabot Heritage Corporation

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