How to Never Lose Money in the Stock Market
Baltimore, Maryland
July 15, 2005
*** A Big Lie: Chasing Winners
*** How to Never Lose Money in the Stock Market
*** The Anti-FORTUNE Trade of the Day
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James Boric reports from Bloomington, Ind.…
*** Good day, Penny Sleuthers! In today’s action-packed issue, you will discover the 10 hottest small-cap stocks on the market according to FORTUNE Small Business (and then we’ll tell you what six stocks you should REALLY own!), a strategy that can help you on every investment and why your fellow Sleuth has an edge over Warren Buffett, Bill Gates, Steven Ballmer and Henry Hillman.
Let’s get right into it…
*** On Wednesday, CNN/Money published FORTUNE Small Business’s top 100 growing small companies. They screened all the publicly traded companies on the market with less than $200 million in sales and a stock price of at least $1. Then it ranked the companies in terms of earnings growth, revenue growth and stock performance over the last three years. Here’s a glimpse at its top 10 fastest growing companies…
1) TASER (TASR:NASDAQ) – down 49% in the last year
2) Laserscope (LSCP:NASDAQ) – up 29% in the last year
3) NGAS Resources (NGAS:NASDAQ) – up 70% in the last year
4) j2 Global Communications (JCOM:NASDAQ) – up 27% in the last year
5) eResearch Technology (ERES:NASDAQ) – down 47% in the last year
6) Sonic Solutions (SNIC:NASDAQ) – up 9% in the last year
7) ASV (ASVI:NASDAQ) – up 55% in the last year
8) EXX (EXXA:AMEX) – up 4% in the last year
9) Sands Regent (SNDS:NASDAQ) – up 34% in the last year
10) Diodes (DIOD:NASDAQ) – up 91% in the last year
Looks great on the surface. These companies are all growing. And most have shot up nicely in the last year. Time to buy ’em, right?
Not so fast. I showed the list to our resident small-cap expert Carl Waynberg, and he was immediately skeptical.
“The trouble with lists like FORTUNE's is they look backward. That’s just the first part of a small-cap investor's job. You then have to look forward. Chasing winners is a surefire way to lose money.”
And there is good evidence to support what Carl is saying…
Tweedy, Browne published a famous study by two professors (one from Cornell University and one from the University of Wisconsin). Over the course of 46 years, they looked at the average returns from owning the top 35 best- and worst-performing small-cap stocks on the market (based on the returns from the previous five years). What they found may be shocking to the mainstream investor…
The portfolio of the best-performing stocks (in years past) averaged 6.6% LESS than the market in the following years. And the worst-performing stocks of the previous five years went on to beat the market by an average of 18%.
Not a bad nugget of information to have in your back pocket – especially as you are barraged with “hot stock tips” every day in the mainstream media…a la FORTUNE’s list of the fastest-growing companies.
So based on this knowledge, what stocks should you keep an eye on?
Our very own Sala Kannan is working on a list of her own – based on Tweedy, Browne’s proven investment criteria. Check it out below in our “Trade of the Day.” But first, look at this…
*** I got an e-mail from a friend the other day that most people would find absolutely useless…but not your Penny Sleuth. It was a list of some of the biggest names on Forbes’ 400 richest Americans list along with a very important statistic – their golf handicaps.
Included on this esteemed list were Warren Buffett, Bill Gates, Steve Ballmer, Henry Hillman and others.
You may find it interesting to know that Buffett’s handicap is a mortal 20.8, Gates gets a robust 24, Ballmer chimes in with a 16.3 and Hillman boasts a handicap of 15.3.
I am proud to say, should I ever have to play those high rollers on the golf course, I would annihilate them – hands down. While not a scratch golfer by any means, your editor normally shoots between an 80 and an 85. So Buffett, if you are reading, let’s play a round. Winner takes all…
Now over to the 19th hole, where Irwin discusses the fine art of protecting your stock gains at all costs…
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How Never to Lose Money in the Stock Market
Warren Buffett’s No. 1 rule was never to lose money – especially once you are already profitable on an investment. Sounds great. But when you are a multibillionaire, you can hire a staff of professionals to help manage your money.
And when you become a multibillionaire, you can do the same. But until then, what?
To the rescue, a simple profit-protector strategy that will also guarantee a sound night’s sleep.
Use a trailing stop.
A trailing stop allows you to let a winning stock run while also protecting your losses. Think of a trailing stop as both the afterburner and the brakes.
As an example, let’s take a blow-by-blow look at the Penny Stock Fortunes CSX pick DURECT Corp….
Editor Angela Roberts recommended the small pharma company on Aug. 26, 2004. Her action to take: Buy it for under $1.50 with a 34% stop loss to limit downside.
On Oct. 27, after some gains, Angela issued a hold action with a stop loss of $1.50 – meaning that shareholders were protected at the entry price, in case bad news triggered a drop.
By Nov. 3, DURECT was up in the portfolio by 30% from the entry price. Angela recommended a trailing stop on half of the position at a 20% gain – locking in those profits. At the same time, shareholders were able to ride the potential upside with the remainder of their holdings.
On Nov. 5, the stock broke $2. Angela’s action to take: Sell half of DURECT and keep on riding the rest up.
On Nov. 15, DURECT soared to over 50% gains, but momentum was slowing. Angela issued a sell recommendation to secure 57% profits.
Angela’s handling of DURECT clearly shows the profit-packing power of the stop loss. She used it to lock in profits – and kept on going to rake in even BIGGER gains.
Unlike a professional such as Angela, individual investors lose their shirts, simply because they don’t know when to get out. Their decisions are clouded by emotion, misguided advice from their brother-in-law or a lack of information about the company. A trailing stop forces you to be disciplined. It’s automatic. That’s especially important on the downside, because investors tend to have no trouble selling winners, but they tend to stick with losers to the bitter end.
The biggest danger in calculating a trailing stop is selling too soon – when a stock pulls back…before it rebounds and keeps on going. Volatility is part of a small cap’s DNA. At one point or another, the stock WILL dip. So how do you get around selling on a minor retrenchment to enjoy that big swing up?
One of the best ways to avoid cheating yourself out of a profit windfall is to integrate the moving average into a trailing stop. Speculators may want to set their trailing stop at the five-day moving average. By contrast, long-term investors might employ the 200-day moving average as their exit point. Either way, you can set the trailing stop to track it – positioning yourself for maximum gain.
With a trailing stop, all you need to ask yourself is one thing: How much money am I willing to lose? The answer: none (remember Buffett’s No. 1 rule?). The end doesn’t have to be a nail-biter – a ride to hell with the bitter taste of defeat. Champagne and caviar are a lot tastier. Trailing stops are the winning ingredients.
Happy investing,
Irwin Greenstein
*** The Penny Sleuth Trade of the Day, brought to you by Sala Kannan…
FORTUNE came out with its list of the 100 fastest growing small companies. Blah, blah, blah. If you want to invest in yesterday’s news, you do so at your own peril. History tells us that’s a doomed approach.
As James told us, Tweedy, Browne (which knows a thing or two about making a buck or two) proved your best returns come courtesy of the beaten-down, undiscovered companies that still have growing top and bottom lines. So that’s exactly what I looked for in picking your Trade of the Day.
I started by searching for companies that the Street has kicked the crap out of over the past year. But I have to admit that sometimes the Street gets it right, so I wanted those companies to have earnings, and for them to be growing earnings. But one quarter of positive earnings wasn’t enough for me, and it shouldn’t be for you, either. Let’s make sure the Street’s really got it wrong by insisting on growth over a five-year period. After all, growth without value really isn’t value at all.
I started with 4,586 small-cap companies to choose from. Out of this, 1,020 companies had fallen 15% or more in the last year. To make sure we were getting a cheap valuation, I looked for stocks with a P/E of less than 25. I found 233. Next, I looked for five-year EPS growth of over 10%. The narrowed results turned up 92 companies. Finally, I wanted quarter-over-last-quarter EPS growth to be higher than the five-year average – just to make sure the company was STILL growing. I ended up with six companies.
So without further delay, here they are – your very own hit list of proven performers the herd is currently ignoring:
Check back in a year and see which list fared best: FORTUNE’s companies or ones from my “against the herd” approach. I’ve got to tell you, my money’s on me.
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If these companies ONLY rise to their “fair value,” you’ll make 26%, 37%, 17%, 21% and 47%. And that’s the WORST-CASE SCENARIO I see!
But if I’m right, you could make $254,973.40.
(And I’ve got 80 years of data that prove I’m right!)
I’ll show you what five stocks you need to own right now to start you on your way to making 25 times your money.
I’ll refund you the entire cost of your subscription if I am wrong.
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