Every few months I like to do a frequently asked question (FAQ) post and so this week I’m going to be doing a few. The reason I’m able to do this is that I’m available to Cabot subscribers–every editor answers many emails each week, so we have a pretty good idea of what’s on subscribers’ minds. I find the FAQ both makes for a good read (I usually get a bunch of positive feedback after FAQ issues … so be sure to let me know what you think, good or bad, about this one) and helps me think through some of the most common and intriguing questions out there. A quick note before I start, the answers to these questions are from my growth stock and market-timing perspective. If you want to know more about where I’m coming from, see my Editor Profile here. So without further ado, on with the show.
Question: How do you handle buying growth stocks in the current environment, when most leaders have already enjoyed some powerful upmoves … yet they refuse to pull back and even continue to move up? Should I wait for a pullback or buy now?
Answer: Every stock is different, of course, but right now, many of the best stocks have recently broken out of a five-, six- or seven-week consolidation areas, so while they’ve enjoyed a good couple of weeks, they aren’t extended to the upside. Thus, for the most part, I think you can basically buy these stocks right here, or on minor (2% to 5%) pullbacks. (One caveat: Don’t load up right ahead of an earnings report, as that’s more like gambling than investing.)
With that said, however, I do think the market will retreat at some point, and it’s foolish to think the leaders won’t be affected. Over the long run, waiting for pullbacks is your better option, so don’t get in the habit of chasing stocks higher. Doing so almost always leads to losses.
Question: How do you balance the fact that many of your stocks have great sales and earnings growth, but also have very high P/E ratios? Isn’t their growth priced in at some point?
Answer: I learned long ago that for growth stocks, P/E ratios are simply not an important factor in determining future performance. Rapid growth and (most important) a revolutionary product or service are better predictors.
Eventually, valuation will matter, but you should let the stock tell you when it does–its own topping action will let you know it’s time to move on. Just remember that a valuation is the result of good performance, not the cause of it.
Question: What do you do when you buy a stock and get stopped out because it trips your loss limit, only to see the stock quickly reverse course and begin advancing again?
Answer: This is a good question to think about because, frankly, such a scenario is going to happen a few times–that’s life in the stock market. Here’s what I would suggest:
First, make sure you’re buying properly; if you’re buying a stock in the stratosphere, you’re more likely to get shaken out on normal pullbacks.
Beyond that, you should consider buying the stock back if it knocks you out but turns tail POWERFULLY. Remember, if you got shaken out, the odds are that many others did, too … eliminating lots of potential resistance. So if the stock turns around, it could be ready for a nice upmove. I know it’s psychologically difficult to do, but oftentimes, buying after a shakeout is one of the higher-odds investments you can make. So keep an open mind to it.
Question: How do you handle stocks that announce new share offerings?
Answer: Usually it’s just best to watch the chart. More often than not, a strong leading stock will not break down because of a share offering, although such stocks usually decline on the news. And these stocks will often be “capped” in the short-term, until their offerings are out of the way.
Just make sure you’re buying because the stock truly merits your support, not because you’re trying to get even.
Really, though, like I just wrote, it’s best to just watch the chart. If a stock announces a big follow-on offering and it breaks below its 50-day line, that’s bearish. But if it pulls back but remains above support, it’s usually worth holding.
That’s all for today. I hope you enjoyed reading the FAQ post as much as I enjoyed writing it. Do you still have a burning question that you want answered by me or one of the other editors? Then leave it here.