I’ve learned a lot of things in the four years that I’ve worked at Cabot and that started the minute I walked in the door for my very first interview. Tim Lutts, Cabot’s president, showed me around the incredible building the office inhabits (it was once a library), ending at a very long-term chart of the stock market. He pointed out that despite setbacks, over time, the stock market has always gone up.

In my last column as editor of Cabot Wealth Advisory, I want to share with you some of the most important lessons I’ve learned here.

1.) Always be optimistic. From that very first talk with Tim, I knew he was a forward-looking and thinking individual. And his optimism became even more apparent during the financial crisis that swept through the markets in the year-and-a-half that followed. That’s not to say everything was rosy, but he never lost hope that the situation would turn around and made sure we didn’t either. And he was right! I never worked with Cabot’s founder Carlton Lutts, but from what I’ve heard, his optimism was boundless. I’m sure that’s where Tim learned it from and I’m so glad he passed this valuable lesson along to me. I now have faith that whatever dark days are ahead, they will end and even better things will come in their wake.

2.) Work should be fun. Cabot is a really enjoyable place to work. Every morning we take a 30-minute break for coffee (you can have tea or water too) and sit around a big table to talk. It’s a nice break from the computer screen and helps everyone in the office get to know each other on a personal level. We also get to go on fun outings (like mini-golf or a brewery tour) when we hit certain goals that we set at the beginning of every year. These trips are great ways for us to bond and feel like all of our hard work has paid off.

3.) Don’t succumb to groupthink. If you read the Weekend Digest regularly, you know that I always publish a button with a saying on it that teaches a lesson applicable to the market and life in general. Tim has been collecting these buttons for decades at the Contrary Opinion Forum in Vermont and has them arrayed in his cubicle where he can read them for daily inspiration. When I was in elementary school, I saw a banner that read “What is right is not always popular, but what is popular is not always right.” That stuck with me through the years and the same theme runs through a lot of what we talk about at Cabot. It’s important to be able to look at investor sentiment and recognize that when it’s at it’s worst, that usually means the market is about to turn around (and vice versa). It’s a difficult thing to do, going against the grain, but you’re almost always rewarded for it!

4.) Never stop learning. As I said at the beginning of this issue, I started learning things the minute I walked in the door for my very first interview at Cabot. Tim is a big proponent of continuing education in the sense that you should never stop learning new things. He reads several newspapers a day and is always interested in discovering something he wasn’t aware of before. I’ve always had a very curious mind (when I was younger, my brother would often implore me to stop asking so many questions … instead I became a journalist where I get to ask questions all day long!) and that attitude has been fostered here. I plan to keep learning as long as I can and I encourage you to as well.

5.) Take risks. Investing in the stock market is a risky business. Sure there are systems and indicators and strategies that can put the odds in your favor, but there’s always risk involved. So once you establish that the market trend is in your favor, do your research on a stock and decide how much of your portfolio to invest in it, dive in! I don’t usually think of myself as a big risk-taker, but in the last few years I’ve learned that sometimes taking a leap brings fantastic results. I often think of one of my favorite Henry David Thoreau quotes when I consider the benefits of taking a risk and it often motivates me to take the plunge: “If one advances confidently in the direction of his dreams, and endeavors to live the life which he has imagined, he will meet with a success unexpected in common hours.”—Henry David Thoreau

Since this is my last column, I want to thank you, our readers for checking in with me every Saturday and for your many emails containing invaluable feedback, advice and encouragement. I hope you keep learning along with everyone else at Cabot for years to come!

He Was a Bold Man Who First Ate an Oyster

The words are from Jonathan Swift, who actually wrote, “He was a bold man that first eat an oyster,” and declined to explain further, no doubt thinking it unnecessary for the simple sentiment. Oysters are a marvelous delicacy, yet visually off-putting; thus the idea is that courage was required to discover the treasure. (Try as I might, I can’t ignore the fact that oysters were doubtless enjoyed by primates long before those primates evolved into men.)

This week, I’m going to spotlight the year’s best-performing Top Picks.

Every year, we ask all of our Digest contributors to send us a recommendation of their single favorite stock to own in the coming year. Their submissions range from unknown small-caps to the past year’s winners, a broad range that reflects the wide variety of investing styles practiced by our contributors.

Once in July and again at the end of the year, we revisit the Top Picks to see what’s working.

As of this writing (just shy of the end of the year), the best-performing Top Pick, with a gain of 53%, is a small-cap technology company called Allot Communications (ALLT). Ian Wyatt, editor of Small Cap Investor PRO, recommended Allot, which made its gains in the first six months of 2011. So it was already a winner at mid-year, when Wyatt wrote in an update:

“I’m pleased with the continued growth of Allot Communications, which reported on Tuesday and beat earnings estimates by delivering EPS of $0.07. The company grew revenues by 38% over the comparable quarter of 2010, and by 6% sequentially. To bring more recent subscribers up to speed, Allot manages broadband networks to maximize their performance. Its customers are wireless cell phone operators around the world, and its competition includes companies like Blue Coat (BCSI) and Cisco Systems (CSCO). The company is growing because its solutions help service providers manage their networks more efficiently–its products solve the pains that come with an overloaded network. With massive growth in mobile technologies, I don’t see this trend ending anytime soon and believe Allot will continue to enjoy growing demand for its solutions. … There are now five analysts following Allot, and on average they believe the company will earn $0.26 in 2011 and $0.38 in 2012 on revenues of $71 million and $83 million, respectively. These projections would put revenue growth at 25% this year and 16% next. I think Allot will do better. I’ll bump up the price target on Allot to the consensus of $17.50–that’s around 15% higher than shares currently trade. Allot is a buy on weakness.”

Since then, Allot broke through the 17.50 level a few times, and even touched 19.15. Shares always meet resistance at those high levels though, and they are now back between 16 and 17. But as Wyatt wrote, this company is gaining admirers, and a strong move past 19 could signal the next phase of the upmove for ALLT. This is certainly one to keep an eye on.

The second-best performer to date is also a small-cap technology stock. This one doesn’t have any potential for new investors though: Global Defense Technology and Systems (GTEC) was acquired for $315 million in March 2011. The acquisition provided a quick 48% gain for subscribers who had bought the shares when Geoffrey Eiten, editor of OTC Growth Stock Watch, recommended them in our January Top Picks issue.

The third-best performing Top Pick is also a technology stock. But unlike ALLT and GTEC, IAC/Interactive Corp. (IACI) made fairly steady gains all year, even as the market thrashed up and down. Originally recommended in the Top Picks issue by David Fried, editor of The Buyback Letter, at 29.41, IACI is now trading in the low 40s. IAC/Interactive owns Ask.com and Match.com, in addition to other Internet properties. It’s hard to tell if the stock’s best days are behind or ahead of it–IACI’s momentum is choppy but upward, as evidenced by a pattern of higher highs and higher lows. Watch to see what IACI does when the market breaks out of its trading range in 2012 (hopefully to the upside).

The fourth-best performer overall was featured in Dividend Digest. Chunghwa Telecom Co. (CHT), recommended by Yiannis G. Mostrous in Global Investment Strategist, is up 35% year-to-date. Mostrous just updated his subscribers on Chunghwa Telecom last week, December 21, writing:

“Taiwan’s largest telecommunications provider Chunghwa Telecom in mid-December announced that its mobile communications division had crossed the 10-million subscriber mark. Chunghwa Telecom also announced that it would spend TWD6 billion (USD200 million) to boost its mobile network capacity–the first step on a path to cultivate a smartphone and ‘Internet of Things’ subscriber base of 10 million. Internet of Things refers to network-enabled objects, such as a refrigerator, and the web-based services that interact with these devices. In 2011, Chunghwa Telecom spent TWD4.8 billion (USD160 million) on expanding and improving its mobile network. The company also said it would contribute USD51 million to a consortium of Asian telecom companies to build high-speed submarine cables that will connect 11 areas in nine countries in the region. The Asia Pacific Gateway project will build an underwater fiber-optic network that will begin commercial service by 2014. The cables will stretch 100,000 kilometers and will link Taiwan, China, South Korea, Japan, Singapore, Malaysia, Thailand, Vietnam and Hong Kong. Chunghwa Telecom said that its November unconsolidated sales fell 1.34% year over year to TWD15.7 billion (USD519.9 million), without providing a reason for the decline. The company’s total revenue in the third quarter rose 9.5% year over year to USD1.9 billion, although net income declined 0.2% year over year to USD406.8 million. However, net income per American depositary receipt (ADR) rose 5% year over year to USD0.51, primarily due to a 20% reduction in outstanding shares. Chunghwa Telecom’s operating profit declined 3.9% year over year to USD473.3 million.

“The company’s mobile business accounted for USD810.2 million of total third-quarter revenue, an increase of 6.6% from the year-ago period. The company’s mobile subscriber base rose 4 percent year over year in the third quarter to 9.96 million, of which 5.83 million subscribers were third-generation (3G) technology users. These 3G users contributed to 40.5 percent yearly growth in mobile value-added services revenue, which came in at USD133.7 million in the quarter. The company expects its mobile Internet subscriber base to reach 1.47 million by the end of 2011 compared to 1.32 million at the end of the third quarter. The company’s Internet segment accounted for USD219.6 million in sales, up 0.6 percent year over year. The company is rapidly expanding its fiber network throughout Taiwan, with the aim of reaching 75% of the country’s population by the end of the year. The company’s broadband subscriber base was 4.48 million at the end of the third quarter. Of this total, 51.8% of broadband users had signed up for the company’s fiber network offerings. The company’s rapid expansion of fiber coverage allowed it to achieve 1 million movie-on-demand subscribers in November, one month earlier than predicted.

“Chunghwa Telecom controls 80% of Taiwan’s broadband market. The company is utterly dominant in the fixed-line market, holding a 96% share of the local fixed-line segment and 77% of the long-distance fixed-line market. The company’s domestic fixed-line segment grew revenue by 17.1% year over year to USD699.7 million in the third quarter, while the international fixed-line communications segment saw revenue decline by 6% to USD128.9 million. However, a recent government ruling has shifted the pricing right for landline-to-mobile phone calls in favor of fixed-line operators, which has boosted Chunghwa Telecom’s top line. Buy Chunghwa Telecom up to USD35.”

In addition to its appreciation potential, Chunghwa Telecom also offers large but intermittent dividends. Going forward, this company looks like a good pick for any investor.

During our lunch, we discussed the market and how pathetic the volume has been for stocks lately. Our conversation turned to options and whether there had been the same kind of drop off in volume. This simple conversation sent me down a path that led me to some pretty staggering findings.

After doing searches for volume data from the New York Stock Exchange (NYSE) and the Chicago Board Options Exchange (CBOE), I discovered that there is a major shift happening in the way investors view and use options.

Let’s start by looking at the volume on the NYSE. From 2005 through 2008, the average annual volume on the NYSE grew by over 10% per year. After the bear market from 2008-2009, the annual volume declined each year, with 2010 volume declining 19% from the 2009 volume. For the 2011 numbers, I used the average monthly volume for the first 11 months to arrive at a total for December in order to get a full year of data. As we enter the final week of trading, we are looking at another double-digit percentage volume loss for 2011.

What this suggests is that the average investor hasn’t come back into stocks at the level they were before the bear market. After dealing with two bear markets in less than 10 years, perhaps the average investor’s confidence is shaken and this is keeping them out of the market.

The next step was to look at the annual volume on the CBOE. Options trading grew by huge percentages from 2005-2008, with an average annual growth rate of 35% over the previous year. However, rather than declining sharply in the last three years, options volume declined by a much smaller percentage than stocks.

I have been trying to tell people for a number of years that options present a way for investors to participate in the market’s movements with far less money tied up in the market. Perhaps investors are starting to realize this and so options volume has been relatively stable over the last three years.

The final step in my analysis was to take the options volume and multiply it by 100 because each option represents 100 shares of the underlying stock. After taking this step, I looked at the options trades as a percentage of the stock trades. For instance, in 2004 there were 369.6 billion shares of stock traded on the NYSE, while 361 million options contracts were traded on the CBOE. In this case, the option volume multiplied by 100 came out to 36 billion shares of stock represented. The math from there is pretty easy as 36 billion is just under 10% of 369 billion. In other words, the amount of stock represented by options traded on the CBOE was approximately 10% of the NYSE’s stock volume.

So options trading grew faster than stock trading from 2005-2008 and then didn’t drop off as much in the last three years.

From the table above we see that the amount of stock represented by the options traded on the CBOE has increased sharply as a percentage of the stock traded on the NYSE. The number of shares controlled by options was just under 10% in 2004; in 2011, it’s estimated to be just under 30%.

Whether it is Main Street or Wall Street, investors have discovered that options present opportunities and strategies not available with stocks alone. With options, you can lower your total dollar exposure, but still participate in the market’s movements. You can use covered call strategies to add income to your portfolio or you can buy protective puts as insurance for your portfolio. But the view that options are only for risk takers is definitely changing and services like the Cabot Options Trader are becoming more sought out by investors. It has been 21 years since I made my first options trade and now more and more investors are realizing how options can play a part in their portfolio. It’s about time.

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