Where Have All The Stock-Pickers Gone?

Earlier this month, WalMart (WMT, $73) and Macy's (M, $44) both reported quarterly financial results that disappointed Wall Street and set off a commotion among analysts and commentators, all of whom are thinking aloud about what this says about the health of the consumer and the economy. Reading the tea leaves for signs of economic strength or weakness has become the obsessive sport du jour because, of course, we might find some clues there as to when the Fed would start to taper its massive bond purchases. Given the amount of ink (liquid and digital) and airtime devoted to such divination, you would think that Ben Bernanke had left his job at the Fed to coach the Alabama football team. Perish the thought, though, because at least Alabama is probably going to win.

Meanwhile, Urban Outfitters (URBN, $42) and TJX Companies (TJX, $54) both posted impressive results. Granted, this is not a true apples-to-apples comparison, since WalMart and Macy's are general merchandisers while the latter companies are specialty retailers, but the distinction actually makes the divergence more compelling. As investors, we know how important it is to understand the big picture, otherwise known as the macroeconomic environment--we don't want to fall victim to failing to see the forest for the trees. However, the concern here may be the opposite, namely that we might fail to see the trees for the forest. The big picture matters, but stock-picking is also all about the little picture, the microeconomic situation unique to each individual company. To stretch the analogy a bit, some of those little trees will grow up to be big and strong, while others will be smothered by the shade canopy, also known, for our purposes, as the competition.

The stock market has been driven higher by lower interest rates, courtesy of the Fed, even as earnings growth overall has been nothing to write home about. Investors have been willing to pay more for each dollar of future earnings, because lower interest rates make each dollar of those earnings more valuable in terms of present value. If the market is going to continue its advance, better earnings will have to carry the ball from here on as interest rates inevitably edge higher. If that pass is successful, the market just might make it through the transition. The good news, as I see it, is that the same factors that would lead the Fed to taper decisively would be the same ones that pave the way for better earnings growth--namely, a more robust economy.

For some time now I have been hearing individual investors say that their investment money is in index funds or Exchange Traded Funds (ETFs). Now, when you put money in those funds the manager is going to buy the stocks in that sector or the stocks in a particular index. That approach has worked out well for some investors, at least to the extent that the rising tide of falling interest rates has lifted all boats. But that's not really stock picking, because you're getting just average companies along with some good ones. So what happens when the tide isn't rising anymore, when interest rates are not pumping up the market? My guess is that individual stock picking will be even more critical to investment success. We're actually seeing that now, as the better growth stocks have performed relatively well during this most recent bout of market volatility. As an example, we've seen weakness in housing-related stocks, the actual home builders in particular, as investors worry that higher interest rates could dampen the housing recovery. However, Ceasarstone (CSTE, $43), the Israeli maker of engineered quartz for kitchen counter tops and other surfaces, has seen its stock advance steadily, up some 170% since the beginning of the year. The reason? Great earnings that seem to indicate that their business is taking market share from more traditional sources of counter tops such as granite.

We could make a similar observation about Michael Kors (KORS, $73) and Starbucks (SBUX, $72), both of which seem to be grabbing a bigger piece of a pie that's not growing robustly. TJX, the operator of discount stores, is taking market share from the likes of Macy's and J.C. Penney, while Costco (COST, $113) seems to be eating into WalMart's business. And just this morning (Monday), Stratsys (SSYS, $112) and 3D Systems (DDD, $52), the makers of three-dimensional printers, are moving higher after both being initiated with Buy ratings at Citigroup. It's all part of the disruption that investors might miss if all they can see is the forest. As famed investor Peter Lynch (pictured above) once said, "The person who turns over the most rocks wins the game."

Judgment Day is coming, as the street preachers like to warn, but it's going to be a separation of the winners from the losers, the companies with stellar earnings growth being the winners. Aren't those the businesses you really want to own? I welcome the return of a more serious focus on stock picking, because that is how individual investors can really gain an edge, if they do their homework and have good sources of information and research. Maybe if General Douglas MacArthur had been a stock picker instead of a military hero, his quote might have been, "Old stock pickers never die; they just fade away." Let's hope they really are coming back.

Life is short. Get busy.

Jim

Disclosure/Disclaimer: My family members and/or I own shares of URBN, TJX, CSTE, KORS, SBUX, COST, DDD, SSYS. Individual stocks are mentioned here for the sole purpose of illustrating investment concepts, and nothing stated here should be construed as the advice to buy or sell any security.

Zombie Investors

The Walking Dead

I have always found that cocktail parties provide a nice laboratory for studying some investor psychology, particularly when the gears of conversation are greased with a few rounds of Bombay Gin, and if you're willing to stir the Petri dish a bit. It sometimes doesn't even take the alcohol to relax the inhibitions enough to bring out the bragging rights. Finding a winning stock apparently triggers the same part of the brain as hooking a 40 pound striped bass or bagging a ten-point buck--something to do with evolutionary psychology, perhaps, and that "hunter-gatherer" genetic wiring. I have witnessed various forms of a conversation that goes like this. Some guy is talking to a group of his fellow guests (typically men, as these parties seem to self-segregate by gender), and he is regaling them with a tale of a certain stock. He first discovered the stock when it was trading at $10, and within a few months it was at $15, then within another few months it had jumped to $20. He seems to know just about everything about it. Since this subject engages my attention, I ask him, as my role in this experiment, whether he still holds his entire position, or if he has taken any profits. His reply, like air whooshing out of a deflating balloon, is that he never bought any of the stock in question--but he sure has been watching it.

Here we have exposed the hallmark trait of the Zombie Investor: inaction. Investing is not a spectator sport, and you can't make any money in stocks without actually buying some. Our zombie in this case has likely acquired his inaction tendency from experience. He doesn't have a true portfolio, but has instead been a serial speculator, fixating on one particular stock at a time, buying at the wrong time, and selling in an emotional frenzy of fear. The hunter has become the deer in the headlights. The more literal, albeit fictional, zombies that grunt and growl their way through AMC's Sunday night gore-fest The Walking Dead (my wife's favorite television show at the moment) are anything but paralyzed, however. Their problem--and the central problem for all of the non-zombie characters in the story--is that something has disabled a large part of their formerly human brains, leaving them governed by their primordial, reptilian brain stems. Today's Zombie Investor suffers not just from inaction, but also from making decisions based on emotions, as if something blew the circuit breakers in their brain compartments for logic and reason.

A familiar case is the investor who will not take a loss in a stock because he is determined to wait for the stock to go up enough to get out at breakeven or better. Now, I want to emphasize that inaction can indeed be the best course of action in some cases--Don't do something, just sit there! as the reversed saying goes--but we need some guidelines for when, and when not, to take action. The first step is to determine whether a stock's decline is due to something company-specific or merely part of an overall market sell-off. I don't like to sell stocks in broad market declines, and that is why I don't like stop-loss orders. As a primer here, a stop-loss works as follows. Let's say you buy a stock at $20 and want to limit your losses to 20%, so you place a stop-loss order to sell the stock if it drops to $16. The thinking goes that small losses can turn into bigger losses, so this is a way of enforcing the discipline to go ahead and take those (hopefully smaller) losses. If the outcome is positive, though, and your stock goes up, then you can raise the stop-loss in tandem with the stock's advance--it goes to $30 and you raise the stop to $24; it goes to $40 and you bump up the stop to $32. The problem with this strategy is that your stop-loss order doesn't know the difference between a change in your company's prospects and a broad-based swoon in the market. We can consider the so-called "Flash Crash" of May 6, 2010, as a cautionary tale. For some reason, the Dow Jones average dropped suddenly by about 1,000 points before quickly erasing most of that decline. Proctor and Gamble (PG, $80), which opened the trading day at $61.91, traded as low as $39.37 before closing at $60.75. So, a stop-loss order here likely would have resulted in your selling the stock at a very unfavorable price. Rather than turn your investment decisions over to "automatic pilot," an alternative would be to use "mental" stops, where you don't place an official order. Instead, you have a price in mind of when you must consider selling the stock. At least this practice gives you time to evaluate the reasons for the decline and whether you should continue holding the position.

Some times, of course, a stock just doesn't work out as we expected, and there are indeed fundamental reasons why it may no longer be a good fit for our portfolios. Let's look at the case of Cree (CREE, $56), the maker of those LED light bulbs, which last week committed the unpardonable sin of failing to hit the "trifecta" with its latest quarterly earnings report. Earnings per share came in right at the consensus estimate, but revenues fell short, and the company's forward guidance for earnings was below the prevailing consensus. That might not be the kiss of death for all stocks, but CREE is (was) a high-flying momentum stock with a P/E (price-to-earnings) ratio that priced in a near-perfect future of growth. The stock took a drubbing, falling now some $20, or about 25%, in the four trading days since the report. Bank of America/ Merrill Lynch chimed in with its assessment that the stock is still over-priced and reiterated a $26 price target, citing the inevitable competition that CREE will face in the retail market for those new bulbs. Predictably, some analysts said the growth thesis was still intact, but the prevailing response was lowered ratings and price targets. Is this a buying opportunity? I don't think so. The stock is in that no-man's-land now, technically broken from a momentum perspective but still too expensive to be a value stock.

I sold my CREE shares at just about breakeven, as my experience has taught me that such high-flyers don't rebound quickly or easily. More important, though, is that one chief reason to sell any stock is when the reasons you bought the stock in the first place no longer hold true. That's a company-specific assessment, of course. I bought CREE as a growth and momentum stock, fully aware that even the slightest stumble would negate the case for owning it. As part of my diversification discipline in the accounts I manage, I am a firm believer in diversifying across investment styles--some value, some traditional growth, some momentum. And in the momentum category, LinkedIn (LNKD, $230) saw its analyst ratings and price targets move up following its earnings report. Despite all indications that CREE would perform in similar fashion, it did not. I "hired" the stock to do a job for me, and when it failed to deliver I let it go.

Maybe an investor has invested, say, $12,000 in a particular stock, and maybe there has been some development that has called into question the case for owning that stock. So now the position is worth $10,000. The investor can talk herself into waiting for the stock to get back to her cost basis, or she can view that $10,000 position as a source of funds. Is the current holding really the best place for that $10,000? Maybe she focuses on what is still there and available instead of the loss. A rose by any other name, to be sure--no amount of wishful thinking or redefinition is going to change the bottom line. Investing, though, is all about what's going to happen in the future, and sometimes our reality checks that come in the form of financial reports tell us that the future may not be as bright and smooth as we had initially thought. There will always be another opportunity knocking.

So that we can end on a more positive note, we'll revisit the television zombies. The AMC Network (AMCX, $65) has managed to pull off at least three shows that are both highly popular and critically acclaimed: Breaking Bad, Mad Men, and The Walking Dead. That would have been unthinkable for a cable network not so long ago. I think the investment case here is all about content, because something has to fill all of those channels that come through our cable boxes and our computers. In a future post we'll look again at some content companies such as Disney ($62), Lionsgate (LGF, $34), and CBS (CBS, $51). The way we receive media content may change over time, but someone is always going to be creating new programs and movies; that's the American Way. In the meantime, watch out for zombies--and don't turn into one. You want your bragging rights to be about something other than the one that got away.

Life is short. Get busy.

Jim

Disclosure/Disclaimer: My family members and/or I own shares of AMCX, LNKD, CBS, DIS, LGF, and PG. Individual stocks are mentioned here for the sole purpose of illustrating investment concepts, and nothing stated here should be construed as the advice to buy or sell any security.

Endless Summer

Part of summer's allure for me as a kid was the season's fleeting nature, the realization that it was here and quickly gone, as evanescent as the last Eskimo Pie on the Merry Mobile ice cream truck. Whenever my mother would hear me say that I wished it could always be summertime, she would say something like, Well, if every day were a vacation, that wouldn't be much of a vacation, now, would it? Of course she was right. The idea of a childhood summer was all about a break from the normal routine, and my summer days were decidedly lacking in structure, the hours always lending themselves to some spontaneous laziness. Doing nothing usually would lead to something, though, if you had a little imagination. Today's kids, in contrast, seem much more scheduled, with summer camps, swim team practices, tennis lessons, and math tutors, with barely time in between to catch a breath--or a firefly. Either way, summer offers something that isn't usually available the other nine months of the year, something for our mental scrapbooks.

Like the lingering memories of a summer romance, some experiences of summer stay with us for a long time, beyond Labor Day and even past Christmas. Several months from now we may look back on the past July and realize that, amid the barrage of market news that fills our inboxes and CNBC each day, there were a few gems of information worthy of our attention. There is, of course, an earnings reporting season for each season of the calendar year, but a couple of the results from the second quarter may be pointing the way toward what we might expect going into the new year. First,  the results from Ford (F, $17), an "old economy" stock if there ever was one, soundly beat expectations for both earnings and revenue. Notable here is that Ford was able to post good results despite Europe still acting as a drag on its operating performance. Many investment strategists have been telling investors to focus on those companies that do the majority of their business here in the United States, which is understandable given the global economic weakness. Sooner or later, though, there's likely to be some recovery in Europe, and by the time it occurs to everyone that such a recovery is definitively underway, it will be a bit late to invest in the companies that will benefit. In a recent article, Barron's named Ford as one way to play a European recovery. I can't get too excited about a company that is projected to grow at only 5%--and note that the P/E ratio of 11 may look cheap, but it is twice the growth rate--but the value here is what Ford's results might presage for other economically-sensitive companies. In other words, it could be less a bellwether and more of a harbinger.

Another eye-catching earnings report came from a "new economy" stock, our old friend Facebook (FB, $38.50). Earnings and revenues that came in well above the consensus forecasts sent shares soaring, up about 50% over the past few weeks (Ford, by the way, is up about 30% year-to-date). Investment analysts who wouldn't touch the stock at $25 are now falling all over themselves to tell you to buy it at $38 and change (FB is now trading slightly above its offering price). Price targets have been ratcheted up to the $45 range. This catch-up behavior may just seem to add to our cynicism about Wall Street, but there is actually some method in this seeming madness. Market prices reflect, among other things, a company's prospects and perceived risk. The risk with Facebook has been all about the concern over how the company can monetize its business model, particularly in the growing mobile area--how it can turn our eyeballs and our clicks into profits. A stock's price has to account for such risk, and in this case we can reasonably conclude that FB trading at $25 was pricing in that risk. Along with great earnings and revenue numbers, the company also reported that the monthly active user count was up 21% in June, while the mobile active user count jumped 51%--and the company now has more than one million advertisers. Facebook has answered the market's call to "show us the money"--or at least some money. Those results, then, alleviate some of the perceived risk, as there is now evidence that the company can actually make money. And that is hard evidence, backed up by the numbers. So, it does make some sense that the stock is more attractive at $38 than it was at $25, since part of the discount for risk doesn't need to be there anymore. Investors who bought the stock at $25 (or as low as $18) were willing to shoulder that risk, and they have been rewarded for doing so--that's how risk works in the market. Investors who want in today have to pay more--they don't get to enjoy the ride from $25 to $38 because they weren't willing to take that risk.

As with Ford, Facebook may be more harbinger than bellwether. The results, thus far, serve to validate the social/mobile/cloud business model, where a good many companies are seeking their fortunes. My brother-in-law and I recently were discussing Yelp (YELP, 51), and he asked, somewhat rhetorically, how I'd like to be in the business of publishing the old printed yellow pages. Had that conversation occurred a few weeks later, I could have said that I would love it, because maybe I could sell the business to Jeff Bezos. Seriously, though, people are still "letting their fingers do the walking" (the old ad slogan for the yellow pages), but those fingers are on the smartphone keypads. On our recent drive to the beach, our daughter introduced us to an app called "Waze," something of a modern-day version of the old Citizens' Band (CB) radio, where users post the latest information about road conditions, traffic, and speed traps (Smokey!). I'm hoping that all those users have a passenger to use the device, lest they end up posting about the road hazard they have just created. The list of what's at your fingertips is growing beyond the more familiar names like TripAdvisor (TRIP, $80) and Open Table (OPEN, $68). This is the convergence of social, mobile, and cloud. These applications rely on input from users--that's the social aspect. As I've noted here before, the mobile revolution is all about being connected without being tethered. Waze is not going to do you any good if you have to be at your desktop computer to use it. And, of course, the cloud is what makes it all work, because all of that computing power is not in some software installed on your device, but rather in a massive network of servers that you tap into. As more companies pile into this space, it's ever more important to beware of the hype and to recognize that there will be winners and losers. As with Facebook, it's all about the eyeballs, the number of users paying attention--and the advertisers who are willing to pay to reach those users. Pay attention!

As for other takeaways from this summer, we have more economic reports and more from the Federal Reserve. Second quarter economic growth was better than expected, but first quarter growth was revised downward. Two steps forward, one step back for the economy. Mr. Bernanke apparently has learned that too much talk about tapering is tantamount to yelling "Fire!" in a packed theater, where it's the traders, not the cinephiles, who stampede for the exits. I think what Mr. Bernanke is really saying might be closer to "Last Call!". Amid all of this struggle between interest rates and economic growth, we have seen some stellar financial results. Middleby (MIDD, $202), discussed in our last post, clocked in with second quarter earnings at $2.00 versus an estimate of $1.78, and revenues that were ahead of forecasts. The stock jumped $23, or 13%, following the news. Lions Gate Entertainment (LGF, $34) reported earnings of $.18, well ahead of the $$.08 estimate, with revenues topping forecasts, as well. Michael Kors (KORS, $72) also beat on the top and bottom line, and comparable store sales were up 27%. Goldman Sachs reiterated its Conviction Buy rating on the shares and raised its price target to $100; KORS is up 41% year-to-date. Goldman reiterated its Sell rating on Coach (COH, $53) and lowered its price target to $47. COH is down more than 3% year-to-date, and some analysts think it's a great value here. I'll go with Goldman on this one--my money is on KORS. It's all about stock-picking here, which is always the case, but even more so when there's no tailwind of robust economic growth.

What the summer gives, the winter can quickly take away--but stocks are not Caladium leaves, which predictably die off with autumn's first chill. I suspect that there are a number of companies with true staying power, and they may really show us something when growth actually picks up. As for summer itself, I guess that one sign of adulthood is the realization that a summer day is really just like any other day, only hotter. But don't tell that to your children--like beer and romance, they'll encounter that on their own soon enough. And several months from now, when you find yourself still at the office for the earlier twilight, you might start humming the last line of that old Nat King Cole song: You'll wish that summer could always be here.

Life is short. Get busy catching fireflies.

Jim

Disclosure/Disclaimer: My family members and/or I own shares of FB, MIDD, LGF, and KORS. Individual stocks are mentioned here for the sole purpose of illustrating investment concepts, and nothing stated here should be construed as the advice to buy or sell any security.