Last week a lot of people lost money in the market; most of them are wishing they had lost less.
But most investors have no idea how to do that except by investing more conservatively–and that’s counterproductive if your main goal is growth.
Today’s column, therefore, is dedicated to addressing ways to improve your investing system–without giving up the potential for growth.
Practice Market Timing
Academics will tell you it can’t be done–but they’re wrong. We’ve been doing it for more than 40 years, and the proof that it works is that Hulbert Digest, which tracks the performance of most major investment newsletters, ranks our flagship Cabot Market Letter the fourth most profitable over the past five years. Specifically, while the Wilshire 5000 gained 1.3% annualized over the past five years, Cabot Market Letter gained 10.9% annualized, and did it with just 90% of the risk!
The key to market timing, of course, is being less heavily invested when the market is falling and more heavily invested when the market is rising.
To do that, we use three main market-timing tools. They are:
The Cabot Trend Lines, which illustrate the long-term trend of the market with the 20-week and 39-week moving averages of the S&P 500 and the 20-week and 30-week moving averages of the Merrill Lynch 100 Tech Index.
The Cabot Tides, which illustrate the intermediate-term trend of the market with the 25-day and 50-day moving averages of five indexes: the S&P 500, the ML 100, the NYSE Composite, the S&P SmallCap 600 and the Nasdaq Composite.
Cabot’s Two-Second Indicator, which monitors the health of the broad market by tracking the changes in the number of stocks on the NYSE hitting new highs or new lows every day.
It’s not a perfect system; there are none. But it does guarantee that we are able to catch every major bull move while sidestepping every major decline.
Most investors know it’s unwise to keep all your eggs in one basket. At Cabot, we recommend owning as least five stocks; 10 is generally better.
But less well known is the value of diversification by time. To illustrate: I received an email last week from a man who had recently become a subscriber of Cabot Stock of the Month, and who, after receiving his first issue, bought three of the stocks recommended there. Well, he’s now lost money in all three, due first to the fact that the market has dropped in the brief time between his buys and now, and second to the fact that he bought the most aggressive three. It would have been better to spread those buys out over time, to reduce the impact of market fluctuations.
Buy Stocks When the Risk/Reward Ratio is Best
For value stocks, such as those recommended by Cabot Benjamin Graham Value Letter, this is simply a matter of buying when a stock is below its Maximum Buy Price.
For growth stocks, however, it’s trickier. From a market perspective, the ideal time is in the early stages of a strong bull market, which is supported by increasing levels of investor confidence. From a long-term stock perspective, the ideal time is when the stock is still young enough that it’s not yet well known, but mature enough that it’s rapidly gathering institutional sponsorship. From a short-term stock perspective, the ideal time is after a high-probability technical set-up.
Cut Losses Short
This doesn’t apply to value investors. If they’re well diversified, they can sit through small losses, confident that in the long run, the stock will reach its full value. Growth investors, however, must be vigilant, remembering that a small loss can easily grow into a big loss. Cabot uses numerous technical tools for achieving sell signals, including moving averages, relative performance lines and volume clues, to name a few, and you can read about them all in the education section of our website. Rest assured that the simplest is the best, “Cut losses short.”
Moving on, I want to talk about my favorite stock, Tesla Motors (TSLA), which I last wrote about here nearly three months ago, on February 20. You can read that article by clicking here.
Tesla Motors is in the business of designing, manufacturing and selling revolutionary new cars, which are powered solely by batteries.
It’s headquartered in Palo Alto, California. It’s managed more like a high-tech company than an old-school automotive company. And its results so far have been terrific.
First the company sold more than 2,250 Roadsters, two-seat sports cars priced at roughly $110,000 each. The total production run of these cars will be 2,400, and the remaining vehicles will be sold in Europe and Asia.
Along the way it signed agreements to build powertrain systems–including lithium-ion batteries–for both Toyota and Daimler AG. That’s a great testament to the quality of Tesla’s engineering and I believe these agreements (and more like them) are likely to last for many years, given that Tesla’s technology is patented.
But the center attraction (for now) is the Model S, a car designed to compete with the mid-level luxury sedans of the leading German manufacturers, Mercedes-Benz, BMW and Audi. Priced at roughly $60,000 (and up) it will seat five adults and two children, will go as much as 300 miles on a single charge, and will blast from 0-60 MPH in 5.5 seconds.
After that will come the Model X, a crossover/SUV with showy but practical falcon-wing doors that is also expected to sell for $60,000 and up.
Eventually, the company is likely to move to higher-volume lower-priced cars for the mass market, as its technology improves and economies of scale make it practical and profitable at lower price points–and it will be interesting to see how low Tesla’s management will go.
In any case, the big news last week, when management revealed its first quarter results, is that Model S deliveries will begin in June rather than July, a full month ahead of schedule!
This is an astounding achievement for a high-tech business doing such revolutionary work, revealing an impressive level of professionalism and perfectionism. Dare I say Tesla is the automotive equipment of Apple?
Additionally, we learned:
That the company has taken more than 10,000 deposits for the Model S.
That the Model S may be “the safest car on the road” once it completes crash testing.
That the Model S is likely to get a mileage rating of 89 MPGe. (That’s miles per gallon equivalent.)
That gross margins of 25% are expected in 2013.
That a major announcement about charging infrastructure is likely in July.
That there will be nearly 30 stores by year-end.
And finally, that Tesla will begin repaying its U.S. loans by the end of 2012, making it the first automaker to do so! This is big. To recap, in 2009, the Obama administration awarded Advanced Technology Vehicle Manufacturing loans to Tesla, Fisker, Ford and Nissan to create jobs and spur development of cars that used less gasoline. The loans must be fully repaid within 10 years.
Fisker has failed to meet some milestones, and been blocked from receiving the remainder of its funds. Ford and Nissan will presumably repay theirs eventually. But Tesla will repay its loan first, and in the process tell investors its positive cash flow is expected to be ample.
Some of that cash flow will come from Toyota. Details are unknown, but $100 million is the value of the current agreement and part of that will be satisfied by the powertrains incorporated in the Toyota RAV4 EV, promised for late this summer. Sadly, the vehicle will be priced at roughly $50,000, roughly double the price of a gasoline-fueled RAV4. Furthermore, Toyota expects to build just 2,600 of the cars in the next three years or so, and sell them only in California, proof that Toyota’s goal is to appease regulators rather than delight customers.
Tesla, on the other hand, is totally focused on delighting its customers. (The fact that its cars are totally electric means they automatically delight regulators in California, as well as Norway, Switzerland, Netherlands and Denmark, where government tax policies favor electric cars.)
The fact that 10,000 deposits have been received (without traditional advertising and without dealer incentives) tells you many consumers are already impressed. But the “moment of truth” will come when the first Model S cars are delivered, and when the first cars are driven by and reviewed by automotive journalists. That day will come soon, and based on the fact that the company has achieved every one of its goals so far, I expect these journalists to be delighted.
One final note about the company. Unlike most traditional car companies, Tesla doesn’t have an adversarial relationship with a dealer network. Like Apple, it owns its own dedicated stores, and every worker in those stores there is an employee of Tesla. And the cars (just like iPads) have prices that are precise and non-negotiable, which most consumers find much more enjoyable than haggling over price and then leaving wondering if they’re been cheated.
So far, I’ve focused on the company. Now let’s look at the stock, remembering that the two are distinct entities.
TSLA came public nearly two years ago at 17, and now it’s trading at 31. So far, so good.
In fact, that performance is substantially better than the stock of General Motors, which the federal government sold back to investors at a price of 33 a few months after Tesla came public, and which is now trading at 22, down 33%.
Yet TSLA is still unloved by the vast majority of investors, if not unknown. Skepticism is rampant.
Why? Because most investors run spreadsheets that look at traditional measures of value, like earnings and stock valuation, and by those measures, TSLA is a disaster waiting to happen. After all, the company has never made a penny and its stock is valued at $3.53 billion, one-tenth the value of GM.
Also figuring into most investors’ reasoning are the problems experienced by other manufacturers, from Fisker (technical troubles, layoffs, the government loans), to Chevrolet (the Volt has had technical troubles and production has been cut because of slow sales). They tar Tesla with the same brush, even though Tesla has made no mistakes yet.
But the simple fact is that most investors are avoiding TSLA because most investors have a difficult time imagining a revolutionary future, and most investors fail to appreciate the power of romance to move a stock.
The revolutionary future in this case revolves around the electric car, which never needs to stop at a gas station, which needs far less maintenance than a gasoline-fueled car and which serves its owner well if it is simply plugged in each night, just as I plug in my iPhone.
And the role of romance means that valuation measures are irrelevant (yes!) in a growth stock’s early phases. You can understand this by considering potential money flows.
In this case, you have an automotive industry valued at roughly $650 billion. Heading the list are Toyota at $140 billion, Volkswagen at $64 billion, Honda at $62 billion and Daimler at $54 billion, followed by Nissan at $44 billion, Ford at $40 billion, General Motors at $34 billion and finally Tata Motors at $17 billion.
Little Tesla is valued at just $4 billion–and that looks high if you simply consider that the company’s revenues in the past 12 months were just $185 million.
But it looks low if you consider the company’s growth potential together with the ability of that $650 billion to shift from one investment bucket to another rather quickly.
All those established manufacturers, you see, are owned by thousands of institutional investors. These investors are a conservative, fearful group, conditioned by the shocks of the economic implosion of 2008 and the weak rebound since.
As a group, they tend to pay more attention to risk management, and many have given up on the prospects for real growth in the industry. But as they see Tesla selling tens of thousands of cars, and turning very profitable very quickly, I think their eyes will be opened. Recognizing the growth potential of Tesla, they’ll bite the bullet and invest “a little” despite the stock’s high valuation.
How much is a little? Well, if it’s just 1% of their investment in those old automotive companies, it would amount to $6.5 billion, or more than twice Tesla’s valuation today!
In short, when TSLA is recognized as the best-managed, most profitable (per car) and fastest-growing major automobile company, every investor in the industry will have to buy in.
My suggestion to you is to invest before they do.
Yours in pursuit of wisdom and wealth,
Cabot Wealth Advisory