- A ‘round trip’ in the stock market ain’t fun
- Be wary when stocks have a ‘high bar’ to beat
- Plus, a phrase to live and trade by…
‘That’s what we traders call a round tripper.’
A friend of mine said that to me the other day when we were looking at a chart of a stock.
The price of this company had gone rocketing up over about two years…only to deflate all the way back to where it started over the same timeframe.
Today’s Profit Watch contains an ASX example…and what we can learn from it.
It’s one thing to make a gain…but so much of investing success is keeping that gain.
After all, nobody rings a bell at the top…
Let’s go back to 2016.
Imagine for a moment you’re browsing your newspaper in the morning.
You read about a company you’ve never heard of before…but it sounds exciting.
The reporter is quoting the chairman of this firm. The article recalls his forecast in 2014 that this company is on its way to becoming a billion-dollar firm.
Nobody believed him at the time. But about two years later, the stock is up 590% since listing on the ASX.
That takes its market cap to over $500 million — halfway to the chairman’s goal. There’s an exciting outlook still ahead.
The article appears on 15 July, 2016.
Perhaps you should have a nibble?
You decide not to.
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Thank goodness! In hindsight, we know that the stock price will peak at an all-time high of $4.29.
That’s literally a week after the article you read comes out.
It’s been downhill ever since…the stock closed at 63 cents yesterday. The current CEO is now resigning.
What’s the company? It’s tech firm Catapult Group International [ASX: CAT].
See the journey here…
This stock has been on my radar for a long time. I never rode it on the way up…and I’ve never nibbled at it on the way down.
I know many people have, though, because it is…or at least sounds like…a compelling story.
And yet it’s never returned to its former momentum.
None of what I’m saying here is meant as a criticism of this business. It’s merely an observation of what’s happened.
Here’s one thing I do know…
Mainstream news? Do the opposite, usually
Generally, when you see a feature article about a stock in the mainstream press, you should be a little wary.
As you can see from Catapult, it was already up 590% by the time it appeared in the news.
That’s why it was news.
By July 2016, the stock was carrying huge expectations well built into the price.
That can make for a very high bar for the company to get over, unless it delivers extraordinary results.
Clearly Catapult has struggled since — hence the selldown.
Buyers who’ve come in later have seen potential to acquire the same ‘growth’ story…at a discount to the previous high price.
But the stock just keeps getting ‘cheaper’.
That’s when ‘buying the dip’ turns into ‘catching a falling knife’.
How to protect yourself against this?
Here are some thoughts …
The folly in holding on at times
Let me make one thing clear: I’m not immune to mistakes around buying and selling.
In August 2017, I recommended a speculative stock. By December, it was up 350%.
The very theme I backed it for appeared on the front page of The Australian Financial Review.
That was a sell signal. I didn’t take it. I reasoned we should hang on a little longer…even if we risked giving back some of the gain.
Little did I know we’d give back all of the gain due to an unforeseen development.
So, I’m not preaching. Learn from my mistake!
One idea is to make a distinction between a market selldown and an individual stock selling off.
If the whole market tanks, a stock such as Catapult will not be immune. A dip like that could be a buying opportunity.
But if the stock you’re following is weakening while the market is going up, it could signal there’s something wrong with the ‘story’.
This is when you need to have done your homework.
Does it make money?
There’s a feature of small caps like Catapult that can help form your decisions around something like this.
It’s this: Generally, they have negative cash flow.
If you’re considering ‘buying the dip’ at any time, you do need to be clear if the company is profitable yet.
It might sound simple, but it’s vital.
Growing earnings can drive stocks higher for a long time.
Stocks that don’t have positive cash flow have a much harder time holding on to their gains…and therefore suit shorter-term timeframes.
For example, a stock could fly up on announcing a great deal or surging revenues or a great deposit.
But at some point, it has to turn this into profit. The higher the stock price goes without this, the more risk you’re taking if you buy in.
Obviously, it depends on where the company is in its lifecycle, too…and potential catalysts ahead… There are a lot of variables here.
There’s no ‘one rule’ that works here in the market. It’s just not that simple or easy.
And we all have different temperaments, timeframes and capital to work with.
However, I want you to remember one thing from today, if nothing else, thanks to Catapult. It’s a good guide to protecting yourself in the market.
I’ve kept that article aside ever since I saw it in 2016.
Here’s what you should always keep in mind…
‘If it’s in the news, it’s in the price.’