Resilient Growth Stocks Vs. Off-The-Bottom Stocks

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Includes: GDX, LVS
by: Cabot

Summary

Investors face several challenges when they buy off-the-bottom stocks.

Gold stocks and casino stocks are good examples of the long bottoming process; it can take many weeks or even months as shares transfer from weak hands to strong hands.

Bottom line: The upside is much larger in real growth stocks that burst to new highs within a few weeks of the start of a new bull move.

By Michael Cintolo, chief analyst, Cabot Growth Investor

It's around this phase of a downtrend, after so many stocks and sectors have been bludgeoned, that investors begin asking us if we see any bargains. And it's not an unreasonable question, especially when you consider some stocks we liked a year ago are 50% or more off their peaks today.

Moreover, as the market has finally gotten off its duff during the past few days, we've seen some of these "off-the-bottom" stocks rip higher. That raises the question-when we get a Cabot Tides buy signal, is it better to buy beaten-down, off-the-bottom stocks (whether they're growth-oriented or not), or focus on more resilient growth stocks that have held within shouting distance of new highs?

There's no definitive right or wrong answer, but buying off-the-bottom stocks does bring challenges with it. First and foremost, these stocks often have lots of overhead resistance (owners of stock at higher prices that want to get out at breakeven)-and that tends to stunt any advance after the initial week or two of rallying.

Second, of course, these stocks are usually beaten-down for a reason … i.e., business has taken (or is likely to take) a big turn for the worse. Thus, again, you often see selling appear on any rally because the fundamentals don't support a long-lasting price rise.

Lastly, don't forget that these beaten-down stocks are in a longer-term downtrend. Thus, the odds favor lower prices over time.

"But Mike," many will say, "at some point these trashed stocks will turn around, right?" Yes, most will, and when they do, there can be lots of upside. But here's the key: In almost all cases, stocks that fall 50% or more must build bottoms before launching higher. Such a process can take many weeks or even months as shares transfer from weak hands to strong hands.

A good example of that would be gold stocks-after plunging more than 80% (!) since 2011, the Market Vectors Miners Fund (NYSEARCA:GDX) built a bottom in the 12.5 to 13 area for a full six months before blasting off during the past couple of weeks. When you have this type of long bottoming process, the odds are much greater that the upmove can persist.

Another possible example is casino stocks, especially those with most of their exposure in Macau, China. We've always liked the group because competition is limited, and the major trend in gambling (especially in Macau) is up. Las Vegas Sands (NYSE:LVS) is the one we're watching closest-it's been trying to bottom out since September, though we'd still like to see a decisive pop above its 40-week moving average to conclude that a bottom is in. We like its various Macau and Singapore casinos, and its huge dividend (recently increased, it now yields more than 7%) doesn't hurt.

Resilient growth stocks, on the other hand, act completely differently. As long as the major trend is down, you almost always see sellers pound a stock that approaches new high ground; thus, you'll often see "strong" growth stocks make little progress during the initial phases of a rally.

However, longer-term, the upside is much larger in a real growth stock that's resisted the market's decline-these are the stocks that morph into leaders and often double, triple or more during a fresh bull market! And that's the main reason we stick mostly with these resilient stocks-in the short-term, you might miss out on a couple of small profits in the off-the-bottom stocks, but over time, grabbing a big winner pays off far more.

In terms of the Cabot Growth Investor Model Portfolio, we're not opposed to buying an off-the-bottom stock or two, especially if they have a growth angle. However, our focus remains on the fact that the big money is made on the big swing, by owning a new leader that bursts to new highs within a few weeks of the start of a new bull move (especially if that move kicks off a new secular bull trend).

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.