During my keynote address at the Investment U Conference at the Four Seasons in Las Vegas last week, I spoke on this year’s theme of “Mastering the Art of Intelligent Speculation.”
(What better place to hold the conference than Las Vegas, the world capital of unintelligent speculation?)
I told attendees that intelligent speculation means buying the RIGHT things, at the RIGHT time, for the RIGHT reasons… and with a clear conception of exactly when you would sell.
Let’s unpack each of these…
What are the best things to speculate on… commodities… precious metals… rare coins… raw land?
None of the above.
History offers a clear answer to this question. No asset class comes close to offering the high returns of common stocks – or better still, uncommon stocks.
And over time, small cap stocks do much better than their large cap brethren.
According to Ibbotson Associates, since 1926, large company stocks have returned an average of 9.9% annually. Not bad.
But small company stocks have returned an average of 12.1% annually.
For those keeping score at home, small companies have returned 22.2% more per year.
And, remember, that’s just the average. Exceptional small caps performed far better.
So what is the very best thing to buy for speculative purposes? Small cap stocks.
When is the right time to buy them? Ideally, in a bear market. Depressed prices increase the chances of higher future returns.
That said, there’s never a bad time to make a good investment. Even those who invested in small cap stocks at market tops – and stuck with the program – enjoyed average annual returns of 12.2%.
Those who bought rapidly growing small caps did substantially better.
What are the right reasons to buy them? It’s not because you think the economic outlook is good, the market is healthy or the man in the White House is doing a bang-up job.
It’s when the prospects for these businesses are truly exceptional.
I ticked off several metrics that indicate when a small cap speculation offers a big potential payoff.
Here are four of them…
- When a company offers truly innovative products and services. (Think cutting-edge technologies, breakthrough medical devices, new blockbuster drugs, etc.)
- When a company’s sales grow 30% or more year over year.
- When a company is able to protect its profit margins with patents, trademarks, copyrights and registered brand names. (Otherwise, competitors will step in and drive down its market share.)
- When a company consistently beats quarterly estimates. Stocks that make a parabolic move higher post positive surprises quarter after quarter after quarter.
How difficult is it to find companies like these?
Quite frankly, it’s not always easy. I spend hundreds of hours a year researching stocks. (You may have better ways to spend your time.)
However, I offered attendees several names that meet my criteria. Among them were Accelerate Diagnostics (Nasdaq: AXDX), Incyte Corp. (Nasdaq: INCY) and Proofpoint (Nasdaq: PFPT), all members of The Oxford Communiqué’s Ten-Baggers of Tomorrow Portfolio.
When do you sell them? We don’t use our traditional 25% trailing stop with this portfolio.
Because these stocks are smaller, often unprofitable – even though sales are growing at more than five times the rate of the average company in the S&P 500 – and more volatile, we don’t want to get knocked out of them too soon.
Nor do we want to invest without a clear-cut sell discipline. That would mean we were simply flying by the seat of our pants. (Not a proven way of beating the market.)
With this particular approach, we issue a sell recommendation if the company misses the consensus sales estimate by 20% or more. (Note I said sales estimate, not earnings estimate.)
It’s revenue growth – or the lack of it – that determines our exit strategy here, not price action.
Our Ten-Baggers of Tomorrow Portfolio is a fine example of intelligent speculation. (It returned 27.6% in 2017, its first full year.)
Want to speculate intelligently? Buy the RIGHT things, at the RIGHT time, for the RIGHT reasons… and with a clear conception of when you would sell.
Thoughts on this article? Leave a comment below.