For the short-term investor and trader, timing a buy of the kind of highflying growth stocks that populate my
Future 50 portfolio is relatively simple -- at least in theory. Wait until a stock like
Metromedia Fiber Network
breaks out of a base and sets off for the moon. That means following any of the proven systems for trading on momentum. In the short term, that works pretty well with this group of stocks.
Long-term investors who want to incorporate this group into the kind of "core-and-edge" portfolio strategy that I outlined in my
June 27 column face a different and more difficult problem. Momentum strategies only work if an investor or trader aggressively buys when momentum appears, then aggressively sells when it flags. Using just half of that strategy -- the buying half -- won't work for the long-term buy-and-hold investor who wants to find the next
while the company is still young, and then hold the position into maturity. Buying on momentum and never selling pretty much guarantees that long-term investors will wind up holding more than their share of the broken momentum stocks abandoned by the short-term crowd.
Buy on the Weakness
Instead, I believe that the long-term investor in these stocks -- stocks with the potential to join a "
50 Best in the World" list one day -- should pursue a contrarian strategy and look for any kind of short-term weakness that is enough to drive down the stock's price, but isn't enough to change the fundamental long-term story.
In other words, unlike the momentum trader who buys on short-term strength and doesn't care much about long-term fundamentals, long-term investors seeks to buy on short-term weakness -- as long as they believe the fundamental long-term story is intact (or better yet, actually improving).
To execute this strategy profitably, an investor obviously has to discriminate between short-term weakness in a stock and the beginnings of a long-term, fundamental decline. To get that right, it helps to familiarize yourself with some of the typical scenarios that produce short-term weakness. If you see one of these situations developing, you can be ready to take advantage of an opportunity and feel some confidence about the long-term outcome.
It also helps to study some stocks where short-term weakness might be a precursor to long-term decline. That way you'll develop a feel for the factors that lead to disappointing performance in a stock once pegged as a growth-stock superstar. And you'll get a useful reminder that -- especially for this group of stocks -- long-term investing doesn't mean that you never, ever sell.
In this column, I'm going to work through examples of several typical scenarios that cause short-term weakness in a stock. Then I'll identify 10 "buys" for the Future 50 and for the edge portion of my "core and edge" portfolio. (For my 10 core picks, see my
June 30 column.)
In my next column, on Tuesday, July 11, I'll work through three cases of stocks in the Future 50 where I think short-term weakness may be an indicator of long-term disappointment.
Looking For Weakness
My "weakness" scenarios, from mild to wild:
Weakness after a good earnings report.
This is a pretty typical scenario in the current market. Short-term traders and momentum players ride a stock into its earnings season hoping for a bump from expectations for a good report -- or for an even bigger jump if a stock far surpasses analyst projections. Those same investors then sell on the news. Why not? Once the company has reported, there's nothing left to hang around for. And so the stock drops even though earnings may have come in strongly above expectations. This is exactly what happened to Oracle just a few weeks ago, when it reported its earnings for the quarter that ended in May. The company beat analyst expectations by almost 20% and reported a 70% increase in earnings from the same period in 1999. But still the stock tumbled as the short-term crowd decided to move on. Weakness like this is a very tradable opportunity for short-term investors. But the move downward usually isn't big enough to create much of an opportunity for the long-term investor looking to establish a position -- unless, of course, some other scenario adds to the post-earnings weakness.
Weakness on management turmoil.
Oracle's stock price took another hit when Ray Lane, president and chief operating officer, announced that he would be leaving the company -- something that had long been rumored. Lane had been widely viewed on Wall Street as the man who brought order and predictability to the cowboy sales culture characteristic of Oracle under its founder, Larry Ellison. During Lane's eight-year reign as operations chief, Oracle had moved away from the aggressive accounting practices that would blow up on the company at regular intervals. So it's really no wonder that the stock fell $11 a share, or more than 10%, in the two trading sessions after Lane's resignation. But from a long-term perspective, this news doesn't significantly change the fundamental strengths of Oracle's business. The company dominates a database market that's growing at Internet speed as networks demand more and more storage. Put earnings and management-turmoil weakness together, and I think it adds up to a good entry point in the stock for long-term investors.
Weakness on seasonality.
Here's an interesting pattern: Some stocks run up into earnings in most quarters. But once a year -- always pretty much in the same quarter -- the stock declines as earnings season approaches instead of climbing. That's because sales -- and hence earnings -- at some companies follow seasonal patterns. Customers may bunch orders to get ready for their busy season in the fall and winter, as happens in the personal-computer industry, and then hold off ordering in the first quarter of the year to work off excess inventory. Even when seasonality is long established and almost totally predictable in an industry or for a company, investors still give these stocks a trimming as the downturn approaches.
Consider the case of
, which came up short in its July 1999 quarter as sales growth failed to match expectations. (In this case, "coming up short" meant matching analyst projections instead of producing the expected earnings surprise, and reporting revenue growth of "just" 80%.) That has led to talk among analysts that the quarter that ends in July will be "seasonally" weak for the company. Could be. But this kind of seasonality isn't a major factor in the long-term fundamental story of Network Appliance, and it's certainly less important than, say, the June 21 announcement of a new product that works with Oracle's new 8i Internet software. Thanks to the possibility of seasonality, a stock that traded at almost $87 on June 20 was selling for $73 on July 6. To a long-term investor, that's an opportunity to buy on short-term weakness.
Weakness on worries of a market slowdown.
This is really just seasonal weakness writ large. Investors abandon entire groups of similar stocks because they believe that growth in the markets that these companies address is temporarily slowing. Sometimes this movement out of a sector is based on sound numbers -- we know that stock trading volume is down this year, and for four or so quarters (two of which are now behind us), that isn't going to be good news for companies such as
that make some of their money when investors buy and sell stocks. But to me, E*Trade seems to be an absolute bargain right now. Currently, investors hate the electronic brokerage sector, but I think the long-term growth rate in the market for all these stocks remains fundamentally solid. Another example: Fears have overtaken the wireless phone sector in the past week as analysts have worried publicly that torrid growth in handset sales could slow in the next quarter or two. Nobody, on the other hand, is predicting that the long-term trend toward wireless everywhere is about to slow. Even when these fears are relatively weak, they can create buying opportunities. Stocks such as
RF Micro Devices
are down on such relatively weak worries.
Weakness on fear of an industry cycle.
Most industries -- even those that aren't officially cyclical, such as aluminum or chemicals -- vacillate between booms, when demand outruns supply, and slumps, when supply outruns demand. The chip equipment sector is famous for these cycles, for example. And so, to a lesser extent, are chip stocks themselves. And I'd expect that the fiber optic sector would, once it gets old enough to have a history, show a cyclical pattern, too. Fears that we may be getting close to the peak of the cycle have taken a bite out of stocks like
in the chip-equipment sector and are knocking down the prices of stocks in the chip sector, too.
The range for one of these cyclical growth stocks can be huge. Applied Materials, for example, traded below $10 in 1996 and moved as high as $115 this year. A long-term investor certainly doesn't want to buy at the peak then spend years riding the stock down and then back up toward breakeven. But I think the cycle in chip equipment is more than a year away from hitting its peak -- that's why I've recommended Applied Materials in
Jubak's Picks for a 12- to 18-month holding period. And I think there's a good chance that the continuing explosion in wireless, flash memory, embedded processors and networking chips could keep the cycle going even longer. It's that belief that leads me to recommend Applied Materials at current prices for long-term investors. I think it could be different this time. I think the optical-fiber cycle has even longer to run, and that makes JDS Uniphase a "buy" for long-term investors at its current price.
Weakness on worries about the economic cycle.
Federal Reserve done its job too well, and are we therefore headed for recession? Is inflation still a real danger, and are we therefore facing more interest-rate hikes ahead? How about such wild cards -- probably more powerful in their effect on the economy than the Federal Reserve -- as energy prices? I think investors are right to be worried about the economic cycle -- the picture ahead is extremely murky, and it's very hard to tell exactly how fast the economy is going to grow. That growth rate, and the accompanying interest-rate picture, will determine the level of the stock market over the next two or three quarters. But note that the uncertainty is short-term. It may scare investors out of the market over the next few months; it may produce huge volatility. But nothing I can see in the economic picture over the next five years or so suggests that long-term investors need to rethink their holdings in U.S. equities. Weakness, even at the macroeconomic level, looks like opportunity to me -- if you take a long-term view.
The 10 Buys
Adding up all these scenarios and applying them to the Future 50, I wind up with "buy" recommendations for Applied Materials, E*Trade Group, JDS Uniphase, Metromedia Fiber Network, Network Appliance, Oracle, PMC-Sierra and RF Micro Devices. To those eight, I'm adding
Wind River Systems
to take up the two remaining, more-speculative slots that I reserved for stocks from Jubak's Picks when I set up my "core-and-edge" portfolio strategy. Both companies have the potential to be huge winners, but both come with big execution risks and therefore get a more speculative rating from me.
Well, enough optimism for one column. Next time, depressing thoughts, I promise, as we see which three stocks should be dropped from the Future 50.
At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: America Online, Applied Materials, Cisco Systems, E*Trade, Intel, JDS Uniphase, Network Appliance, PMC-Sierra, RF Micro Devices, Wind River Systems, and WorldCom.He welcomes your feedback at
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