Invest and Trade Profitably with Jon Johnson

The following is an Oct. 04, 2000 quote from Michael Murphy: “What you need to decide during times like this is whether you are an investor or a speculator. If you are a speculator, you buy popular stocks at high valuations that are moving up, in hopes of selling them to a greater fool at a higher price. You must ignore measures like price/growth flow or price/earnings ratio, because they will literally cause you to do the wrong thing. You should be looking for new buy ideas in the New Highs list. Most important of all, you shouldn’t kid yourself about what you are doing. To you, a stock is a piece of paper and investing is like playing Hot Potato or musical chairs–it’s a game, and not one that we want to play. If you are an investor in the new economy . . . you are trying to associate your capital with great companies at low prices. Stocks that are falling become more attractive to you, not less. You are looking for buys in the New Lows list, turning the volatility in tech stocks to your advantage by buying when they are depressed.” I like your site. I also appreciate Michael Murphy. What would you reply or direct me to understand this issue of valuations: perhaps a book or an area on your site? Understanding this issue is critical to making wise choices for my investing future.

August 30, 2000

It is hard to argue with buying a great stock at a low price. That is what we advocate when we say that two times each year, usually the spring and the fall, there are great buying opportunities in technology stocks. At those times even the leading stocks get taken down somewhat with the rest of the market. We saw that with JNPR, NTAP and others just recently. Still, they held onto their positions as market leaders even when they pulled back.

The problem with what is being advocated in the question is that it can often get you in trouble. If you are willing to hold a stock for months even years without much appreciation, but you believe in the company, then this is fine. Then the stock may make the expected move and return great gains. The problem from an accounting point of view is that you could have put your money to work with some other stock while this stock corrected and made its base.

History shows over and over that the stocks with the greatest moves go through corrections that shake out the sellers and then breakout on big institutional support when the institutions once again believe in the stock. There are signs of this, e.g., when a stock breaks out of a basing pattern on huge volume. If you go fishing for stocks in the new lows section, you are not following the market leaders. This section is inhabited by the former leaders and the stocks that never made it to that level. Before we want to put money in a stock, we want to know that it is going to move up for us. A good chart pattern, super revenues and earnings, and institutional support are the hallmarks of these stocks. A stock such as INTC, DELL, or MSFT is still undergoing a serious correction. The stocks are being sold by mutual funds, not accumulated. You might think you are smart picking up INTC for $37, and someday you may be proved right. But I would rather grab hold of a leader that can return me 100% while INTC goes through its travails and purges its demons. It will give signs it is ready to move, primarily by forming a solid base such as a cup with handle pattern. It definitely has not shown it has hit bottom. And that is the problem with stocks hitting new lows; do we know the company is going to come back? Will it cure its earnings woes? Is its primary sector dead? The market is very efficient in telling us what a stock’s future is. Right now, these guys may look attractive, but do we know they will recover?

CSCO, MSFT and INTC have gone through long bases before (each has undergone a base of at least one year) and then broke out and started huge runs again. During that time many, many other stocks gave 50%, 100% and better gains. How did we spot those? By looking at revenue and earnings growth and watching for breakouts of patterns that have shown year in and year out that a stock is starting a strong run. Right now, there are not many of those, but we are getting great rides from leaders such as JNPR, AMCC, and VRTS that showed us last week that they are way ahead of others in their industries by posting whopping gains in earnings and revenues. And their charts show it. Will MSFT, DELL, and INTC be back? It is hard to imagine that such rich companies could ever not be the cream of the crop, but history is littered with giants that could not fail, but through a changing economy and shifting technology, they did just that. If these stocks show us they are at bottom and ready to move up, i.e., a good basing pattern, we will be interested. With waning earnings, we are not interested. We would rather get a great stock that is growing its earnings and revenues by at least 50% a quarter, year over year, as those historically are the stocks that lead the markets higher. That is not speculation. Speculation is a stock that has no earnings and is being bid up. The leaders that we find for you and follow are not those types of companies. Real earnings, real earnings growth in leading sectors. They are heading up. We don’t know when or if the others ever will. If they do, however, we will have the chance to get in them. For now, we will put our money at work in those stocks that are the leaders in the leading sectors as that gives us the best return on our money. If they get roughed up and the market shows us it is recovering, all the better; we then get them at an even better price.

As for a good book, take a look at “Making Money in the Stock Market” by William O’Neil. That book is an eye opener for many investors.

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