Over the past few days we’ve seen a bunch of references to something called the ‘Great Rotation’.
What does it mean?
The cynic in your editor says it’s just another catchphrase created by the financial drones. These are people who are incapable of +buying or selling unless there’s a fancy phrase to go along with it.
Want to sell stocks? Not until they’ve got a ‘fiscal cliff’ or ‘debt ceiling’.
Want to buy stocks? Not unless they’re in the midst of the ‘Great Rotation’.
So what’s the next catchphrase the financial drones will make up as an excuse to buy or sell stocks?
Who knows? But to be honest, we don’t care. We’ve long stopped caring what the self-important drones think. We’d rather stick to picking good stocks at a fair price.
Trouble is where do you start?
Well, it depends on the kind of stock you’re looking for.
If you’re after a beaten-down blue chip stock you can look at the usual financial metrics: balance sheets, income statement, price-to-earnings ratio, price-to-book value, return on equity, and so on.
You can then compare different stocks to figure out which is the best value.
In fact, even some of the basic online trading platforms include a simple screening tool that helps you filter stocks based on certain criteria.
For instance, you may have a theory that all stocks are worth buying if they have a price-to-earnings (PE) ratio of 7 or lower.
Plug that into the screening tool and hey presto! you’ll have a list of stocks with a PE less than 7.
Easy, right?
Well, it’s easy to get the info. But remember the old saying, ‘Put rubbish in, get rubbish out.’
In other words, if your theory about buying all stocks with a PE below 7 is a bad theory, then the screening tool won’t necessarily give you winning stock picks.
It may give you some winners, but it will probably give you a bunch of losers as well. So how do you pick the good from the bad?
There’s More to Picking Stocks Than Balance Sheets and Ratios
That’s what makes experience, practice and trial-and-error so important. It will help you figure out which ratios are relevant and which aren’t.
In fact, most analysts and stock pickers use several criteria to filter and pick stocks. Even then, it’s not cut and dry. Most analysts will also look at other aspects of a company — what the company does, who its customers are, who its suppliers are, and what’s the outlook for the company’s industry.
That means it takes a lot of time to analyse stocks. But perhaps the cruellest thing of all: after you’ve done all the analysis and separated the wheat from the chaff, you still may not have a stock to invest in…so it’s back to the drawing board.
But at least when you’re backing beaten-down blue-chip stocks you’ve got a place to start. That isn’t always how it is with small-cap growth stocks…
This is why small-cap growth stocks are so much riskier than blue-chip stocks. In many cases it’s not worth looking at the income statement because the company doesn’t make any money.
And the only reason to look at the balance sheet is to see how much cash the company has left. Most small-cap growth stocks eat through cash pretty quickly as they attempt to uncover the game-changing resource discovery or technology that could transform their business.
As for PE ratios, price-to-book ratios or return on equity, forget about it. When a small company is exploring for a new resource, or developing a new technology, those ratios are meaningless.
Of course, not all small-caps are resources explorers or small technology stocks. Some small companies are profitable but stay small because they operate in a niche market.
With those companies it is possible to analyse their financial statements (one of our small-cap value stock picks is up 86.2% including dividends since last June, beating the S&P/ASX 200 which is only up 20.4% over the same timeframe).
Here’s the Real Exciting Stock Story
But back to small-cap growth stocks. We suggest there’s still a lot of potential growth in this market…despite the strong rally since mid-November.
To put things in perspective, there are roughly 2,000 stocks listed on the Australian Securities Exchange (ASX). Yet, there are 1,323 stocks that have gained less than 15% over the past year.
That’s roughly two-thirds of the Australian share market.
So, when we hear some investors say they’ve missed the boat and that everything is too expensive, we don’t buy it.
Sure, there are a lot of expensive stocks. But there are many more stocks that are still cheap. And it’s not just because they’re bad companies with bad ideas (although there are plenty of those), it’s just that right now those stocks haven’t convinced investors they’re worth buying.
So it’s the job of the analyst and stock picker to filter through those 1,323 stocks to figure out which one could be the next big thing…which stock is on the verge of convincing investors it’s worth buying.
As you can guess, the numbers are stacked against the small-cap investor. But it’s also why if you can get on board a stock before it pops, the returns are much greater than if you buy lower risk blue-chip stocks.
All this sums up why we’re still picking stocks and backing potential little Aussie winners…while the mainstream focuses on the irrelevant and meaningless issues like ‘Fiscal Cliffs’, ‘Debt Ceilings’ and ‘Great Rotations’.
Given a choice we’ll take the risk and excitement of innovative small-cap stocks any day of the week compared to the fluff and nonsense that drives the share prices of lumbering blue-chips.
Cheers,
Kris
From the Port Phillip Publishing Library
Special Report: How to Hunt Down 2013’s Biggest Stock Market Winners
Daily Reckoning: The Great Rotation Into Stocks
Money Morning: This Share Market Rally Has Angered Some Investors
Pursuit of Happiness: It’s Time to Set Your Retirement Gameplan
Australian Small-Cap Investigator: Why Invest In Small-Cap Stocks? And Why Now?
