A Hot Stock To Help Keep Your Cool

03/21/2012 10:00 am EST

Focus: STOCKS

Michael Cintolo

Vice President of Investments and Chief Analyst, Cabot Heritage Corporation

This company has emerged as a leader for 2012, and it’s always good to stick with the leaders in today’s environment, writes Mike Cintolo of Cabot Market Letter.

Holding on to a couple of longer-term winners is tougher than cutting losses. The real trick is to develop what we call staying power—that is, a combination of a profit cushion and the mental wherewithal to sit through the inevitable deep, quick, scary corrections that even the best stocks have.

It’s easiest to hold on to a long-term winner when you have just a single share of stock; the money invested is so small that you can sit through a 20% or 30% retreat without breaking a sweat. Of course, with one share, you’ll never make any real money.

Thus, the goal is to put on a position size that’s small enough so you don’t freak out when a stock suffers a sharp retreat…but large enough so your portfolio reaps some serious benefits.

(Unfortunately, there’s no perfect position size—Carlton Lutts, Cabot’s founder and a great investor, could calmly sit through a stock’s downturn even if he had 25% of his account in the stock. Personally, that sort of drawdown would freak me out. But the point is that everyone has a different threshold, and you should strive to find yours.)

My point is that you need to focus on developing at least a few large winners during a bull market. Make it a point of emphasis in your own trading. If you’re the type that constantly takes profits when you’re up 10% or 15%, try to take partial profits instead (selling half your shares) while holding the other half with a trailing stop.

If you’re the type that gets nervous about losing even a 5% profit, consider buying smaller amounts initially, so that the swings of a few percent don’t impact your psyche.

And if you’re the type that is so risk-averse that you’ll never put on a large initial position, then consider building a position over a few weeks, averaging up two or three times (if the stock heads higher) so that, if the stock does get cranking, you have a good-sized position.

There’s no magic bullet, but just remember that, in the big picture, it’s the outliers that will determine the lion’s share of your performance.

As for the current market—I’m bullish. Of course, I’m also keeping my feet on the ground, knowing that after a three-month advance, some sharp shakeouts or even a full-blown 5% market decline could be in the cards. But the overall trend remains very healthy, both among the indexes and leading stocks.

My biggest piece of advice for you right now is to stay focused on the leaders of this advance. In my experience, it’s around this time where investors either:

  • fall back in love with some old, past leaders whose best days are behind them, or
  • start buying up speculative or lagging stocks

In a bull market, you might get away with buying a few dogs, but your best course of action is to stick with the primary or secondary leaders of the advance. In this environment, if you buy the right stocks at opportune entry points, your odds of success are very high.

For my stock idea, I’m going to highlight a second-tier leader that recently gapped up on earnings. Better yet, the stock really hasn’t been a leader before, so it’s fresher merchandise—meaning institutional investors are likely to want to own more going forward.

The stock is Sourcefire (FIRE), an emerging leader in Internet security. Here’s what I wrote about it in Cabot Top Ten Trader back on February 27:

"The rise of organized hacker groups like Anonymous and LulzSec has propelled cybercrime and cyber-security out of the darkness of corporate server rooms and into the limelight of mainstream news. This new era of online crime has prompted corporations to invest heavily in network security, directly benefiting companies like Sourcefire.

Sourcefire’s 3D (for discover, determine, and defend) software and FirePOWER acceleration technology secure networks and applications without sacrificing performance and efficiency. The company’s main customers are located in the finance, government, health care, manufacturing, and technology industries.

The latest round of cyber attacks against the federal government and major financial institutions was a boon for Sourcefire, prompting better-than-expected fourth-quarter earnings from the company. What’s more, citing its strong market position, the company also said it sees fiscal first-quarter revenue of $40 million to $42 million, easily topping Wall Street’s consensus estimates."

The stock exploded higher following those first-quarter results—FIRE shot ahead 26% on ten times average volume. Granted, the stock wasn’t the most well-traded name before the report (about $17 million of daily dollar volume), but the move was decisive and took the stock out of a multi-year rest period.

I don’t call FIRE a first-tier leader. It’s not going to be an institutional favorite anytime soon because of its relatively low trading volume. But I do think it’s a new leader, and the combination of the stock’s explosive earnings move, its resilience since the gap, and the firm’s history of strong sales and earnings growth means higher prices are likely.

You could buy a little in the upper-$40s, but I prefer to look for weakness, aiming to get in around $45 with a stop around $38 or $39.

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