Seizing Opportunities
With the market closed tomorrow for the New Year, I’m sending you our Weekly Update a day early. We’ve got lots to talk about, so let’s get right to it!
Small-cap stocks traded in circles this year, providing the perfect opportunities to add value to our portfolio with active screening and well-timed trades. Keeping our money moving throughout the Breakout universe helped our sells beat the benchmark close to two to one, so now it’s time for our active positions to take over the spotlight.
Compared to past years when money poured into smaller and more obscure corners of the market, 2014 has demonstrated that it takes a little more effort to make money when the tide isn’t exactly in your favor.
End to end, our benchmark, the Russell 2000, squeezed out a 5% total return over the last 12 months. The average small-cap growth manager actually fell 2% short of that relatively modest mark, and small-cap value funds lagged by an only slightly smaller degree.
Meanwhile, we were actively buying and selling, riding the wave when we could and locking in profits whenever we had the chance, like we did on Monday with First Bancorp (FBP) and Crown Media (CRWN). Including our additional sale of Innovative Solutions & Support (ISSC), we opened and closed a total of 36 full positions in 2014 for an average gain of 7.95% per exit.
Not every call was in the money, but with our wins outnumbering our losses by four to one and a full 80% of our winners closing in the double-digit breakout zone, the odds clearly played out in our favor. Overall, our average performance nearly doubled the Russell.
Chart Focus: A Tale of Two Markets
So how did we end up so far ahead of the pack? It boils down to working to keep our capital in parts of the market rollercoaster that were rising and then getting off at or as close to the peak as possible, all while minimizing the amount of time we spent in a downswing.
Let’s take a quick look at the Russell 2000’s performance over the last two years, which really explains it all:
Our Breakout universe had plenty of wind beneath its wings in 2013 when the Russell climbed steadily higher across the 12-month period – minus a few 5%-6% retreats.
Clearly, this year was a bit of a different story. For all practical purposes, a trader could have reaped the small-cap benchmark’s entire full-year upside by buying in on January 1, selling in early March and spending the next nine months putting the returns to work elsewhere in the market.
As you can see above, the Russell moved around quite a bit from March to December but never convincingly broke above its March peak until just a few days ago. A buy-and-hold position during those months would have amounted to little more than dead money, opportunity costs and a lot of risk along the way. But here in Breakout, we spent those months staying busy by harvesting our profits – a full 20 winners – while seeking out those stocks in position to make money no matter the market conditions.
In the world of physics, work is defined as a factor of effort and distance. For traders, those key elements are capital and time, so the rule of physics is simply this: The less time your capital spends going nowhere, the more upside it can ultimately capture.
Even with no long-term trend in the asset class to work with, our focus on individual stocks with transformative potential gave us one shot after another at enhanced performance. This year, we took those shots and were able to rack up a score that most professionally-managed small-cap funds were unable to beat.
In 2015, I want to cut even more dead time out of our trades so that we can make sure our money is working as fast as possible for us. Whether we end up seeing a rising trend like the one in 2013, a flat year like 2014 or an even more difficult market environment in 2015, my goal is to squeeze as much out of our universe for you as possible.
Continue to Hold FAC, LIOX, STS
With the New Year knocking on our door, we still have several names on our Buy List in sight of scoring position. However, there are also a few positions that have yet to really breakout, so I wanted to use today’s issue to take some time to talk about each one in more detail.
First Acceptance Corp. (FAC) remains both volatile and thinly traded, which isn’t the most ideal situation when looking for a smooth exit. While we have had several chances to close this position at breakeven, or even a few percentage points in the black, the window to do so proved frustratingly fleeting at each time. However, I still expect FAC to shimmy back into positive territory. I’m watching our position closely and will be in touch right away when it is time to take action. But for now, continue to hold FAC.
Lionbridge Technologies (LIOX) has evolved into a much rosier story, as it is now delivering a bona fide breakout chart as it nears the end of its allotted time with us. This stock finally has the momentum behind it to give us a decent score in the next few weeks. With nothing in the foreseeable future that might indicate that recent action has peaked, I recommend continuing to hold LIOX as the current momentum runs its course.
Supreme Industries (STS) has fallen victim to low trading volume. While the position was briefly positive for us, the gains were too short-lived for us to get the smooth exit I was looking for. However, the price is now holding support above $7.13 and the longer-term trend still points toward the upside. As long as those conditions hold steady, there should be another opportunity for us to limit or losses or breakeven. Continue to hold STS.
Bracing for Volatility in the New Year
Rising small-cap volatility was a major factor for us this year, as the sound and fury in our trading universe ultimately signified very little upside for many stocks. With the Russell 2000 looking a little rich from a fundamental perspective – as well as technically top-heavy – we may see the asset class gyrate over the next few weeks. If so, there will be both winners and losers, so it’s increasingly important to remain nimble and ready to seize solid opportunities that present themselves.
Once fourth-quarter earnings season kicks off in the next few weeks, I believe our Breakout world will be on much firmer footing. Energy will most likely continue to be a drag on the broad market, but since the sector only accounts for a small slice of the small-cap pie – roughly 3%-5% depending on the day – our exposure to the largest of disappointments will remain minimal.
Beyond the oil patch, Breakout candidates may be winding down a fantastic quarter. Whenever Wall Street covers these companies (if at all), the targets often reflect expectations for enormous growth. In many industries – especially the healthcare and the recovering materials sectors – we could see some names surge in the next few months after reporting earnings that have improved 60%-70% over the past year. Relatively warm weather, cheaper fuel prices and what looks like a decent holiday retail season may boost the numbers even more.
In the meantime, plenty of the financial and utility stocks in our world still look cheap compared to their gigantic (and widely covered) counterparts. As a group, the materials producers are now signaling the kind of deeply-discounted value that drew me to the mining group a few months ago, and I’m looking forward to Wall Street finally catching up to the story there.
Foreign stocks, telecom companies – like Cincinnati Bell (CBB) – and even start-up IT ventures should also feed into the rich stream of prospects hitting my screens over the next few weeks. And average daily turnover on the smaller side of the market is already up 8% over last year’s levels. If this is our chance to outperform not only our benchmark, but the broad market as well, I say we seize the moment.
In fact, we were able to jump on an opportunity just yesterday with my recommendation to buy Arrowhead Research (ARWR). If you missed the Flash Alert, you can read it here. The stock has since popped above our buy limit, but still presents a solid opportunity if you can find it below $7.15.
For now, let’s say a warm farewell to 2014 and welcome 2015 with open arms. With the holidays coming to a close, I’ll be back in touch with our next Weekly Update on our regular day next week. And don’t forget that the market will be closed all day tomorrow for the New Year’s holiday!
I wish you a safe and happy New Year!
Sincerely,
Hilary Kramer
Editor, Breakout Stocks Under $10
P.S. Effective January 1, 2015, you will need a personalized user name and password to log in to the Breakout Stocks site. To create your own now, please click here.