Growth Stock Strategy: Buy Bullsh*t Downgrades
- Joshua M Brown
- February 28th, 2012
OK, since we’re back to trading and investing in growth stocks again, I’m dusting off an Old School strategy for opening and building growth stock positions in a portfolio. Rookies, don’t try this stuff at home without professional supervision or risk capital you’re not planning to eat with the next day – because growth stocks are volatile and their higher multiples require some degree of faith…
When stalking a growth stock awaiting better entries or looking for new growth stock ideas, one of the best things you can do is get a hold of Wall Street’s Upgrades and Downgrades each morning. TheStreet.com has a good one if I recall as do 24/7 Wall Street and Benzinga. Look for something a bit more in-depth that will give you a sentence or two synopsis of each analyst ratings change. Learn to spot the bullsh*t downgrades over time and start studying how the higher-growth stocks tend to react to them – both initially and over the intermediate term. Typically a fast-growing company will stumble on a specious analyst downgrade and then the accumulation will resume as the institutional fans of the story get over it and come back with buy orders.
What constitutes a bullsh*t downgrade? Anything that can be perceived as having a hidden agenda or that sounds like the analyst is just looking to be a bit more visible or justify his work. This happens all the time. So do bullsh*t upgrades when a big client of a brokerage firm needs someone to drum up enough buyers to make an exit from a particular stock. You can see it in the tape, little buyers cleaning up a big seller.
But I digress…
Some examples of Bullsh*t Downgrades:
1. Valuation – growth stocks don’t trade on “valuation”, they trade on sentiment and the expectation of future earnings, see the numerous valuation-based downgrades of lululemon and Whole Foods.
2. Dropping Coverage – believe it or not there are institutions who will actually sell on the news that a brokerage firm is dropping or suspending coverage in a name due to an analyst leaving or something.
3. Channel Checks – there is only one thing sell-side analysts suck more at than tackle football and that is “channel checking” – they literally cannot do it in such a way that there are actionable insights to be gleaned from it. Think about how many times you heard about strength in non-Apple tablets (there never really was any) or weakness in the iPhone 2 (also, never really happened). Channel checks are a money-loser in most cases – wait for the actual hard data, forget what people say they’ll do or think they’ll do.
4. Short-Term Pressures – chances are if you are interested in a growth stock investment, what happens tomorrow or the next day has little to do with anything. For example, I saw an analyst downgrade Buffalo Wild Wings, one of this moment’s greatest growth stories, because of a rise in chicken wing costs in early February. And while the analyst was correct in terms of those costs rising, it’s really a trivial, short-term matter to anyone who intends to invest in the business. $BWLD is being bought for the massive national footprint they’ll be building out for the next ten years, not a penny or two in wing costs. The stock is up like 20 points in the 3 weeks since that downgrade, btw – managers in the growth space simply have to own it.
5. Strategic Direction – some people are meant to run businesses and others are meant to analyze and critique them. When a company announces a new strategic direction or goal, the knee-jerk Wall Street response is to cut it to neutral due to “uncertainty”. I have no interest in seeing sell-side analysts vote on the strategic decisions of a company – management often knows more about their market than the eggheads do.
Anyway, these are just a handful, what are examples of the bullsh*t downgrades you’ve seen out there?
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The Reformed Broker is a blog about financial markets and the economy. Joshua Brown is a New York City-based investment advisor for high net worth individuals, charitable foundations, retirement plans and corporations... More.