Chapter 7 - Stocks Selected For Trading Profits

For most people the greatest success in stock investment comes through selection of sound securities and hanging on to them. The gift of knowing when the market is "too high" is a rare one, and probably as much money has been "lost" by selling a good security too soon as by buying poor securities in the first place.

Reviewing the past two chapters, those who buy primarily for income have no particular reason to sell so long as dividends are maintained or increased in the issues they hold. Income-minded buyers tend to hold stocks like American Tel. and Tel., General Electric, American Tobacco, Union Pacific, Con Edison, and General Motors through thick and thin without concerning themselves greatly about the height of the market, Equally, those who buy growth stocks do not, as a rule, trade in and out with them. They hold for some years until the growth potential originally predicted or hoped for has been achieved. Many investors like their growth stocks so well they never sell. Shares like IBM, Zenith, Connecticut General Life, Minnesota Mining, etc., have been so rewarding that long-term holders would consider it almost a heresy even to consider selling.

Who are the Traders?

There are at least three classes of people, however, whose market motivation is not the search for income or long-term growth but eagerness for trading profits.

These three classes would include: (1) the constitutional speculators, not necessarily gamblers, but people willing to "take a chance"; to take big risks in hope of great gain; (2) those who think or hope they can supplement their incomes by modest trading in and out of the market; and (3) people with very large incomes to whom fully taxable income is unattractive, but to whom long-term (over six months) market profits at only 25%, are most alluring.

In entering the market for trading purposes, tuning is all-important. In fact, most successful traders seem to have a special talent, something like that of a person who can play the piano beautifully without ever having taken a lesson. Such gifted individuals seem to possess a market crystal ball that tells them when to step in and buy and when to unload. For us ordinary folks, however, trading for rapid gains requires some sort of definite plan or technique.

Cyclical Stocks for Trading

The most traditional medium for short-run speculation has been in so-called "cyclical" stocks. These shares are found in those industries most sensitive to swings in the business cycle. They include the heavy industries such as steel, machine tools and heavy machinery, metals such as copper or lead, building supplies, railroads and railway equipment, motor cars and motor parts. In contrast with utilities and food chains which provide things people have to have in good or bad times, many cyclical companies serve the "capital goods" market the building of new factories, roads, bridges, new homes, apartments, or office buildings. These activities are traditionally strongest in periods of prosperity and at low ebb in times of recession. The trick, therefore, is to buy cyclical stocks in the early stages of a business upturn and sell them as closely as possible to the crest. All of which is not easy!

You have some guides to go by, however. Take copper. Its price is most volatile. In 1953, business was in an upturn, but copper had not got under way and was selling below 25¢ a pound rather low historically. The stage of the cycle was right and the price of copper was right. Had you bought Magma Copper common at its 1953 low, 21, you could have sold it with a handsome gain three years later at 139. Steel shares and machinery companies such as Caterpillar Tractor and Babcock and Wilcox were other examples of favorable cyclical "buys."

To succeed in trading cyclical stocks, you must follow business trends with great diligence. If you make your purchases at the cyclical height of business activity, you may lose instead of win.

A second road to success lies in watching the earnings of a particular company. When the earnings of a cyclical company have, in a business slack-off, dwindled by 50% to 75% from the preceding high of reported net, probably the shares of that company are in or near a buying range.

Unfortunately, there are no absolute rules to go by. Here is, however, a list of cyclical stocks that in the right phases have performed well in the past for market traders.

St. Joseph Lead
Libby-Owens-Ford Glass U.S. Gypsum 
Lone Star Cement 
Cerro de Pasco
Goodyear Tire 
Bethlehem Steel 
Anaconda 
Illinois Central
Blaw-Knox

Rejuvenated Companies

Another likely field for short-run (six months to three years) speculation is in revived or reviving companies. Here the thing to look for is a new management, a new product, a new technique for selling, advertising, or production. For example, Lorillard Tobacco was a quite unexciting company for many years. It tagged along after the leaders, Reynolds, American Tobacco, Liggett & Myers. In 1956, Lorillard common sold at 15⅛ The strengthening of top management and the dramatic introduction of a new mi-cronite filter changed the whole picture. Sales and earnings rocketed and Lorillard, which had been a tired stock, gained over 300% in two years.

Another classic example of this successful speculation in corporate rejuvenation is American Motors. While other American manufacturers paid little heed to the market penetration by small foreign cars, American Motors researched and introduced its Rambler. This was an outstanding success, and American Motors common shot up over 100% from a low of 8 in the spring of 1958.

So keep your eyes open for either reanimated old companies or lively newer ones with imaginative new products and merchandising methods. Companies such as Atlas Sewing Centers, Revlon, Holiday Inns, Diner's Club, Inc., come to mind. In all of these, old companies as well as new, the controlling factor over time is earning power. If net earnings are rising rapidly, stock prices tend to follow them up.

Profits and Perils in Glamor Stocks

It is not well enough understood that there are fashions in finance, just the same as there are fashions in women's apparel and motor cars. The dictates of fickle financial fashion create popular favorites speculative darlings in the markets. These glamorous issues, in their vogue, attract tens of thousands of investors, not necessarily because they are the best values, or most certain to produce the greatest long term gains; but because psychologically or emotionally they capture the imagination of speculative minds. These fashionable stocks are talked about and "tipped" in brokers' customer rooms all over the country, and the excited following they generate often leads to swift and fantastic price gains. But merely because a stock is in the height of fashion is no assurance that you will make money on it. It may indeed produce a tragic loss.

To illustrate, in 1930, Technicolor Corp. had a new process that seemed destined to revolutionize the movie industry, producing pictures in natural colors instead of the traditional black and white. The romance of this new process fascinated speculators and they bought Technicolor avidly. It sold as high as $85 a share in 1930, yet dropped dismally to $1 a share in less than two years when it was realized that the process was quite expensive and would take a long time in commercial development. In the years since, Technicolor never again sold anywhere near 85.

Radio Corporation common was a great favorite in 1929. It sold at 104 and has not sold that high in the 31 years since. Bank stocks were dreamboats in 1929, but many dropped 90% in the next three years. Railroads were also favored items in the twenties. In that decade dozens of rail stocks sold at prices never equaled since. A number of them were rubbed out altogether, or drastically compressed in the reorganizations of the next decade.

Motor car stocks, too, were exciting in the twenties, and great market profits were gleaned in the rise of Chrysler and General Motors. But there were dozens of others that didn't do as well Durant, Reo, Hupp, Pierce-Arrow, Marmon, Packard, Studebaker, to name but a few. For the relatively few who made fortunes in General Motors, there were thousands who, in due course, lost their shirts in some of the other 800 automobile companies that have come and gone in this century. The motor industry was, and is, one of the fabulous phenomena of our time, but just buying motor stocks was no sure road to wealth. You had to buy the right ones and there turned out to be very few of them.

In the era after World War II, oil stocks were in great vogue and sensational rises were recorded in them. Between 1946 and 1956, you could have made several hundred per cent on Standard of New Jersey. Amerada, Phillips, Texas Land Trust, etc. and had nothing but declines in them from 1957 to 1960. The bloom goes off every rose.

In the markets of 1959 to 1960, what went on? What were the dazzling leaders? Texas Instruments, Polaroid, Fairchild Camera, IBM, Brunswick, Loral, Nafi, Motorola, Thiocol. These are the issues people rushed to buy, paying in some cases 50 to 60 times earnings to become a stockholder. The romance of new technologies in cameras, missiles, electronics and new concepts of the profits from leisure these were the market propellants. Now some of these are great companies, and will be greater. But some may be stars already at or past their zeniths, in which future declines may be as dramatic as past gains. This statement is not said to warn you about, or disrecommend, any particular stock; it is merely made to emphasize that in these glamor stocks there are pitfalls, as well as profits. If you follow and buy such shares, with their heavy daily trading volume, remember you may be paying too high for them, and if the industry in question wanes or fades the glamor may turn to gloom.

It is very hard to ignore glamor stocks, however, particularly when romantic newcomers are ever entering the firmament. For example in 1957, Itek Corp. common sold (over-the-counter) below $5 and within three years reached $340 a share. Accoustica was publicly offered at $1 a share in 1954. It sold at $37 during 1960. Loral Electronics was publicly offered at $12 a share in the summer of 1959. It sold past $90 in 1960. All these represent imaginative entries into scientific technologies. But before you cry too much about such missed opportunities, ask yourself: "If I had bought Itek at $5 would I have held it to $340? Or would I have sold it at $20, delighted to get three times my grubstake in profit?"

Yes, there are profits, gaudy ones, in the right glamor stocks bought at the right time and sold before the fashion fades. There are also pitfalls those generated by back spins in the stocks themselves and those created by errors in your own market judgment. Most of us are pretty good at the errors!

Popular Favorite

Another successful trading technique is to move along with the popular stocks of the moment. There are always such: rails and air lines in 1946, television and pharmaceuticals in the early fifties, electronics in the late fifties, and leisure stocks boating, bowling, etc., most recently. Following the fashions in finance is almost as hazardous as following the fashions in clothing. If by using good logic you are convinced that a new industry, say pre-fab housing, is about to boom, then cautious selection of a likely stock in this industry may prove most rewarding. The trick is to buy early, and at the time when everyone is clamoring for shares in that industry, sell! Almost invariably a market darling at the height of its popularity will sell far above a sensible valuation. Apply logic when you enter and when you sell.

Special Situations

Another successful speculative gambit is in special situations. These cover a multitude of things possibility of merger, liquidation or partial sale of assets, spin-off of stock in a subsidiary or related company, sudden increase in value of an asset such as a patent, real estate holding, or mineral land. More than in any field of speculation, success in special situations depends on accurate information. If a stock is being accumulated for merger purposes and the merger falls through, you may have what the radio announcers call "that locked-in goodness." Incidentally, in mergers the shares of the company sought, rather than those of the buyer, are more likely to advance rapidly.

In all of these fields of speculation, keep in mind marketability. When you buy for an upswing, you will want an assembly of eager buyers waiting for you when you are ready to sell. Don't get trapped in thin, inactive markets. The big active issues will usually provide the best arena for your trading forays.

Resume

1. Make sure you want to "trade" and can view market swings, up or down, with aplomb.

2. Cyclical shares can be rewarding if bought early enough and sold soon enough.

3. Revived old companies have proven sensational gainers, so look for renovated management.

4. Special situations can create great gain but require accurate advance information.

5. Speculative trading should be confined to broad, active markets, not thin ones.

6. Buy and sell promptly. Don't quibble for the last "eighth."

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