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Swimming in the Rain


Swimming in the rain, and other un-crowded trades...

After a weekly Saturday morning basketball game I like to swim laps at my club. During the summer, however, the pool is often too crowded to get an open lane. This past weekend was a rainy one and inside was even more crowded thanks to cancelled golf and tennis matches. The pool was completely empty, of course, and I figured my day was done. Walking by, I didn't see the "Closed" sign on the outside door. Hmm. Just an oversight I reckoned, it was still pouring outside. They have a sophisticated weather sensor that picks up the threat of lightning even a half-hour away. In the past, I have been out there without a cloud in the sky, when the alarm goes off and the pool is closed instantly because it sensed something on its way. Today everyone knew it would be closed. But they were wrong.

I walked outside in the rain and sure enough, it was open, but I was the only one there to see it. This place is usually crawling with hundreds of people by now. I wondered, if there was no threat of lightning how bad could swimming in the rain really be? Mixing water into a swim was a risk I was willing to take. In Houston it's 95 degrees before lunch, so a few cool drops on my back felt pretty good. It was the best Saturday swim I had all summer.

I could not help but think about the stock market while sitting alone in the hot-tub afterwards. There was not a soul in sight over two acres which would be flooded with people in a few short hours when the rain let up. I think about the market every time I'm there but I've never been alone. I had just sliced up the S&P 1500 earlier that day as I do each week. This index combines the small 600, the mid 400 and the large and well-known 500, and it's the best benchmark for my firm to measure its performance against. Relative performance is for consultants and committees who believe in peer comparisons and endless meetings. I get paid to significantly outperform a risk-free rate of return regardless of which style or size of stock is in favor. I think finding those is our job, not an explanation. But everyone still crowds around the S&P 500 instead, and many do not even know about the S&P 1500. All it's done is outperform its more popular cousin over the past 2,5,10,15, and 20 year time periods.

Since August 1999, the S&P 500 has a total compounded return of exactly 0.0% as I write this. I remember that month well because my firm gave birth to our Jumbo Shrimp Indicator. My partner and I had consistently noticed the size of the cocktail shrimp at a research conference was inversely related to the remaining upside in that room's ideas. The trade was crowded when the buffet was longest.

One way to measure the shrimp without a plane ticket or wrinkled suits is to simply look at Wall Street's shrimpers and see how many analysts follow each stock and each sector. With help from our trusty database from my friends at Thomson Financial, I sliced the top 20 year-to-date performing stocks from the S&P 1500 (through the beginning of September) and found 125 analysts covering these stocks. At the very top of the list were five stocks: CPI (CPY), Chapparral (CHAP), OM Group (OMG), Atmel (ATML), and Cryolife (CRY). Each of these stocks are covered by four or fewer analysts. Each of them is a double or better this year, with 100%+ returns. Topping that group is CPY, up more than 150% so far this year, with a grand total of zero Wall Street analysts talking about it (all according to Thomson Financial). It seems that Sears photo booths, steel beams, specialty chemicals, integrated circuits, and human tissue treatments are not very interesting to our shrimpers right now. However, those are the five businesses, respectively, tied to the best performing stocks this year. The names and sectors change but we've noticed one common theme in our two decades of experience – that you do not want the loudest cheers nor the most deafening boos for your stocks, you want to start with silence instead. My firm is looking for under-owned stocks, and this is but one measurement we use to find them.

Compare those top performers to the 20 stocks inside the S&P 1500 whose year-to-date performance is closest to 0%. All are within decimal points of doing absolutely nothing this year and yet are followed by more than twice as many Wall Street analysts, a total of 275. Why? I believe that ideas can become too crowded and performance gets muted once positions are established. Investors often make the mistake of treating this as a company market, but it is called a stock market for a reason. It may sound counterintuitive but careful and exhaustive analysis is precisely what you may not want. Why? Because those groups are likely already long the stock! If you are looking for unique upside in a stock you need new buying pressure from new owners, not new research from existing holders.

I do not think it is a coincidence that the homes of top 5 are not crowded cities or near Wall Street. Our 100%+ club hails from, in order: St. Louis, Midlothian, Cleveland, San Jose, and Kennesaw. So un-crowded that I can spot you the cities and I'll bet you still don't know which states two of them are in! Those locations remind me why I need to swim in the rain more often - there are no crowds and plenty of upside. I headed back inside after the swim last Saturday just as the rain stopped. I wondered why dozens clustered around one door. Turns out it had just flooded inside, where the crowd was. As I've often said - there are no ironies.
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