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Author: Larry01Gott Big gold star, 5000 posts Old School Fool Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 3435  
Subject: Surprising protection against declines Date: 10/29/2003 1:21 AM
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My mission is small here.
All I want to do is change forever the factors and criteria you use to buy stocks, and I think I have some very surprising statistics to show you.

But first, some considerations, seemingly isolated:

1. Invest or Trade? Statistics taken over a number of years show that investors (mid-to-long term) who own stocks in a certain type of company – the subject of this post -- continually beat traders who are in the same stocks. For every trader who does well in the type of stocks that are the subject here, there are as many as three who don't.

2. Beta. For a more general discussion, see this post:
http://boards.fool.com/Message.asp?mid=19646747
But here, a specific discussion about upward Betas and downward Betas.

If you've noticed, a month ago or so I added Beta to my Report and Ratings. Further, I broke out the upward Beta and downward Beta. Have you noticed, for reasons that will become evident, the upward Beta is almost always the larger of the two – and often considerably larger? [if you don't know what I am talking about, go back and read the link above]

I'm looking at my sheet on SINA now. It shows an upward Beta of 4.58 (4.58 times the market movement upward), and a downward Beta of 2.20 (2.20 times the market movement downward).

I calculate all my own Betas, based on the last 6 cycles of over 10%.
So here is the way beta works conceptually:
When the market goes up 5%, Sina goes up (5% x 4.58) 23%. Then when the market goes down 5%, Sina goes down (5% x 2.20) 11%.

Up 23%, down 11%, up 23%, down 11%, and the market itself is right back to where it started, but Sina is up 20%. Why is that? The beta doesn't CAUSE Sina to be up 20% when the market stays level, but it MEASURES something that is happening.

Take another example: The market goes down 10%, and up 5%, and down 10%, and up 5%. I'll save you the trouble of reaching for your calculator: That market has just gone down 10.7%. (Like the Nasdaq for example, going from 1930 to 1723.)

But what has happened to Sina? The market goes down 10%, Sina goes down (10% x 2.20) 22%. The market goes up 5%, Sina goes up (5% x 4.58) 23%. The market goes down 10%, and Sina goes down 22%. The market goes up 5%, and Sina goes up 23%.

(If you are completely lost by now, raise your hands. Try reading through it again from the start – that may help. If not, take two aspirin, and post something in the morning.)

The end result is that the market has gone down 10.7%, but SINA has gone down only 9.2%. (starting price x .78, x 1.23, x .78, x 1.23) Not bad at all.

So, here is the question: What is the characteristic of SINA that makes it gain significantly when the market is even, and decline only about as much as the market when the market declines?

It is this: that SINA is a fast-growing company (defined as over 40% growth per year). All fast-growing companies have this BUILT IN protection against declines, and a BUILT IN inclination to soar when the market rises.

But on this post, the subject is protection in a decline. Just in case that Michael Belkin is right!

3. Does this work in the real world? It's all very nice THEORETICALLY, but does it actually WORK in a market decline?

One of the worst declines in history is the decline of the Nasdaq from 5100 in March 2000 to the low of 1108 in October 2002. Hardly any stock withstood THAT decline.

But lets take just the 56% drop from Dec 00-Jan 01 (2500) to October 2002 (1108) – MUCH worse than our Beta illustration of 10%.

(All the following prices are eye-ball approximations from their charts)
How did JCOM do when the market went from 2500 down to 1108?
JCOM went up from $5 to $10
And Lexar Media? It went up from $3 to $4.
And Martek Biosciences? From $14 up to $15.
And Marvell Technology? From $15 to $15.
And Omnivision? From $2.50 up to $7.00
And UTStarcom? From $12 to $12.

Do any of these stocks sound familiar? Yes, they are Fab 15 type stocks, fast-growers with growth rates well over 60%.

The point is this: (excuse me for shouting at you)
Fast-growing company's stocks have their own built in protection against market declines, due to the special upward pressure of the company growth, and therefore are good buy-and-hold candidates.

If the Nasdaq stays even for a year, Omnivision stock might go up 60-80% in price.
If the Nasdaq stays even for a year, JCOM stock should go up 40-45% in price.
If the Nasdaq stays even for a year, Sina could go up 100-150% in price, due to their internal company growth.

I expect this will bring up quite a bit of discussion – and that's good.
Hopefully, I've given somebody a new way of seeing the market, and seeing stocks.

Be good to each other out there,
Larry
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