Published: April 8, 2009

I was talking with a long-time subscriber last week--a professional money manager--when the topic of education came up. He told me, "The thing I've always liked about Cabot is you educate your readers. You don't just tell them what to buy and sell, you explain why."

Today, recognizing the value of that thought, I'm going back to basics, bringing you five rules for successful growth investing, complete with the all-important reasons why.

1. Use market timing to guide your investing. In bull markets, we say, "A rising tide floats all boats." In bear markets, we say, "It's hard to swim against the outgoing tide," ... as so many investors have learned over the past year. So learn to recognize the major trend of the market, and learn to respect the power of that trend. Today the market's big downtrend appears finished, and a new uptrend is trying to establish itself.

2. Do your very best to ignore the economic news. The fact is, the stock market is always looking six to nine months ahead, so today's news means nothing. Sure, it's fun to talk about the ongoing drama at A.I.G. and the U.S. Treasury Department, but it won't help you make money. In fact, if you're always focused on investing according to the hottest news, you'll find you're always one step behind the professionals. You're at a disadvantage. To succeed as an investor, you've got to find an area where you have an advantage, and that's on the road less traveled, namely younger, less well-known companies.

3. Invest in fast-growing companies. Fast growth can overcome a huge number of smaller deficiencies, like inexperienced management, competition, weak patent positions and more. And fast growth eventually attracts the attention of institutional investors, who are very useful in both providing downside support and in pushing prices higher as they buy their way in. Your best bets are in small companies growing at triple-digit rates--100% or better--through organic growth, not acquisition. One company that fits the bill today is Alexion Pharmaceuticals (ALXN), and another that nearly makes the grade (these are tough times) is Onyx Pharmaceuticals (ONXX). Interestingly, both companies are developing--and selling--drugs to treat cancer, and both, after years of losses, turned profitable in 2008.

4. Average up in your winners. As the song says, "Accentuate the positive." So when you've invested in a small, fast-growing company, and the market gives you a profit, don't take the profit. Wait for a normal pullback, and then buy some more.

5. Cut losses short. As the song says, "Eliminate the negative." If a stock you bought has declined, it has not done what you hired it to do. Thus, you should consider letting it go. Analyze the chart carefully, and tolerate no losses exceeding your own personal pre-set limits. Our absolute maximum loss limit is 20% in bull markets and 15% in bear markets, but we do our best to cut them even shorter. The very worst thing you can do is let a loss get bigger and bigger.

Perhaps the biggest rule of all, which has existed for centuries, is about diversification. "Never put all your eggs in one basket." Of course, everybody knows this, so I don't even include it my five top rules. But sometimes ... people forget.

Which brings me to Bernie Madoff, who now sits in jail while the SEC moves down the ladder of responsibility at his firm. For weeks, we've heard sob stories about his victims, most prominently those who invested their millions only with Bernie, and, in the great fall of the dominoes, found they had lost it all. So today I want to applaud Joe Nocera's column in The New York Times back on Saturday March 14, in which he argued that the SEC has no responsibility to reimburse Madoff's victims, especially those who lost "all their money."

"Isn't the first lesson of personal finance that you should never put all your money with one person or one fund? Even if you think your money manager is "God"? Diversification has many virtues; one of them is that you won't lose everything if one of your money managers turns out to be a crook. Every day in this country, people lose money due to financial fraud or negligence. Innocent investors who bought stock in Enron lost millions when that company turned out to be a fraud; nobody made them whole. Half a dozen Ponzi schemes have been discovered since Mr. Madoff was arrested in December. People lose it all because they start a company that turns out to be misguided, or because they do something that is risky, hoping to hit the jackpot. Taxpayers don't bail them out, and they shouldn't start now. Did the S.E.C. foul up? You bet. But that doesn't mean the investors themselves are off the hook. Investors blaming the S.E.C. for their decision to give every last penny to Bernie Madoff is like a child blaming his mother for letting him start a fight while she wasn't looking."

Moving on, the market has advanced considerably from the lows hit early last month. To me, the reason for the market's strength is unimportant (see Rule #2 above). To me, only the charts are important. Coming off a bottom that's brought the lowest consumer confidence numbers in history, this uptrend has the potential to be a big one ... precisely because no one expects it.

Let's face it; nobody is greedy today. People are worried about the safety of their banks! And to me that spells opportunity.

So, looking around at my growing Watch List, I find this company well worth writing about ... and perhaps investing in.

It's Allegiant Travel (ALGT), a budget airline focused like a laser on the price-sensitive vacationer headed for California, Las Vegas, Phoenix, Florida or South Carolina. Now, mention airlines to most investors today, and they'll say, "No thanks." Everyone knows the airlines are in rough shape. Demand has fallen off the cliff. All the big guys are cutting flights, mothballing planes in the desert, and offering rock-bottom fares to fill the seats in the planes still flying.

But that's exactly why now might be the best time to invest in an airline! So let's look at Allegiant.

Headquartered in Las Vegas, the airline was founded in 1997. It's grown revenues every year of this decade, and in the fourth quarter of 2008, when every major airline was crying its eyes out, Allegiant's revenues even grew 21% from the year before to $122 million. Perhaps more impressively, it even saw revenues grow from the third quarter to the fourth quarter!

Most impressively, its after-tax profit margin was a plump 14.9%!

So how does Allegiant do it? It flies from small cities to those vacation spots, so fees are lower at one end. Competition is lower too. It flies only MD80s, thus minimizing complexity. And it partners with hotels, vacation planners, car rental firms and vacation planners to offer low-cost package deals.

It's a classic growth story; the little upstart, with bare-bones overhead, coming in to steal business from the big old companies who simply have too much overhead and can't get their costs down to compete.

Also, the fact that the stock is young and little-known means it's much more sensitive to potential buying power than potential selling power. At last count, the stock was owned by only 57 mutual finds, while Southwest (LUV) was owned by 295 and Delta (DAL) was owned by 198.

The chart is the main reason the stock came to our attention in the first place, and here's what we see today. ALGT came public in late 2006 at 24, peaked at 39 in late 2007 and bottomed at 16 in July 2008, four months before the market crash. It then ran all the way up to 49 at the end of 2008, and since then it's been digesting that gain. Most recently, it's been building a base at 40, and if you like the story, you could nibble on a few shares here.

Yours in pursuit of wisdom and wealth,

--Timothy Lutts
Publisher
Cabot Wealth Advisory

Editor's Note: Just starting out investing? Not sure which style fits you best? Cabot Stock of the Month Editor Timothy Lutts finds the best Cabot stock across all sectors each and every month, so you get a sampling of what each of our publications is recommending. It may be a value stock, Green stock, growth stock, emerging markets stock or momentum stock, but it will always be the best for current market conditions. Cabot Stock of the Month gives you exposure to a broad array of sectors and investment styles. Click here to get started today.