Chasing Momentum: A Losing Game
Value investing often means being early. Going against the crowd is uncomfortable and tests your conviction. Momentum trading is exactly the opposite. You are buying stocks that everybody loves. Buyers hope to get in high to sell even higher.
Many columnists as well as the Wall Street Journal’s rival, the Investors’ Business Daily, scan the new highs list continuously looking for new names to buy. IBD thinks it’s great to chase new pinnacles. There can be “no overhead resistance” on prices high enough that they haven't had the chance to disappoint previous investors.
Paying more than anyone else ever, for exactly the same shares, gives these guys a thrill. Knowing this, it wasn’t all that surprising to see Caterpillar (NYSE:CAT) show up in my morning e-mail as Zacks ‘Bull of the Day’ (no pun intended… I think).
- Warning! GuruFocus has detected 7 Warning Signs with CAT. Click here to check it out.
- CAT 15-Year Financial Data
- The intrinsic value of CAT
- Peter Lynch Chart of CAT
CAT had closed the previous day just six-cents under its 52-week high. It was the best performing component of the DJIA year to date through July 16. I don’t know Zacks’ columnist Eric Dutram but, based on his photo, I doubt he’s been through a lot of market cycles.
Eric’s commentary would be funny if people weren’t likely to act on his advice. Here are some of his comments regarding today’s selection, verbatim (bolding: mine).
My comment: 2013 would have been a great time to buy Caterpillar. The stock spent most of last year between $80 - $86 per share.
My comment: CAT only trades for 20x is when earnings are cyclically depressed as they were during the Great Recession. Value Line notes CAT’s 10-year median multiple has been 13x. Buyers in early 2011, at 14.9x forward EPS, are still underwater today, more than three years later.
At Wednesday’s closing quote of $111.40 CAT commanded more than 18x this year’s up to date Zacks estimate of $6.16. A regression to a normalized P/E of 13 times the, perhaps optimistic, 2015 projection of $7.10 would only support a $92.30 target price 18-months out. Allow for a ZIRP- inflated 15 multiple and CAT’s goal price would still be only $106.50 by around Dec. 31, 2015.
Fight the urge to jump on a train that has already left the station. If you own CAT, it should be sold. If you were thinking about buying, wait for a much better entry point.
Disclosure: No position