While many investors don’t consider a stock without looking at its price/earnings ratio or some other valuation metric, Michael Cintolo of the top-performing Cabot Market Letter says he doesn’t look at valuation.
“The stock market is a contrary creature; when dealing with growth stocks, you generally get what you pay for,” Cintolo writes in a piece for Nasdaq.com. “It turns out that things like P/E ratios are not great predictors of future growth stock performance. In fact, the vital truth is that many investors are confusing the cart with the horse: Valuation is often the RESULT of great performance, not the CAUSE of it.”
Cintolo explains that during bull markets, thousands of mutual, hedge, and pension funds have to own stocks, and they will focus on “the real leaders that have the best products, the fastest sales and earnings growth and the surest prospects to continue growing rapidly for many years.” As funds load up on those stocks, their valuations balloon, he says. “What causes the buying demand in the first place is the growth, the unique products and the enticing prospects for the future.”
Cintolo stresses that he’s talking about true leaders — stocks like Apple, Netflix, and Lululemon have been in recent years. And he says timing is critical in terms of knowing when the bull market is fading and the big fund investors are bailing.
As for current market conditions, Cintolo likes what he sees. “The market actually bottomed back in early June, but anyone who tried buying strength for the six or seven weeks following that low was burned,” he says. “In my mind, what really transpired was a prolonged bottoming process, where the indexes chopped around (there were an incredible nine swings, both up and down, of at least 4% in the Nasdaq from that June low until the end of July!!) as money very slowly rotated from defensive stocks (tobacco, big telecom) into more traditional growth areas (chips, networking, software, retail, etc.).” He says he’s not “super-bullish”, but he’s not “souring on the market — if anything, the advance has picked up a little steam as the sellers have run out of ammunition.”