• Breakout science has Wall Street buzzing.
• Yet a deeper analysis reveals an unusual anomaly.
• An early “rebalancing” is needed, ASAP.

PolarityTE Inc. (Nasdaq: COOL) ranks among the biggest gainers of the year.Shares are up a staggering 403%.

Yet despite such tremendous momentum, the company is still worth less than $100 million (in terms of market capitalization).

So does the fact that PolarityTE carries a valuation of a measly $67 million bode well for its future prospects?

I studied PolarityTE’s breakout science, and here’s what I discovered…

1. The science is showing promise regenerating skin in pigs.
2. Human trials could begin later this year, according to management.
3. If proven viable, the science would fill a void in the medical market, as burn and wound victims have limited options.
4. PolarityTE’s CFO just acquired 100,000 shares of stock.
5. With $3.8 million in cash reserves, the company’s operations aren’t in immediate danger.

So the stock is a screaming buy, right?

Wrong!

Believe it or not, PolarityTE’s primary source of revenue is from the sale of video games.

Yes — this is a video game developer trying to break into biotechnology.

Talk about an identity crisis!

If you’re a shareholder, please consider an early rebalancing strategy.

My senior analyst, Martin Hutchinson, gives you all of the details below.

Ahead of the tape,

Louis Basenese
Chief Investment Strategist

Question: Martin, you’re helping us compile the ultimate library of important investment catalysts. What I mean is baseline concepts that every investor should know.

Today we’ll be talking about the subtle intricacies of portfolio management. In one of our previous pieces we talked about asset allocation and diversification, but let’s unpack that a little bit more. We’ll cover some of the other subtle things folks can do to construct a proper portfolio.

Help us dive right in, Martin.

Martin Hutchinson: I think one of the most important things you can do is rebalance a portfolio every six months or every year. Because when a stock zooms up, it becomes a larger part of your portfolio, and that increases your risk.

A crash in something that’s, say, 15% of your portfolio, is damaging. That’s even more true if you’re heavy in the sector (like tech) and it’s outperformed. You can easily get it to represent 50% of your portfolio when you add all the tech together.

For most people, that’s an unacceptable level of risk.

Question: Let me stop you right there, Hutch.

Suppose I was able to beat the S&P 500 on a given year. Two of my stocks happened to be in the tech sector and they’re up big. So now I need to adjust for that when we get into the new year.

How would I do that?

Martin Hutchinson: The way you do that is every six months or so you look at the weightings in your portfolio compared with the weightings of sectors in the S&P 500. And you sell some winners and bolster up areas where you’re thin.

Question: Are there any historical data to support that? Because at first blush I’m thinking, well, I’ve got momentum on my side. I’ve got a winner here. It strikes me a little bit odd that I’d be selling that momentum stock and applying it toward some of the other parts of my portfolio.

What types of historical data do we have to support this?

Martin Hutchinson: The most interesting strategy that does this is one called Dogs of the Dow.

In that, you buy the five companies of the 30 in the Dow Jones index with the highest dividend yields. That strategy was invented in 1991, and back-tested to the 1920s. Yippee, it outperformed the Dow, which looks very attractive. Except since 1991, it’s only matched the Dow. Because it has the usual problem with investment strategies. Once people start using them, they stop working.

The same thing happened with David Dreman’s Contrarian Investment Strategies, which said you should buy everything that’s unfashionable. It was a beautiful idea when he wrote it, a very convincing book.

The only trouble is everybody started buying things that were unfashionable, so they stopped being unfashionable.

Question: So the Dogs of the Dow theory told us basically to take the best components of the Dow, sell them and apply them back toward the least performing parts of the Dow, and that worked for a while.

Where are we now?

Martin Hutchinson: One variance on that would be we could buy the Dow companies that have performed worst over the past six or 12 months.

But the problem is sometimes stocks are undervalued for a reason, and the markets are often slow to catch up with secular changes, ones that are changing over the long term.

For example, today I would currently be underweight on brick-and-mortar retail. There’s a negative trend that’s clear and big, which is that the internet is eating its lunch.

And the market’s reacting only slowly.

The same was true of small oil companies late in 2014 when oil price began to drop from $100 to $50.

The small oil companies only went down fairly slowly. A lot of them, of course, ended up going bust once they ran out of cash, so it certainly was not a good idea to rebalance into those small oil companies just before they went bankrupt.

So it’s a very tricky strategy overall.

Question: I see what you’re saying, so if we rigidly accept the Dogs of the Dow and implemented it, we may be buying into a retail company on its way out, and putting a lot of our funds toward that.

How do we protect against making such a mistake?

Martin Hutchinson: I think rebalancing is a useful technique, but you have to not be mechanical about it. Because bad sector performance can persist.

In other words, when you rebalance at the end of each year, it’s not a question of automatically selling all your good companies and buying some rubbish.

It’s a question of saying, “Well, OK, this retail sector is now only 1% of my portfolio, but do I really want it to be 5% of the portfolio? (Where it should be, according to the S&P.) Or is 1% actually about where I think it should be at the moment because I don’t like retail?”

But at least if you look at rebalancing at the beginning of each year, it will make you think about whether you’ve got too much of some things and too little of another. And that’s a very useful technique.

It’s just that you shouldn’t do it mechanically.

Question: It sounds like there’s always some room for some good old-fashioned common sense.

If you’re overweight in a certain stock or sector, before you just plow it back into the least performing asset, maybe look under the hood a little bit, is that fair?

Martin Hutchinson: I think that’s absolutely right, yes.

You need to look, you need to analyze. But your thought is more important than just a mechanical strategy.

Question: Before we let you go, Hutch, it’s interesting to note that retail has historically been a sector that has gotten an allocation in any portfolio. But might that be on its way out as part of a conventional properly constructed portfolio?

Is the slice of the retail pie going to eventually disappear?

Martin Hutchinson: Some of the retail pie is just going to tech.

I mean, what’s Amazon? Is it a retailer or a tech company? It’s a bit of both because it’s got its cloud business. But some of your retail portfolio should be online these days, and you’ll probably find the online bits in the tech sector.

I don’t believe that people will stop buying goods by some distribution mechanism. I mean, it can’t happen. You can’t have an economy without people buying stuff. But the brick-and-mortar retail at any rate will diminish, although I don’t think it will disappear altogether.

I think there are some companies in the tech sector retail, internet retail, that are assuming that the world’s going to come to them, and that may be wrong. So it may be dogs on both sides of the Dow, if you like.

Question: Before I let you go, Hutch, are there any other dog sectors that you would be wary of plowing money back into aside from retail. Or is retail the only one that we should be really careful about overweighting right now?

Martin Hutchinson: I think retail’s the only sector within the U.S. that you clearly want to think about undervaluing. But the U.S. market as a whole is very highly valued at the moment. So you may want to look at reducing your investments in that, compared with international stocks, which look less highly valued.

Question: Thanks for your time today, Hutch.

Martin Hutchinson: Great to be with you.

Question: This is Wall Street Daily signing off.