Buying Environment Decent, Not Great
Last week
(Wednesday through Wednesday)
brought us some more upside breakouts in stocks almost meeting our criteria,
along with no downside breakouts in downfuel stocks. Top RS/EPS New Highs list did not continue to consistently
show more than 20 issues. What is
consistent is that our Bottom RS/EPS New Lows list is pathetically small.
decent for the buy-side (though far from great), and pretty poor for the
sell-side, for those utilizing our strategy and methodology.
Once again last week we got a
handful of stocks that almost met all our criteria for both upfuel and a valid
breakout of a flag or cup-and-handle.Â
We’ll take a look at these in a second.Â
First though, some of you have asked
more questions about the criteria for our upfuel and downfuel stocks.
advised to read my 10-week
course (available to one- and two-year TradingMarkets.com members), my book Hedge Fund Edge, and my course Science of
Trading (both available through M. Gordon Publishing via this site).
It appears to me that many questions have
come from people who have not even bothered to read my 10-week course. You will definitely not be able to understand what I’m doing without at
least thoroughly studying this course. However, let’s
briefly review some of the upfuel criteria I use to pick stocks.Â
First, we determine whether the
stock is a “Consistent Grower” or a “Turnaround
Stock.” A “Consistent Grower” is a
stock that:Â Â
1)
earnings higher than earnings of the prior year, or has the last two years’
annual earnings higher than earnings of the prior year, plus estimates for the
coming year that are higher than last year’s;Â Â
2)Â has a long-term growth rate
of 25% or more;Â Â
3)
or more from last year’s same quarter;Â Â
4) has earnings momentum — earnings momentum exists when either this
quarter’s earnings are higher than last quarter’s, or this quarter’s earnings
growth rate is higher than last quarter’s earnings growth rate.
Once we determine that a stock is a “Consistent Grower,” we then compare the PE of the stock to the lowest of:
a)Â
the long-term growth rate; orÂ
b) the lowest growth rate of the last two
quarter’s earnings. Â
The PE should be
70% or less of the lowest of the above three growth rates in “Consistent Grower”
stocks.Â
| “The trend of the market is not yet fully clear… I continue to be happy with the allocation indicated by our strategy. So far, it’s doing a great job … Let’s stick with it, and see if the market can prove this rally better with higher-quality breakouts.” |
People
often ask us why we use
this valuation constraint. Doesn’t it
keep us out of some high-flyers? The
answer is yes. It does keep us out of some of the more speculative high
flyers. But our research shows that it
also reduces our drawdowns significantly, and it doesn’t reduce our upside as
much as you would imagine. Stocks with
PEs in excess of any growth rate of earnings they’re showing tend to get hit
much harder in market declines than stocks that are relatively undervalued when
compared to their growth rates. In
addition, a stock that is relatively underpriced when compared to its growth
rate, is usually undiscovered and most often shows gains in price from a
rapidly expanding multiple as well as from earnings growth.
higher than any growth rates they’re showing are often meteors — they’ll soar
in the short-term but have to come crashing down to earth when reality
hits. These are speculations, not
investments. This means they’re not as
safe to build successful pyramids in.Â
A turnaround stock has each of the
last two quarter’s earnings growth rates above 70% and earnings momentum (see
above). In the case of a turnaround
stock (like Keithley Instruments
(
KEI |
Quote |
Chart |
News |
PowerRating) and Elantec Semiconductor
(
ELNT |
Quote |
Chart |
News |
PowerRating)) you compare the PE to the lowest of the last two
quarter’s growth rates and be sure that the PE is not more than 70% of the
lowest of these two figures.
Remember also, that debt should be at
30% or lower (unless the whole industry is heavily indebted).
35% or below (and ideally at 15 or less and rising institutional
sponsorship). The stock should have
both EPS and RS ranks at 85 or higher.Â
And the pattern should be a valid cup-and-handle or flag pattern of more
than four weeks, with the breakout occurring on volume 40% above average, and
preferably on a TBBLBG.
Let’s now look at some close
ones
last week that didn’t quite cut it on the long side.
T. Rowe Price & Associates
(
TROW |
Quote |
Chart |
News |
PowerRating) was in
Alliance Cap. Mgmt.
(
AC |
Quote |
Chart |
News |
PowerRating)‘s group, but
its RS was too
low on breakout, its handle was in the middle of the cup-and-handle, and the
volume was marginal on the breakout.
Quanta
Svcs
(
PWR |
Quote |
Chart |
News |
PowerRating) met all our upfuel criteria as a
turnaround but had no handle.
Green
Mountain Coffee
(
GMCR |
Quote |
Chart |
News |
PowerRating) had debt too high, no real handle,
and no earnings momentum.
Technitrol
(
TNL |
Quote |
Chart |
News |
PowerRating) met all our upfuel criteria, but its cup-and-handle was just a tad too short, in terms of time.
cup-and-handle pattern. In fact, if this
had been a flag, we would have taken it, because it barely had 20 days in
the pattern.
AmeriCredit
(
ACF |
Quote |
Chart |
News |
PowerRating) had debt levels too high, as did Gildan Activewear
(
GIL |
Quote |
Chart |
News |
PowerRating).
Tollgrade
Communications
(
TLGD |
Quote |
Chart |
News |
PowerRating) met our turnaround criteria.
However the handle on TLGD was more than 30% and broke far into the
bottom half of its range.
It should also be noted that we got
two close-calls on the short side. Loral Space
& Communications
(
LOR |
Quote |
Chart |
News |
PowerRating) met our downfuel criteria, but broke down on pathetic volume and no TBBLBG.
(
HRB |
Quote |
Chart |
News |
PowerRating) didn’t have a viable pattern.
For next week we will continue to
advise investors to only take two new positions on the long or short side — and
continue to be selective, as we detailed last week.
How did you do?
that’s okay. Most of these stocks will do
well if the rally continues. But take a
look at why we didn’t buy it and make sure you understand our criteria better.
Our overall allocation remains
low. We are now around 48% long
(including open profits) and 14% short for aggressive accounts using leverage
(24% long and 7% short for unleveraged, more conservative accounts).
15.5% (and with 48% allocation this added 7.45% to our overall portfolio on the
week), while our shorts rose an average of 1.5% (and with 14% allocation this
subtracted 0.2% from our overall portfolio), giving our overall portfolio a
gain of about 7.25% on the week, and leaving us with around a 64% gain on the year
on a 12% maximum drawdown so far.Â
Conservative investors not using leverage show about half these gains
and drawdowns.
For those not familiar with our
long/short strategies, we suggest you review my 10-week trading course on
TradingMarkets.com. Basically, we have
rigorous criteria for potential long stocks that we call “up fuel,”
as well as rigorous criteria for potential short stocks that we call “down
fuel.” Each day, we review the list
of new highs on our “Top RS and EPS New High list” published on TradingMarkets.com
for breakouts of four-week or longer flags, or of valid cup-and-handles of more
than four weeks. Buy trades are taken only
on valid breakouts of stocks that also meet our up-fuel criteria.
meeting our down-fuel criteria that have valid breakdowns of four+week flags or
cup-and-handles on the downside. Â
We
continue to buy new signals and sell short new short signals until our
portfolio is 100% long and 100% short (less aggressive investors could stop at
50% long and 50% short). In early March
we took half profits on nearly all positions and lightened up considerably as a
sea-change in the new economy/old economy theme appeared to be upon us.
masse until the trend has already started, they make up for lost time because
the stocks that breakout move much more swiftly than the rest of the market.
That’s why our long positions have outperformed so strongly on the upside and
our short positions have outperformed so strongly on the downside as well this
year.
Upside breakouts meeting fuel
criteria (and still open positions) so far this year are:
(
KP |
Quote |
Chart |
News |
PowerRating) (@13.38 level) w/ 15 ops;
PC Connection
(
PCCC |
Quote |
Chart |
News |
PowerRating)
(@26.46) w/ 39 ops;Â Alliance Cap. Mgmt.
(
AC |
Quote |
Chart |
News |
PowerRating)
(@44) w/
44.5 ops;Â Keithley Instruments
(
KEI |
Quote |
Chart |
News |
PowerRating)
@37 — now use 42
ops on half position and 58 ops on half position as KEI had a volume climax
today; and Elantec Semiconductor
(
ELNT |
Quote |
Chart |
News |
PowerRating)
@50.25 w/ 40
ops; and this last week we had no valid pattern breakouts up in stocks meeting
our up-fuel criteria (see 10 week trading course):The average gain in these stocks from breakout points of
entry to Wednesday’s close is 53%, substantially outperforming the NASDAQ, DOW,
and S&P for the year to date. Continue to watch our NH list and buy flags or cup-and-handle breakouts
in NH’s meeting our up fuel criteria.Â
On the downside, this year we’ve had
breakdowns from flags (one can use a down cup-and-handle here as well) in
stocks meeting our down fuel criteria (and still open positions) in:
(
CKR |
Quote |
Chart |
News |
PowerRating)Â (@5.5) w/ 3.5 ops;
(
RTHM |
Quote |
Chart |
News |
PowerRating) (@16.56) w/ a 21 ops;
breakdowns in downfuel stocks. These
shorts are down over 12% from breakdown levels on average so far this year
(before current prices or exits). Continue to watch our NL list daily and to short any stock meeting our
down fuel criteria (see 10 week trading course), breaking down out of a downward
flag or down cup-and-handle. Â
The trend of the market is not yet
fully clear, although things are looking better for buy-side stocks.
stocks, some breakouts in stocks close to our criteria, and lukewarm breadth
so far. Aggressive traders could
increase long exposure a little beyond our model-portfolio level, but not much.
You can do this by buying stocks that meet almost all our criteria and have the best technical criteria in their breakouts
and are in top groups. However, I
continue to be happy with the allocation indicated by a religious application
of our strategy. So far, it’s doing a
great job of telling us what to do — when,
and with how much allocation. Let’s
stick with it, and see if the market can prove this rally better with higher-quality breakouts.