Using Technicals
And Fundamentals To Find Emerging Leaders
By Daniel P. Delaney
TradingMarkets.com
Â
One of the
more difficult aspects of trading is the ability to spot
the up-and-coming market leaders that will likely become the next
“must own” group of highflyers. How many times have you heard
someone excitedly tell you that a particular stock is the next
Cisco, Intel or Microsoft? Given the speed with which technology
companies appear today, the desire is to find the next America
Online (AOL),
JDS Uniphase (JDSU)
or Juniper Networks (JNPR).
All too often, that “sure thing” turns out not to be such a gem
after all. Spotting the next market monster is tough, especially if
you are trying to find it before everyone else has discovered it.
Usually, by the time the general
market consensus becomes clear, a highflyer is probably already
over-owned by every momentum player, hedge fund manager, mutual fund
and even your daytrading neighbor. As so often occurs, just when
these high flyers start to get mentioned in all the major financial
press and websites, they are usually over-extended, over-hyped,
over-owned, and ready for a steep decline. In other words, if you
are buying on the market buzz over a stock, you are probably too
late to the game for that particular stock.
The goal of this lesson, then, is to
get you thinking about how some of the new tech leaders emerge and
how you can go about trying to discover the next round of new
technology winners.
Searching For
Leaders
So what is the best way to spot the
up-and-coming winners? Traders have many different styles for
spotting the next round of leaders. Some focus specifically on
charts and search for stocks that hold up the best as the broader
market turns downward, with the assumption that the strongest
performers that refuse to cave in will ultimately lead the next
market upswing.
Others look for stocks under
accumulation by the larger money managers and hedge funds. Following
promising chart patterns and tracking price and volume movements
help tip a trader off as to when a potential new star is being born.
Obviously, a stock breaking out of a longer-term base on surging
volume is under accumulation by those managers and institutions that
have the highly-paid research departments endlessly searching and
predicting the next round of winners. For this reason, hopping on
the train in front of the big players can sometimes lead to a
profitable trade.
Searching Beyond
Charts
Many successful momentum traders will
enter a position knowing only the stock’s pattern setup, relative
strength, and its stock symbol. While many traders are perfectly
comfortable at using only charts to find the up-and-comers, other
traders may want to know if there are ways to find fundamental
aspects of a stock that they can use to give them an extra edge in
finding any up-and-coming highflyers. What follows are several ideas
of how to combine fundamental company data that might help give your
trading decision an extra edge.
Obviously, if you are looking for new
high-growth companies, the best place to look is in the technology
arena. That is where the most rapidly growing companies tend to
emerge from, and what also makes them so interesting is that the big
Wall Street firms are often not covering some of the newest emerging
technology groups. A perfect example of this took place in the early
days of the Internet explosion. In early 1996, America Online (AOL)
was demonized by many of the big Wall Street firms who felt AOL used
questionable accounting practices. Within two years, AOL had grown
twenty-fold, and nearly every Wall Street firm was touting AOL with
strong buy ratings. The chart below shows the split-adjusted price
of AOL back in 1996 and 1997.
A similar scenario to that of AOL
played out with Amazon (AMZN),
which also faced harsh criticism from analysts before the big firms
realized the millions they could make in embracing the early
Internet leaders and taking public the multitudes that would follow.
Amazon became the leading e-tailer, and with that leadership came
big moves in price. Sure, it eventually had problems in 2000, but
the percentage increases as it emerged were spectacular.
As for AOL, just look below what AOL
went on to do once the mainstream analysts and investors finally
realized that AOL would become a profitable media powerhouse. So in
this case, it would have paid to be researching the fundamentals and
technology behind AOL. It became one of the top leaders in the
Internet sector, and its biggest moves came long before Wall Street
had noticed it.
Beware: New
Sectors Can Crash
I use the AOL and Amazon charts as
examples because as 1999 and early 2000 showed, traders, investors
and Wall Street took the New Economy mantra to wildly excessive
extremes. One by one, the hot new Internet sub-sectors emerged. In
the end, they nearly all had crashed, but they were definitely worth
watching and trading as they ran.Â
Among the sectors that lit up the sky
during the late 1990s were portals, e-tailers, incubators, Internet
software, B2B (business to business), global Internets, wireless,
and Internet infrastructure plays. The infrastructure plays quickly
broke into their own sub-groups like broadband chip makers,
networkers, optical networkers, optical component makers, and even
wireless Internet platform makers.
By late 2000, however, many of the
“New New Things” had crashed, along with most of the traditional
technology and telecom leaders on the Nasdaq. So the lesson from
that wild run-up was that if you could find the leaders before
everyone knew they were leaders, then there were some extremely
profitable trades to be had. Will this ” Wild West” of the
investment world ever rise again? Who knows, but at least it’s worth
learning about what to look for in these companies, from a
fundamental standpoint.
New Leaders Often
Lack Track Records
Since many of these companies ramp up
and go public in just a few short years, there is rarely much of a
long-term track record of revenues, earnings, or price and volume
chart action. What, then, are the best fundamental aspects to look
for when you are trying to spot new leaders? Obviously, with
established companies, earnings growth rates are the key, and
ideally these rates should be in the 30% per year or more range.Â
It’s tougher to find winners in the
new sector groups like B2Bs or optical companies that seemingly
appear out of thin air because they don’t really fit into
conventional valuation models. Sometimes they might not even have
earnings yet. In fact, this is why so many of the large Wall Street
firms were so late to the Internet-related stock explosion that
occurred. Wall Street is far more comfortable with traditional
valuation models, and for that reason, they remain hesitant to start
following what are essentially concept stocks. For this reason, the
big institutions are sometimes late to the emerging tech sector.
So if new emerging leaders lack Wall
Street-analyst coverage and have recently gone public and lack a
longer-term chart history, you might ask what other ways are there
to find these future leaders?
Becoming Your Own
Research Department
I think the best way to find the new
tech leaders is to read everything. That sounds simple, but if you
really research and learn about enough new companies, you will
likely see the trends and leaders emerge. There are many new
technology and financially-oriented magazines and Websites that
track the up-and-comers. Since I personally enjoy reading and
learning about the wide variety of new technology products and
services that continually enter the marketplace, it doesn’t really
feel like work.
Your goal in doing all of this
reading is, in a sense, to become your own research department. It
does take time, but you would be amazed how quickly you will pick up
the lingo and jargon regarding technology companies. As you learn
about a new emerging sector, you will notice that certain names keep
popping up. By keeping a list of categories and adding new emerging
names, you will get a feel for who the winners might be. Once you
have potential winners, then keep watching them from a technical
standpoint, and also continue to research them through some
unconventional techniques.
Unconventional
Research
Thanks to the Internet, you have
access to more company information than most Wall Street analysts
had just ten years ago. Instantly, you can access earnings reports,
Edgar filings, insider selling, company profiles, management
profiles, market capitalization, lists of a company’s competitors or
customers, press releases, analyst’ opinions, and company financial
statements. Sometimes you can even learn a great deal by just going
directly to a company’s Website!
When I find an interesting company
that looks like it might be an emerging leader, I will pull up a
company profile, which is available on nearly every financial portal
or Website on the Internet. Some of the areas I like to check even
include such minute details as a company’s address, who their
Venture Capital firm was, who is on their board of directors, and
what educational backgrounds their management might have. So you
might ask, what does this have to do with trading?
Well, say for example that I have a
name from one of my sector emerging leader lists and its stock is
beginning to look great from a technical standpoint. Say it has
risen to the higher left side of a healthy-looking base pattern. By
having researched the company thoroughly, I have extra confidence
that the trade will not only work in my favor, but also might be the
start of a large, longer-term move.
A Dream Example
When they asked bank robber Willie
Sutton why he robbed banks, he said because that was where the money
was. The same principle can apply to your emerging-tech research.
What I love to see in a company profile is a company address right
in the center of Silicon Valley, Calif. Menlo Park, Sunnyvale,
Redwood City, or Mountain View are great to see. Then, I like to see
that the company founders are engineering types from MIT, Cal Tech
or Stanford. There are also high-caliber tech people from
universities worldwide, especially from top programming havens like
India or Sweden. Also good to see is that the company’s board of
directors includes the Chairman of Cisco or the Dean of Wharton
Business School.
For this dream example, the company
might have been partially funded by Sun Microsystems or Microsoft
and then backed by a Venture Capital firm like Kleiner Perkins or
Sequoia Capital. To top it off, say the company supplies software or
a specific product that is going to be used as a standard for
wireless Internet access and so on. Obviously, leaders tend to beget
leaders, so I think you get the picture, but the main point is that
this kind of fundamental research can at least move the odds more in
your favor for a trade. And it’s got to be much smarter than getting
a tip from a friend or an Internet chat board!
JDS Uniphase
Example
For instance, I learned about JDS
Uniphase by reading a technology journal in early 1998 when the
company was just called Uniphase. They were a leader in “wave
division multiplexing,” which is the splitting up of light waves so
that they can carry data faster and more efficiently on the
Internet. This would supposedly help solve the Internet speed or
bandwidth problem, and by tracking the stock, you would have seen
the emergence of one of the new tech darlings. The company had
several of the “dream” criteria I described above, so it was
definitely worth watching.
Uniphase began trading as JDS
Uniphase in July 1999, and as the chart below shows, JDSU soared
more than 700% above the July 1999 price that you see above (The
chart below is adjusted for splits).
By late 1999, JDS Uniphase was one of
the most widely held stocks in hedge funds and mutual funds. Yes, it
peaked with the rest of the Nasdaq in March 2000 and sold off, but
it still maintained solid gains above the mid-1999 levels.
By researching JDSU early enough and
developing an understanding about the sector (optical networking),
you would have had all the more confidence in the stock as you saw
the stellar chart pattern unfold in late 1998 and 1999. Thus, by
blending your tech research with technical analysis, you can
increase your odds of finding one of the up-and-coming tech
monsters.
Closing Remarks
While trying to find the next round
of emerging leaders might take a lot of reading and research, it
really does keep you up-to-date on the rapidly changing technology
sector. Since some of these newer technologies have no track record,
it would almost make more sense for an engineer or software
programmer to find the emerging leaders. But as a trader, just
applying some of these basic fundamental principles and tracking
your leaders list, you can likely get a trading edge that will help
you make smarter decisions.
