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This rally's 3 standout strategies
Even in a market that's up across the board, these approaches seem to have generated the best performance so far.
By Michael Brush
In a market that's up well over 20% since March, its been hard not to own stocks that pay off. But some market strategies, of course, are paying off better than others. To find the standout strategies, I reviewed my columns for the past six months to see what has worked the best.
Three market approaches stand out, producing gains over just a few months of anywhere from 30% to 200%. They are:
Value investing with a momentum twist.
The mimicking of insiders who are buying shares in their own companies.
Buying stocks of small-cap companies that are getting the best increases in their earning estimates.
What stocks win favor using these themes?
For the value-investing camp:The follow-the-insiders approach bubbles up these names: And three small-cap companies getting excellent upward estimate revisions are:Here is a closer look at what stocks may benefit from these home-run themes now.
Value investing: no longer like watching paint dry
When I finished a business-school program and began writing for The New York Times in the mid-1990s, I met a value investor in New York named Alan Kahn, who was a good source on a couple of successful value plays. Id check in regularly for new ideas, but hed usually say: I have nothing of interest to a financial journalist, because being a value investor is like watching paint dry.
Over the past six months, value investor John Buckingham, manager of the Al Frank Fund (VALUX), has proved this view wrong, showing that value investing can offer the kind of fireworks usually reserved for hot momentum plays. To be sure, Buckingham cautions readers of his Prudent Speculator newsletter (up 65% year to date) that they need to buy value stocks for a holding period of several years. But many of the stocks that he and I have singled out together have exploded in a far shorter time frame.
Stocks that have worked the best among Buckinghams picks are what I will call handoff stocks -- meaning they've been "handed" off from value investors to momentum investors. These are still fairly cheap stocks. After all, theyre held by value investors like Buckingham. But theyre starting to get upward earnings estimate revisions, which attracts the hot money of momentum players. (Far more typically, the earnings estimates of value stocks look brutal because of some recent disaster.)
The footwear company Deckers Outdoor (DECK, news, msgs), from my July 30 column, Outdoor chic is investing's latest fashion, is a great example of the kind of gains a handoff stock can bring. It traded at around $8 in the days after that column came out. But it jumped 75% to trade above $14 within two months as the story of its brand expansion caught on and estimates kept going up.
Trident, which designs chips used in liquid-crystal-display televisions, is another good example. It traded for under $19 around mid-October, right after a column of mine about flat-panel TV plays came out. Recently the stock went for over $22, a 15% gain in just two weeks, while the overall market has been sloppy. Given the long-term trends in flat-panel-TV sales, Trident probably has much more to go.
What handoff stocks does Buckingham have now? I checked the estimate revisions on stocks hes recommending to readers and came up with this short list. (A caveat: Buckingham may be trimming positions in some of these.)
First, despite the powerful run in chip companies of late, at least two are still cheap enough for Buckingham. Yet Advanced Micro Devices and Cypress are getting very strong upward earnings estimate revisions and thus attracting the momentum crowd. AMD has a hit with its new Athlon 64 processor, the first 64-bit PC processor thats compatible with the Microsoft Windows operating system. The company also sells flash memory used in cell phones. The company has a price-to-sales ratio of 1.6, compared with 7 for rival Intel (INTC, news, msgs). Sales of chips and timing devices from Cypress are strong, thanks to brisk demand for digital cameras, game consoles and personal computers.
Another handoff stock is Aspect Communications (ASPT, news, msgs), which sets up corporate call centers that integrate traditional phone systems with Internet-based communications such as Voice over Internet Protocol and e-mail, and wireless systems.
Elsewhere in the value camp, a group of king cash stocks was hot. Put together for an April 30 column, 15 stocks you can buy for 'free', the group advanced 31% by mid-June and was up 68% last week. These days, there arent many companies whose stocks trade at or below their level of cash per share, the definition of a king cash stock. But there are a few that Buckingham likes because they have lots of dough on the balance sheet.
They include:
- Traffix (TRFX, news, msgs), an online database marketing company which has $3 in cash and recently traded for $4.45.
- Aether Systems, which has around $4 per share in net cash or short-term investments and trades for about $4.70.
- Avici Systems (AVCI, news, msgs), which has about $4.80 in net cash and trades for around $6.
- Tellabs (TLAB, news, msgs), which has about $2.57 and trades for about $7.10 per share.
These companies all face challenges, like most value plays. Aether Systems sells wireless and mobile communications systems to businesses -- which still arent in a spending mood. Avici and Tellabs sell telecom equipment, a sector thats still in the doldrums. But Buckingham bets that with their high cash levels, these companies have the strength to stay in the game until business turns around.
Insiders lead the way
My June 4 column -- 10 stocks the insiders are still buying -- discussed the strong insider buying activity at companies such as Intervoice (INTV, news, msgs), Cerner (CERN, news, msgs) and Providian Financial (PVN, news, msgs). These stocks are up anywhere from 29% to 180% since then. This makes sense, because insiders, including top managers and board members, have the best seats in the house for close-up viewing of business trends.
So what are insiders buying of late?
Both Lon Gerber, an insider expert with Thomson Financial, and George Muzea of Muzea Insider Consulting, point to Conagra, the food company. The stock has gone nowhere for the past year because of weak sales. But that hasnt stopped insiders such as board member David Batchelder from stepping up to the plate. Batchelder, who cut his teeth in business working for T. Boone Pickens Mesa Petroleum, must sense a turnaround in store, as the company sheds less profitable divisions. In October, he bought a massive $28 million worth of stock. Hes never bought anywhere near that amount before, says Muzea. Other directors and the chairman were buying significant amounts during the summer.
Muzea, author of "The Vital Few vs. The Trivial Many: A Unique Concept for Always Making Money in the Stock Market," also likes Del Monte Foods. The stock has been stuck in a trading range between $8.50 and $9 since June. But insiders have been snapping up shares the whole time.
Most recently, Nils Lommerin, a vice president, bought $730,000 worth of shares at around $8.60 in late September. That is the first big buy in the stock by an officer in five or six years, says Muzea. And various board members and top managers were nibbling all summer. At 10 times 2004 estimates, Del Monte trades 33% below the average for food-industry stocks. Obviously, insiders think turnaround efforts at the company will help close that gap.
Thomsons Gerber also likes Copart, which auctions salvage vehicles. Director Harold Blumenstein bought $2.2 million worth of the stock in early October at around $11.20. This was the largest-ever insider purchase at the company and the first insider purchase since October 1999, says Gerber.
Despite big bets like these, insiders overall are gloomy and selling, for the most part -- which doesn't bode well for the market. Insiders are very, very bearish. Insider selling suggests that we should be selling stock, too, says Michael Painchaud, of Market Profile Theorems in Seattle. To be sure, selling the same stocks that insiders were selling in early June did not always pay off. We suggested selling j2 Global Communications (JCOM, news, msgs) back then, and it is still up 100% despite its recent setback.
Given the overall bearish insider sentiment, however, it might make more sense to mimic insider sellers right now -- and not just the buyers. Painchaud points out there has been significant selling at Bear Stearns (BSC, news, msgs), Morgan Stanley (MWD, news, msgs) and Apollo Group (APOL, news, msgs). The newsletter Vickers Insider Weekly says there has been heavy selling at Comverse Technology (CMVT, news, msgs) and Mandalay Resort Group (MBG, news, msgs).
Earnings-estimate revisions point to further gains
Identifying the little earnings bumps at tiny companies has been a good way to find climbing stocks in the past three months. Six of the companies in a mid-July column on this theme -- 5 ways to profit from earnings revisions -- have beaten the S&P 500, with gains of 20% to 50%. The star of the group, stun-gun maker Taser International (TASR, news, msgs), is up 200%. Those gains handily offset the moderate underperformance of four stocks in that column. There was only one real dud, though: Advanced Power Technology (APTI, news, msgs), which has suffered a 21% decline since then.
Tiny companies with excellent estimate revisions and barriers to entry around their products include QAD, which sells software used by manufacturers to streamline operations. QAD has a good international presence, so it is benefiting from the move of manufacturing operations to lower-cost regions like China.
LeCroy sells testing equipment such as advanced oscilloscopes, used in growth sectors like semiconductors and storage, as well as auto design. It has a new line of oscilloscopes coming out next year. Bio-Reference, which does medical lab testing, is expanding by adding new contracts -- especially at prisons -- and offering more expensive and esoteric tests. Thanks to tactics like these, sales have grown at around 20% per year in recent years, compared with 5%-to-7% growth at other lab testing companies.
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