(c) 2000 by Ash Gujral
Growth stocks are coming back, offering opportunities for the stock investor who gobbles up leading stocks as they emerge from decent price ranges. Now is the time to go over the fundamentals of how to buy stocks when the market is moving higher.
The first step: Target the very best choices. Which groups of stocks are showing the healthiest price action? And which names within those leading groups have superior earnings, sales, products and management? Keep a sharp eye on the top-ranked industry groups in “Investor Business Daily’s” “Daily Industry Prices” and “52-Week Highs and Lows”. That will tell you which groups the market favors. The electronics, computer and telecom sectors have been near the top of the new-high list. Next, zero in on the best stocks in the best groups.
The stocks should have high Earnings Per Share (EPS) and Relative Strength (RS) scores. A company with an EPS rating of 92 , for example, grew its earnings faster than 92% of all other stocks during the past three to five years. A stock with an RS of 89 appreciated more than 89% of its peers over the past year.
Look for stocks with strong sales, margins, and return on equity. They also should have good Accumulation /Distribution ratings, which indicate whether mutual funds and other big investors are buying shares.
The Second Step: Once you have identified your prospects, be patient. It is preferable to buy stocks as they break out from sound price bases in heavy volume. Here is a typical scenario: You have your eye on a high-RS, high-EPS stock. The stock has made a long advance. But buying now would put you in an extended stock that could be susceptible to a serious sell-off. This happened to late buyers of Internet stocks in April ’99. Instead wait for the stock to enter a correction. It may fall as much as 50% from its all-time high before bottoming. Then wait for the stock to prove its mettle. Sit back as the stock recovers. Once the stock near its old high, it may trade sideways, showing support at that level.
If the stock suddenly breaks higher on strong volume, buy before it becomes extended. Also set a floor at which you will sell if the stock gets into trouble. Many investors set their initial stop-loss level at 7% to 8% below their purchase price. Examples of stocks that recently underwent breakout patterns are consumer electronics retailer Best Buy, which broke out June 3; chip-gear maker KLA-Tencor, June 30; and chipmaker ARM Holdings, July 1.
Don’t buy too late. Once a stock has advanced more than 5% from recent support, the price may be extended and prone to a pullback. This doesn’t mean that you missed out after the stock’s initial advance. Many breakout stocks will put in normal pullbacks for a few days after bolting out of a base. Avoid buying on pullbacks if the share price falls back into the old base. That signal becomes even more ominous if it occurs on strong volume.
If a lot of leading stocks break down into their old bases, that can be an indicator that the rally is losing steam. At market tops, leading stocks often give way before the general averages. –oo–