Pasadena IBD Meetup Investing with Conviction March 13, 2013 Mike Scott.
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Transcript of Pasadena IBD Meetup Investing with Conviction March 13, 2013 Mike Scott.
Pasadena IBD Meetup
Investing with Conviction
March 13, 2013Mike Scott
If you don’t have rules to keep you in a stock you will never make big money
William J O’Neil
What are common themes connecting each Wednesday’s IBD article How To Find & Own
America’s Greatest Opportunities?
Themes
1. Impeccable timing2. Knowing the company3. Having a set of trading rules4. Investing with conviction
THE MARKET
KNOWINGYOURSELF
THE “IT” FACTOR
FUNDAMENTALSAND
TECHNICAL ACTION
THE ECONOMY
PYRAMID OF CONVICTION*
* Developed by David Sato Chung
The EconomyMarkets respond to decadal shifts in demographics, technologies and world economies
– Technological innovations create gigantic shifts in allocation of resources
– Resource ConstraintsShortages/Over Supplies
Government induced constraints
– Government policies
– Global consumerism
Steam engine AutomobilesElectrification InternetRadio/TV Biotechnology
Tax cuts / Interest Rates Deficit spending
Growing welfare states Making war
Demographic Trends Effect Markets
Baby boomers will spend less overall but will spend more in areas like health care and wellness, nursing homes and assisted-living facilities, and in conveniences like lawn and gardening care. The up and coming (albeit slightly smaller) echo boom generation will spend more on the basics as they form new families in the next decade, on things like apartments, starter homes, smaller cars, basic furnishings, basic cosmetics, and etc…. Harry S. Dent
10,000 boomers turning65 every day
Where are We in theSecular Market Cycle?
Low cyclically adjusted P/E appears to be necessary to initiate a secular bull market
Cyclically Adjusted P/E PerspectiveP/E = S&P Price/10-Year Avg Earnings
1982
1950
Source: http://www.econ.yale.edu/~shiller/data.htm
You arehere
Need toget here
S&P500 Cyclically Adjusted Price/Earnings
Market Timing• 75% of stocks follow the major trends in the market• Your chances of landing a big winning stock are much greater
at the beginning of a bull market• Typically cyclical bull markets last 3-5 years
– Containing 2+ up legs separated by intermediate corrections– Most leading stocks will breakout at the beginning of the bull market
run. Others will sporadically breakout somewhere in the first two years
– Late stage initial breakouts are suspect• Try to know where you are on three time scales
– Secular, multi-cyclical cycles– Cyclical, multi-year cycles– Intra cycle, early-middle-late
Higher Risk
Lower Risk
12
3
You are here
Two cyclical bull markets in a secular bear market, so far
Secular Time Frame Risk
Cyclical Time Frame Risk
Tools to Navigate Cyclical Trends
• Follow-through days with action of leading stocks signals shift from cyclical down move to a new rally
• Market School exposure model-a refinement of the above
• Other tools– IBD6000 %E (IBD)– Coppock curve (www.freestockcharts.com)– Market internals thrusts (Eureka, Phoenix)
Market Thrusts
• NYSE market internal data (Advancing issues, Declining issues, Advancing Volume, Declining Volume)– Eureka: Positive thrust, three conditions:
• A/D > 2.98• Adv Vol/Dec Vol > 5.4• (A/D)/(Adv Vol/Dec Vol) < 0.63
– Phoenix: Negative thrust, three conditions• A/D < 0.63• Adv Vol/Dec Vol < 0.33• (A/D)/(Adv Vol/Dec Vol) > 2.43
A Eureka within 2 weeks of a FTD increases likelihood of a tradable rally
Monthly Coppock
Helpful for cyclical cycle starts
Buy BuyBuy
Weekly Coppock
Helpful for intra-cycle starts
Buy BuyBuy
Weekly Coppock buy within 4 weeks of a FTD produces higher probability of a tradable rally
IBD6000 Index %E
%E = 100*274/(723+2542+1293+809+274) = 4.9%Low %E (<7.4%) on FTD often leads to rally failure
Follow-through day compilation
10/10/2012 All Markets Bull Market Bear Market Total Pass Fail Total Pass Fail Total Pass Fail FTD 83 32% 67% 53 42% 58% 30 17% 83% +Eureka 42 43% 57% 27 48% 52% 15 35% 65% -Eureka 41 22% 78% 26 35% 65% 15 0% 100% Coppock <4 weeks 31 61% 39% 20 80% 20% 10 40% 60% > 4 weeks 52 15% 85% 31 19% 81% 20 5% 95% %E <7.4% 24 13% 88% 15 20% 80% 9 0% 100% %E > 16% 28 21% 79% 14 29% 71% 14 14% 86% In-Between 30 60% 40% 23 65% 35% 7 42% 57% Unknown 1
+Eureka
+Coppock 21 76% 24% 14 86% 14% 7 57% 43%
This is what a new cyclicalBull Market looks like
A new bull market is born…Just when the biggest opportunity is there the news is often just terrible. Without mechanical rules to operate by most investors will not act.
The “IT” Factor
• The Fundamentals• The Story• The Behavior– The path chosen– Price Targets
IT Factor Fundamentals Screen
Screen developed by David Sato Chung around Cisco and Microsoft fundamentals before they
made their big run
Price Club “IT”Story
“I saw my first Price Club in the summer of 1981…they only had two stores then…every gondola was packed with $100-$200 or more of merchandise. So Price Club had just invented a new type of cash-and-carry wholesale warehouse store.” WJ O’Neil
Leading-Stock BehaviorIf you know how leading stocks have behaved in the past you are prepared to handle them in the future
1997-2000 Model Book% Move of Length of % Pullback Length of Length of Weeks in PercentBreakout Run after Pullback Consolidation Move MoveRun Days Breakout Days Days
Average 34 15 -17 7 16 56 1532Median 22 9 -16 4 12 61 1031
Best 142 99 -11 1 4 16 872910th Percentile 72 35 -12 1 6 20 309120th Percentile 46 22 -13 2 7 25 205650th Percentile 22 9 -16 4 12 61 103180th Percentile 14 4 -20 8 21 73 56690th Percentile 10 3 -25 14 33 94 448Worst 4 2 -34 60 83 139 228
% Move of breakout run represents increase from close on breakout day to the intraday high that precedes the first 12% or greater pullback
Length of consolidation represents total number of days from the intraday high of the breakout run to the date the stock closes in new high ground
Leading Stock Behavior
Bull market 2nd year Model Book
Beware of quick to bottom stocks and short bases P/E expansion is a key methodto develop conviction
F 5 Networks P/E Expansion Target
145.76, close enough
P/E Expansion Target 136.40
BIDU 130% P/E Expansion
165.96, Close enough
Expansion Target 171.12
ALXN P/E Expansion
130% P/E Target = 120.61
Use 98% P/E Expansion on Large-caps and Cyclical Stocks
Price Target = $718
$705.07, close enough
Know your chartsFlawed chart patterns should usually be avoided
– Buy point not within 15% of 52-week high– Base too short: 7 weeks for cups and double bottoms– Lagging RS line– Vee-shaped cup patterns, should be rounded– Too quick to the bottom (<=2 weeks)– More down weeks (days) with above average volume closing in lower
40% of range than up weeks (days) with above average volume– Correction too deep (>30-35%)– Handle in lower half of base– Lack of tight closing weeks in base– Volume not drying up at bottom of base and handle– Unrecognizable base pattern– Late stage base– Already reached price target
-1+1-1
+1-1
-1 +1S+1
-1
+1-1+1
Upper60% of Range
Support Bar
Accumulation/Distribution Bar Counting
Lower40% of Range
DistributionBar
Any Positive Close
AccumulationBar
S
+1+1
Breakout
Net Count: -1 -1 -1 +1 -1 +1 -1 +1 +1 +1 +1 +1 = +2Daily (not shown): +7
First Week of Base
Net Accumulation-Distribution Weeks and Days Study
• The Accumulation bar minus distribution bar count should be performed on both the weekly and daily charts and the results netted to a single number
• A study was conducted that included 433 stocks that were on the IBD 50 (100) which broke out from 2003 through 2007
• There is a clear performance bias to selecting only stocks with non-negative net counts
Percent of stocks that achieve profit level
Net A-D Stop Loss_Profit Plan
Bar Count 5%_15% 7.5%_22.5% 7.5%_30%
All (433) 38% 36% 30%
<0 (114) 13% 12% 9%
0 (44) 39% 34% 25%
>=0 (319) 39% 37% 32%
>= 5 (98) 38% 40% 37%
2010 100-Best Stock Study
• Pick liquid stocks with great fundamentals showing strong supply/demand
0 50 100 150 200 250 300 3500
50
100
150
200
250
% Gain vs. Liquidity ($M)
0.0 1.0 2.0 3.0 4.0 5.0 6.00
50
100
150
200
250
% Gain vs. Demand/Supply (%)
0.0 5.0 10.0 15.0 20.0 25.0 30.0 35.00.0
50.0
100.0
150.0
200.0
250.0
% Gain vs. PTM+ROE
84.0 86.0 88.0 90.0 92.0 94.0 96.0 98.00.0
50.0
100.0
150.0
200.0
250.0
% Gain vs. Comp Rating
Preferred Stocks to Buy• US Stocks, ADR’s are okay but none from countries where rule of law or transparency is in
doubt (USSR, Venezuela, etc.)• IPO’s may be purchased. Prefer IPOs and ADRs who are underwritten by one of the
following underwriters: – Goldman, JP Morgan, Morgan Stanley, Merrill – Credit Suisse okay for the Chinese stocks
• Liquidity (price times average volume) greater than $20M/day, greater than $40M/day is ideal
• Minimum price $15 (NYSE) $20 (NASDQ). Consider the market, towards the end of a cycle where stock prices have been bid up. Lower cost stocks (even $50 stocks) could be suspect at the end of the cycle.
• Demand/Supply (50dma volume percent of float) 1% or greater, 3% or greater is ideal• Prefer higher quality CANSLIM fundamentals. Prefer stocks with:
– Triple-digit EPS gains– 3 quarters of EPS acceleration– 3 Quarters of Sales acceleration– 3 Quarters of increased Intuitional Sponsorship– Pre-Tax Margin + ROE > 50%
• Stock is owned by one of the high quality mutual funds• Satisfactory responses to Three Questions:
– Is this the very best stock I could own?– Where is the stock in the cycle? Where is the market in its cycle?– What do I think the stock pattern could be? This is important for an early entry
Knowing Yourself
• Investing is like Baseball– Each team plays 162 games in a season– LA Dodgers 2012 standing was 53% games won– This means they lost 47% of their games– How do the players maintain high morale in the
face of many lost games?– Same problem with investing
• Investors need a method to keep moral up
• Baseball Players are taught to focus on batting, running, throwing and catching
• If they are better at these basics than the teams they play, the win-loss record will take care of itself
• Same with investing
Where we go wrong
• Violate a rule—This undermines your confidence – Single best reason why to follow the rules
• Not cutting losses• Selling winners too soon, fear at work
– If you don’t have a rule to keep you in a stock you will never achieve 100% gains
• Averaging down on losers, ego at work• Trading against the trend, greed at work• Buying a stock before it proves itself, act on what you see,
not what you want to see• Holding out for the last fraction of a point, greed at work• Bottom Fishing• Keeping a pet stock, draws attention away from leaders
Investing with Conviction
Wow!
3 Year EPS +110%Annual Sales +53%ROE 55.4%
P/E Expansion Target >$100