N is for...News!
"It takes something new to produce a startling advance in the price of a stock," says William O'Neil in his best selling How to Make Money in Stocks. More specifically he mentions new products, new management and new highs. In other words - news, the third criterion of stock selection in his CANSLIM methodology.
I would go a step further than O'Neil and add new contracts, new deals, new partnerships, and new strategic alliances, all of which have driven stock prices higher.
The key word here is "startling". We're not talking steady incremental growth here. We're talking about leaps in stock price. Superb examples of this principle in action are price surges in a couple of stocks I followed in the late 90s.
InfoInterActive, a tiny firm operating out of Bedford, Nova Scotia with dynamic management and a superb patented product and a market cap of under $50 million doubled when Intel Corporation decided to license its technology and take a 10% stake in the company.
Another company, Infowave Software, which had already produced spectacular returns over the last year rising from $2 a share to $32 a share on the success of its imaging software, doubled again on the news of a major contract with the giant multi-national Nokia Corporation. It jumped from 16-bagger to 32-bagger in one week!
Sometimes news by itself, never mind revenue growth or earnings growth, can propel a stock price higher. This is particularly true in the mining exploration field. A new gold find or even a nickel find such as the one at Voisey's Bay in Newfoundland, can send an unknown stock flying.
O'Neil only mentions new products in passing and gives even shorter shrift to new management, these being fairly self-explanatory. But he focuses a lot of attention on one of the most misunderstood phenomena in investing - the tendency of stocks hitting new highs to keep going higher.
He said that in surveys of the thousands of people attending his investment conferences over three decades, 98% said they do not buy stocks that are making new highs. The vast majority of investors, he says, whether new or experienced, "feel delightful comfort in buying stocks that are down substantially from their peaks".
This has even been ingrained in one of the classic old saws of investment lore, the maxim "Buy low. Sell high!" But a far better piece of advice is to "Buy high. Sell higher!"
This reluctance, nay fear, of buying stocks hitting new highs is palpable. It affects me and I know better. I've been scared out of buying many stocks because I've thought, "Oh my God! It's gone so high already, it can't possibly go any higher". Or "Oops! Too late! Missed the boat on that one!" or other similar excuses. And I've made the most money when I fought my fears and bought stocks hitting new highs.
O'Neil says "The hard-to-accept great paradox in the stock market is that what seems too high and risky to the majority usually goes higher and what seems low and cheap usually goes lower". He studied the daily new highs and new lows for several up as well as down markets. The results were clear. Stocks on the new high list tended to go higher. Stocks on the new low list tended to go lower.
His conclusion - "a stock making the new high list the first time during a bull market and accompanied by a big increase in trading volume might be a red-hot prospect worth checking into".
A Word of Caution
Stock promoters are well aware that news drives up stock prices and some stocks, penny stocks in particular, are sometimes subject to hyping - the issuing of flurries of news releases in the hopes of driving up the stock price. Be particularly wary of hyping on message forums such as Silicon Investor, Raging Bull and Stockhouse.
In fact, it is rather amusing to browse through the message boards on such stocks. Many of the speculators involved work these boards feverishly, boosting the morale of fellow investors, disparaging bad news, playing up good news, finding excuses for price declines, and cursing anyone who dares throw a little sober reflection into the conversation.
And new highs are not a panacea. In fact, O'Neil says you should look for stocks that are breaking out or near to breaking out to new highs after undergoing a price correction and consolidation. And he cautions that you should "avoid buying once the stock is extended more than 5% or 10% from the exact buy point off the base".
Moreover, one should look for new price highs in conjunction with the other elements of the CANSLIM formula. And sometimes, you have to be nimble and sell a stock quickly after it surges from its break-out point.
I don't want to go into great detail on selling points, but of the 35 or so selling signals O'Neil mentions, there is one which I wish I had paid closer attention to as I've been burned a few times by failure to sell at a high point. The selling principle - "If after a stock's price is extended from a proper base, its price closes for a larger increase than on any previous up days, watch out! This move usually occurs at or very close to a stock's peak".
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