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"A Vital Source for the CANSLIM Investor" 

Monday,  May 31st, 2004 | 8:23 PM
June 2004
Volume 7, Issue 6
 

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Because Of Tuesday's Action, This Is What I'm Doing
Since January 16th, you know where I have stood when it comes to this market. Recently, based on extreme oversold conditions, I called for a bounce in the BOND MARKET as well as INTEREST-RATE SENSITIVE stocks. I must tell you, the move in some names, particularly HOMEBUILDERS, caught me by surprise. Then, in my last report, here are some of the words I penned:

"Shorter-term, I think we can bounce more...but I must tell you that the bounce the market is attempting is about as anemic as they come. All our indicators are deeply oversold, which normally leads to  decent bounces. So far, any move up on just an intraday basis...is getting slapped down by the close. In fact, if not for a last second flurry to the upside, Friday's market was working on another negative reversal akin to Wednesday's. For the hundredth time...go slow. If the market wants to break to the upside, it will let us know. So far, ain't happening. In order for this market to make this bounce get at least a decent leg, keep a watch on these numbers...DOW 10,094, S&P 500 1,106 and the NASDAQ 1,937 [see charts below]...all numbers that break above last Wednesday's highs. Keep in mind, even if these levels are breached, I am not sure sure you should get too excited...but it will be a start." 

On Tuesday, those levels were breached...a potentially very positive sign. I now print part of what Investors Business Daily writes in the May, 26 2004 issue in the article, "Big Picture."

"The price and volume combination came on the sixth day of the Nasdaq's attempted rally, right in the sweet spot of when you like to see the market show real power. The one caveat? Volume finished slightly below average. Most successful follow-throughs arrive on above-average trading.

The rally turned broad as stocks of all sizes advanced. The Dow industrial average and S&P 500 each gained 1.6%. NYSE volume grew 26% and finished 5% above its 50-day average. Their percentage gains were on the border for follow-throughs. However, the market needs only one index to confirm an attempted rally. The Nasdaq met that objective.

As noted recently, leading stocks already were flexing some strength. They rallied hard Tuesday afternoon, with many delivering big gains in heavy volume.

What does the follow-through mean for investors? First, remember that while all major market advances have shown follow-throughs, not all follow-throughs lead to extended rallies. Don't blindly rush back into the market and bloat your margin balance.

Instead look for stocks with powerful earnings and sales growth as they break out of sound price bases. Buy them as close as possible to their pivot points.

If your initial purchases turn profitable, look to add shares or buy other leaders. Don't let any initial losses grow beyond 8%. Sound trading will automatically push you into a successful rally and pull you out of a faltering advance."

I couldn't say it any better. I have been waiting for this type of action for over 4 months...and we are finally getting it. I am already hearing both sides yap away. The bulls say the "correction" is over. The bears say it is a short-covering rally which will be short-lived.

- Gary Kaltbaum

Editor's Note:  We appreciate Gary Kaltbaum (who is not a daily contributor to CANSLIM.net's coverage of the markets) for providing our cover story this month.  CANSLIM.net strongly encourages its members to listen online to Gary Kaltbaum's "Investor's Edge" radio program live 5-7PM EST, or download from the archive of recent shows.

*CANSLIM.net's most timely buy candidates are analyzed by our experts in great detail in the "Stocks to Watch in This New Market "section.   

Note: Links above (in Leaders column) refer to write-ups on previously featured stocks.

- CANSLIM.net News Staff

For those who may not have otherwise noticed, four years ago the very first issue of “Investing for the New Millennium” was introduced. This (INM) became a monthly exercise for me to best communicate my ideas and insights aimed at helping a growing list of readers find success using O’Neil’s CANSLIM investment approach.  I am very proud of the work that has been done along the way, and I am glad to see the way CANSLIM.net has been able to greatly expand upon those meager beginnings.

It is no mistake that each piece of work I publish has a strong CANSLIM-bias, being that I have been fortunate enough to achieve greatly improved investment results for many clients by using the CANSLIM strategy.  Going beyond the usual day-in and day-out happenings, this column has covered topics ranging from assessing the market outlook, outlining proper buy and sell disciplines, trading tactics and types of orders to use, and a lot more.  Countless educational topics were also discussed along the way, while an impressive list of timely stocks has also been covered. The emphasis has always been on the quality of the information over the quantity of issues featured.

Over the years, many points have been reiterated, but it is never a bad time to go back to review the basics.  So, with the benefit of hindsight, I’d like to revisit a key point that was made in the June 2000 issue.  That ground- breaking issue ran with the headline, “Bargains Are Not as Good as Strong Leaders”.   The lesson had been intended to show that companies that had recently been showing up on the new highs list were the better purchase candidates, while the beaten down stocks (that looked like bargains to some investors) were not actually good purchase candidates at all.  At the time it was mentioned that two strong ideas, Rehabcare Group Inc. (RHB) and Timberland (TBL), had reached new 52-week highs and then quickly risen about 30% in 3 weeks, clearly contrasting with Yahoo, which already been beaten down 40% from its $250.00 high when it broke below support to close at a new 17-week low on April 7^th, 2000, but it proceeded to drop an additional 30% in the next few weeks.

What makes these old examples even more interesting today is what we see when taking the time to study what happened in the months afterward.  Mind you, when written, the article was pointing out how laggard stocks tend to continue on as laggards, while leaders tend to keep on leading.  Acknowledging that both of the leaders had already advanced quickly, and neither was at a perfectly timed buy point, one should still note that Rehabcare Group Inc. (RHB) proceeded to better than double in the next four months, and Timberland (TBL) doubled in seven months, while Yahoo went on to lose more than 90% of its value in the one-year period that followed.  Get the point?  The bargain was not a good bargain!

In the limited space of this column it would be nearly impossible to summarize all of the great examples from INM’s past 48 issues.  It would also be rather unrealistic to expect everyone to be enthused about going through and studying lots of old examples, especially when smart investors are interested in making the most of the market right now.

With a confirmed rally beginning to take hold, in many ways, the overall market looks a lot better for CANSLIM-oriented investors today.  And the way the stock market operates has not changed from the way it did when INM was getting started.  So, it is a smart idea to closely review everything you see making it to the new highs list.  The bargains, however, we would stay away from!

Kenneth J. Gruneisen - A Registered Investment Advisor & Registered Principal, Ken manages a Source Capital Group (Member NASD,SIPC) branch office and offers personalized assistance. Investors with a significant financial interest in equities may inquire about opening an account by calling the office locally at (954) 785-1990 or 1-888-237-8399 or emailing to kgruneisen@sourcegrp.com  Further information is always available upon request. Contact us if you know anyone that may have an interest in receiving this or any of our other reports. Comments contained in the body of this report are technical opinions only and are not necessarily those of Source Capital Group, Inc. The material herein has been obtained from sources believed to be reliable and accurate, however, its accuracy and completeness cannot be guaranteed. Our firm, employees, and customers may effect transactions, including transactions contrary to any recommendation herein, or have positions in the securities mentioned herein or options with respect thereto. Any recommendation contained in this report may not be suitable for all investors and it is not to be deemed an offer or solicitation on our part with respect to the purchase or sale of any securities. Source Capital Group, Inc. is a NASD/SIPC member firm.

Financials  Message Board  News  Chart  SEC  Zacks Reports

Profile: Armor Holdings, Inc. is a manufacturer and provider of specialized security products, training and support services related to these products, vehicle armor systems, military helicopter seating systems, aircraft and land vehicle armor systems, protective equipment for military personnel and other technologies used to protect humans in a variety of life-threatening or catastrophic situations. The Company's products and systems are used domestically and internationally by military, law enforcement, security and corrections personnel, as well as governmental agencies, multinational corporations and individuals.  It maintains a very high ranks from IBD, and fundamentals have turned up as earnings per share increases in the two most recent financial reports were up over the year earlier by +36%, +126% in Dec '03 and Mar '04 respectively while sales revenues accelerated.  Insiders hold 13% of shares outstanding, keeping them motivated to look after shareholder value. Confirming strength provides a nice reassurance the stock is among a leadership area in the market, with other high-ranked leaders in the Commercial Services - Security/Safety group (now ranked in the top 2% of IBD's list of 197 Industry Groups) including companies with familiar ticker symbols like TASR, MAGS, LAKE, and MSA.

What to Look For and Look Out For:  Given the fact that its recent breakout provided a technical buy signal, the outlook is positive for the stock and it could spend many more weeks advancing.  Deterioration back under $35 and dropping it back into the prior base would be a concern, yet a great deal of support should exist well above the 50-day moving average line.  A violation of that short-term moving average line would be considered a technical sell signal, especially if volume rises on such a breakdown.  

Technical Analysis: On May 25th the stock powered out of an orderly 7-week base on top of a prior base pattern, then it followed through on May 26th with gains on heavier volume but reversed off its high.  Its consolidation on above average volume has thus far stayed above what should now be solid support in the $35-36 range. In the accompanying graph also notice how prior consolidations found ideal support at its 50-day moving average line, and the breakouts came with very big volume spikes indicative of institutional accumulation. 

Financials  Message Board  News  Chart  SEC  Zacks Reports

Profile:  BEI Technologies, Inc. designs, manufactures and sells electronic devices that provide vital sensory input and actuation for the control systems of advanced machinery and automation systems that provide information that is essential to logical, safe and efficient operation of sophisticated machinery.  It develops and produces motors and actuators, which are the prime movers in high-performance machinery.  Product groups include: traditional sensors, micromachined sensors, magnetic actuators and motors and engineered subsystems, such as inertial measurement units, scanner assemblies, and electronic servo control systems and trackballs.  It gets very high ranks from IBD, but should be noted that its annual earnings history (the A in CANSLIM) is blemished by a downturn in 2002.  However, its fundamental sales and earnings have been improving nicely, as earnings per share have increased (versus year-earlier losses) while sales revenues have generally accelerated in the most recent quarterly financials.  Insiders hold 25% of shares outstanding, keeping them very motivated to look after shareholder value. Confirming strength provides a nice reassurance the stock is among a leadership area in the market, with the Electronic - Scientific/Measuring group now ranked in the top 18% of IBD's list of 197 Industry Groups.

What to Look For and Look Out For:  There should now be solid support in the $24-25 range, and while its recent breakout provided a technical buy signal, it would probably be most ideal to try to accumulate shares on any lighter volume dips back toward the latest support zone.  Barring any high-volume price breakdown, the outlook is favorable, but deterioration back under $25 and rolling back into the prior base would negate the latest breakout and be a cause for concern.  A violation of the 7-8% max-loss rule would probably be considered a technical sell signal before a violation of its 50-day moving average line would even come into play.

Technical Analysis:  While the broad market was struggling and the major indices were hitting new yearly lows, BEIQ began charging above its 50 DMA and heading toward prior highs on above average volume.  The stock had been consolidating since March, and it was under its 50-day moving average at the start of May.  On May 12th it broke out to new highs on the heaviest volume yet, but investors were soon whipsawed as the May 17th intra-day lows violated its 50-day moving average.  Most impressive was its ability to find support, and then on May 27th it followed-through with additional gains on heavy trading volume, lifting it above the new pivot highs.

Financials  Message Board  News  Chart   SEC  Zacks Reports

Profile:  L-3 Communications is a leading merchant supplier of intelligence, surveillance and reconnaissance systems and products, secure communications systems and products, avionics and ocean products, training devices and services, microwave components and telemetry, instrumentation, space and navigation products. Its customers include the Department of Defense, Department of Homeland Security, selected U.S. Government intelligence agencies, aerospace prime contractors and commercial telecommunications and wireless customers.  Insiders own a 10% interest.   It has a very high EPS rating in IBD, and in the quarter ended March 31, 2004 earnings were up 33% as revenue leaped 40% over year earlier period.

What to Look For and Look Out For: LLL’s latest gains put it in very close range of its May 2002 highs near $66.  Its ability to reach new all-time highs would be encouraging, and it would be even better if such were to occur on one of its biggest volume days.  However, any violation of its 50-day moving average (now $60.59), where it has shown support three times this year, could spell trouble.  Prior lows in the $59 range are a very important support level, and a violation would be a technical sell signal, making a sell-stop order in the $59-60 range an especially effective risk-management tool.

Technical Analysis:  While building a reasonable length base above its 50-day moving average, LLL was among the first handful of high-ranked stocks climbing to new highs in the budding rally.  Note that the most recent down week that occurred on above average volume happened way back in mid-January. LLL has shown the a classic downward sloping handle pattern, since April, on what would be an almost 2-year cup-with-handle chart (see 3-Year graph).  

Augmenting IBD’s Quality Fundamental Analysis with Estimates of Value: Building a Watch List of Stocks Ripe for the Buying
The CANSLIM approach to stock qualification, augmented with Investor’s Business Daily’s fundamental rankings, identifies fundamentally sound companies. An additional question is worth asking before buying: Is there value remaining in the present price? A company may have excellent fundamentals (earnings, profit margins, sales, etc.) but, at the same time, not have value remaining because price has run up significantly. Here, I consider two value qualifiers: the price-to-sales ratio (PS) and the PEG ratio (price-to-earnings-to-earnings growth). The first value qualifier deals with top-line growth, the second with bottom-line growth.

Over the long term, future price depends on three factors: earnings, earnings growth, and the stability of each. Peter Lynch in "One Up on Wall Street" said: “The PE ratio of any fairly priced company will equal its (earnings) growth rate.” Thus, a PEG ratio equal to one marks a fully valued stock. The Motley Fool calls the PEG ratio their “Fool’s Ratio” and defines an undervalued company as one with a Fool Ratio less than 0.50. Clearly, PEG ratios mark value, and that is well recognized.

James O’Shaughnessy in “How to Retire Rich” described his research utilizing Standard & Poor’s Compustat database, the most comprehensive database available today with information on 10,000 stocks going back to 1951. He found that a stock’s PS ratio (how much one pays for $1 in sales) was the single best ratio to watch. Note: while he considered PE ratios, he didn’t consider PEG ratios. Over a 45 year period (’51 to ’96), an investor buying the 50 stocks with the lowest PS ratios would have seen $10,000 grow to $8.3 million—a compounded return of 16.09% per year. Conversely, one who consistently bought the 50 stocks with the highest PS ratios would have seen a $10,000 investment grow to just under $92,000, a compounded return of 5.04%. Both PEG and PS ratios reflect value left in a stock’s price.

Figure 1 breaks down the six-month price gain for both groups (YHOO, IGT, and FRX were members of both). The S&P 500 are assembled by PEG ratio, where the mean of each grouping is marked by a circle with lines protruding from the top and bottom—each one standard deviation of that grouping’s price gain (together covering 68% of the membership in that grouping). With the exception of the left-most group, which contains 147 stocks with negative PEG ratios, i.e., with either negative earnings or earnings growth, groupings with lower PEG ratios experienced greater price gains over the six-month period. The entire S&P membership, excluding those with negative PEGs, averaged a 1.25 PEG ratio for ’03; whereas, the fundamental 11 averaged a 0.51 PEG ratio.

Figure 2 similarly depicts the PS relationship for these two groups: PS averaged 1.96 for the S&P stocks and 3.54 for the group of 11. For the S&P stocks, both extreme PS groupings had greater price growth, the lower because of value and the higher, most probably, because of popularity. The fundamental group of 11 typically had large PS ratios and small PEG ratios.

A second series of fundamentally sound stocks (5/21/04 IBD 100) averaged a 0.64 PEG. 35 stocks were from 0 to 0.5, 27 stocks from 0.51 to 1.00, and 16 stocks from 1.01 to 1.50. These stocks also had average PS ration of 3.56. 28 stocks from 0 to 1.5, 20 stocks from 1.51 to 3.0. The following offered both PEGs and P/Ss less than 1.0: CCE, PAS, SAFM, TTC, BGFV, GTRC, CVH, SIE, NOBL, WIRE, SCSC, ROV, WCC, FSH, LLL, JBHT. Just remember, great fundamentals are not enough to produce winning trades: both price/volume technicals and value are important.

- Dr. Richard Miller, Ph. D.

On Tuesday, May 18th the NASDAQ showed us its highest volume total of the year. Possible interest rate hikes, oil prices falling slightly from record highs and news that President Bush will re-nominate Greenspan as Federal Reserve Board Chairman helped the NASDAQ start a new attempted rally up from its Monday low of 1,865.40. The NASDAQ gained +1.1% yet total trading volume was lower than the previous day.

The front page of the Investor’s Business Daily on Wednesday, May 19 stated “Current outlook: Day 1 of Nasdaq attempted rally” (Market Pulse section in The Big Picture). This is a very important piece of information for those trying to understand and be a part of a market turnaround. It is crucial to understand the importance of the day that an attempted rally comes through. “The fact that one of the major indices closed above the session low or the previous session’s low, is the first day of an attempted rally” (page 64 in “How To Make Money in Stocks” under the paragraph titled “How You Can Spot Stock Market Bottoms”). This is the day you start the count and begin watching for the new rally’s follow-through day on the 4^th to 10^th day. The most powerful follow through days occur on the 4^th and 7^th day of an attempted rally.  Study page 65 of the book, “How To Make Money In Stocks”, where under the paragraph titled “How You Can Spot Stock market Bottoms” it discusses this subject.

On May 25^th, the 6^th day of the latest attempted rally, we had a follow through day! This is the day that investors should have been looking for during days 4 through 10 of the attempted rally. The NASDAQ closed up +2.2% on 24% higher trading than the previous day. Unfortunately the volumes were not above average. Read page 65 of the book “How To Make Money In Stocks”, where it discusses what an ideal follow-through day should look like. This is why IBD pointed out this particular point in the May 19 issue. This is what every CANSLIM-oriented investor should have been looking for! Keep in mind that the market only needs one index to confirm an attempted rally. In this case it was the Nasdaq Composite.

Now that we are in a confirmed rally, it is still imperative that your carefully select stocks that have exceptional earnings and sales, and move quickly on those that are breaking out of sound base patterns on higher than average volume. Your buy point should be as close as possible to the pivot point so that you avoid purchasing a stock that is already extended.

I recommend that you read a previous article I wrote titled, “A Review Of The Market’s Green Light For Investors”, appearing in the July 2003 issue of CANSLIM.net News. The confirmed rally and follow-through day that occurred in mid-March of 2003 is reviewed in detail in that article.  Along with the current article, it can help you to better understand the correct time one can enter the market.

Soraya Nasrallah, obtained her Series 7 license in 1992, and has served in the capacity of Sales Assistant, Head of Operations Department, and Stockbroker.  Contact Soraya Nasrallah via email at snasrallah@sourcegrp.com or by phone at (954)785-1990 for assistance you with your portfolio. She will be pleased to offer ideas that suit your investment needs, and she can help you achieve the gains you have been searching for.  Miss Nasrallah has just introduced a new educational program called InvestorWiz! specifically created for teenagers and novice investors, incorporating stock market basics with CANSLIM in a colorful and picturesque format. It is the perfect gift for those who just don’t know much about the world of stocks and investing! Comments contained in the body of this report are technical opinions only and are not necessarily those of Source Capital Group, Inc. The material herein has been obtained from sources believed to be reliable and accurate, however, its accuracy and completeness cannot be guaranteed. Our firm, employees, and customers may effect transactions, including transactions contrary to any recommendation herein, or have positions in the securities mentioned herein or options with respect thereto. Any recommendation contained in this report may not be suitable for all investors and it is not to be deemed an offer or solicitation on our part with respect to the purchase or sale of any securities. Source Capital Group, Inc. is a NASD/SIPC member firm.

With continued growth, we also improve and enhance our products and services. Most recently, we have upgraded the CANSLIM.net Leaders List on our website. Gone is the static list that was difficult to sort and almost completely inflexible.  Now, our Leaders List can be easily sorted by almost any of the columns!  Members can simply click the column headings to sort and find stocks based upon price gain for the day, company name, 52 week high, etc.  We hope that you take advantage of this new functionality!  To check it out, go here: http://premium.canslim.net/leaders/leaders.asp.

We are very sensitive to the needs of our subscribers. We read every email that you send whether it is a complaint, a suggestion, or a compliment. While we may not implement every suggestion, we take each one very seriously and discuss it internally. If you have any input on our website, please feel free to use our inquiry form. Every department here reads every form submitted, so please don’t be shy with your comments. To find the inquiry form, go here: http://www.canslim.net/inquiries.htm. You can also call us directly at 800-965-8307 or 954-785-1121. We take pride in publishing our phone number and having representatives available to answer calls (9:30AM to 6:00PM, eastern time).

Many new subscribers have found us through recent advertising campaigns on TheStreet.com and CBS.MarketWatch.com. If you have purchased a CANSLIM.net StockNews membership through ads at either one of these impressive financial news services, know that we are very pleased to welcome you aboard!   We hope that you find this monthly newsletter and our daily reports useful and informative. We do not spoon feed our subscribers, as we expect everyone to complete their own due diligence when researching and buying stocks. That is why we include as much analysis as practical when presenting featured stocks here, or whenever timely ideas are featured in our CANSLIM.net Stock Bulletins and CANSLIM.net Stock Alert Reports. The bulletins and reports are released on an ad hoc basis during the month.

One of the recent challenges to distributing our newsletter and reports electronically has been the increased use of spam filters by the major Internet service providers. We deliver all of our pay reports via email, so if you do not receive email from us, please be sure to contact us and verify that your record in our database is up to date and accurate. If your information is indeed confirmed as accurate, your not receiving our emails may be the result of your ISP using very strict spam filters. In such cases, you may need to contact your ISP to resolve the issue.  After we send the emails out to a valid address, we have no control over how the email is received by your ISP and ultimately dispatched to your email account.  Such spam filters present a challenging situation for us, as we want each and every subscriber to receive his/her emails promptly.

Andrew C. Hansen
Editor, CANSLIM.net
editor@canslim.net

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