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Look out for fallen favourites.
Fallen favourites are stocks which have declined a long way over a period of time following earnings disappointments. They tend to fall to levels that take leave of the underlying fundamentals and fail to take account of recovery prospects. However, it is important to check that the balance-sheet is not over- stretched . If there is net cash, so much the better.
Patience is essential - it is almost impossible to time the turning-point for recovery situations. It is also important not to buy in the early stages of the price fall. Wait for the first signs of stability to appear in both the business and share price.
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Calculate annual R & D expenditure per share and compare it to the share price.
If the PRR (price-research ratio - share price divided by R and D per share) is 5 or less it is nearly always worth buying the shares. This applies particularly to recovery situations. As long as an exploration company has the wherewithal to drill holes, there is always the possibility it will strike it lucky. The same goes for an out-of-favour technology company. As long as it can continue to invest in R and D there is the chance it will come up with a blockbuster product. The lower the PRR the more development bang you get for your buck.
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Use Relative Strength to detect significant changes in a stock's performance relative to the market.
In particular, I like to use 10 and 20 week moving averages of Relative Strength. Relative Strength is particularly useful when buying into recovery stocks or when considering sales of long- term winners. The larger the market capitalisation of the stock the more useful Relative Strength is. For small cap stocks, price movements are too erratic and random for Relative Strength signals to be reliably useful.
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Never plan to hold a stock forever.
Be prepared to take part-profits if the price gets too far ahead of the underlying fundamentals. Sell if newsflow disappoints in a big way.
Use stop-losses, but only in certain situations. They are most helpful when protecting profits after a huge rise in the share price. Use of a stop-loss in early-stage recovery situations is rarely a good idea. Simplistic stop-loss rules, such as sell on a 20% price drop, should be avoided. Instead, chart patterns, trading volumes and moving averages should all be used to help identify suitable stop-loss points.
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Recurring revenue streams, the larger the better, are very attractive.
They provide predictability of sales and profits going forward and reduce the likelihood of nasty earnings surprises . Companies that change to a business model which steadily increases the recurring proportion of revenue are likely to undergo a market rerating.
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Watch for management changes.
Top-level management changes at a company that has gone stale nearly always lead to a revitalised performance, although not necessarily immediately. The new management team normally experiences a honeymoon period with the stockmarket which nearly always sees the share price outperform even before the new team delivers improved results.
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If investing in early-stage companies, go for those with a realistic chance of playing a significant role in a fast-developing emerging market.
Ideally, the management team should have at least one previous small company success under its belt in delivering enhanced shareholder value.
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Look for medium-stage companies with a dominant share of a high growth market.
For medium-stage tech companies, that is those that are already profitable but far from mature, look for companies with a dominant share of a high growth market and with a product or service that provides significant cost benefits to customers.
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Avoid companies with a sales-dominant corporate culture.
All too often, accounting irregularities and questionable practices creep in sooner or later, ultimately leading to restated results, a loss in investor confidence and an overnight collapse in the share price.
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Look for companies with a PEG (current year prospective P/E divided by the growth rate for the following year) of less than 1.
This enables comparisons to be made between stocks with varying multiples and growth rates. If two stocks have more or less equal PEGs, go for the one which looks most likely to achieve market expectations.
