Trade Like a Stock Market Wizard: How to Achieve Super Performance in Stocks in Any Market: How to Achieve Superperformance in Stocks in Any Market

by Mark Minervini

In the following figure, note that the 200-day moving average for Amgen has turned up and is in a definite uptrend. The 150-day moving average is above the 200-day moving average, and the stock is trading above both the 150-day and 200-day moving average during the markup phase. Note, too, the surging volume on the rallies, contrasted with lighter volume on pullbacks. For Amgen, by the time stage 2 was clearly under way, the stock price had already advanced more than 80 percent from its 52-week low. This would be the point at which I would start to consider a new purchase; any earlier lacks confirmation and is premature, meaning you run the risk of being stuck in dead money. Mos...

TRANSITION CRITERIA 1. The stock price is above both the 150-day and the 200-day moving average. 2. The 150-day moving average is above the 200-day. 3. The 200-day moving average has turned up. 4. A series of higher highs and higher lows has occurred. 5. Large up weeks on volume spikes are contrasted by low-volume pullbacks. 6. There are more up weeks on volume than down weeks on volume.

With a buildup in earnings momentum (or in some instances earnings expectations), the stock price starts to escalate because of a surge in demand for shares as big institutions buy the stock in size. A daily and weekly price and volume chart will show big up bars representing abnormally large volume on rallies, contrasted with lower volume on price pullbacks. These signs of accumulation should appear during every stage 2 advance.

By the time stage 2 is under way, the stock has been moving upward in a stair-step pattern of higher highs and higher lows. The share price may have doubled or even tripled at this point; however, this may be only the beginning. The stock could still move substantially higher. If the company continues to deliver strong earnings, the growth rate will soon attract widespread attention and subsequent buying, especially if the company has reported several quarters of impressive earnings gains.

STAGE 2 CHARACTERISTICS • The stock price is above its 200-day (40-week) moving average. • The 200-day moving average itself is in an uptrend. • The 150-day (30-week) moving average is above the 200-day (40-week) moving average. • The stock price is in a clear uptrend, defined by higher highs and higher lows in a staircase pattern. • Short-term moving averages are above long-term moving averages (e.g., the 50-day moving average is above the 150-day moving average). • Volume spikes on big up days and big up weeks are contrasted by volume contractions dur...

STAGE 3 CHARACTERISTICS • Volatility increases, with the stock moving back and forth in wider, looser swings. Although the overall price pattern may look similar to stage 2, with the stock moving higher, the price movement is much more erratic. • There is usually a major price break in the stock on an increase in volume. Often, it’s the largest one-day decline since the beginning of the stage 2 advance. On a weekly chart, the stock may put in the largest weekly decline since the beginning of the move. These price breaks almost always occur on overwhelming volume. • The stock price may undercut its 200-day moving average. Price volatility around the 200-day (40-week) moving average line is common as many stocks in stage 3 bounce below and above the 200-day average several times while topping out. • The 200-day moving average will lose upside momentum, flatten out, and then roll over into a downtrend.

Stage 4 is essentially the opposite of stage 2 in terms of price and volume characteristics, with higher volume on down days and lower volume on up days. You should definitely avoid buying while a stock is in stage 4. STAGE 4 CHARACTERISTICS • The vast majority of the price action is below the 200-day (40-week) moving average. • The 200-day moving average, which was flat or turning downward in stage 3, is now in a definite downtrend. • The stock price is near or hitting 52-week new lows • The stock price pattern is characterized as a series of lower lows and lower highs, stair-stepping downward. • Short-term moving averages are below long-term moving averages. • Volume spikes on big down days and big down weeks are contrasted by low-volume rallies. • There are more down days and weeks on above-average volume than up days and up weeks on above-average volume

it’s important to understand that the study of the four stages of a stock’s life cycle is not meant for pinpoint timing purposes, which requires a more precise approach and tactics that I will discuss below. Rather, the four stages are most useful for gaining perspective on where a stock is in its life cycle pricewise and then to compare that with where the company is in its earnings cycle. A stock can go through the cycle many times. By studying the four stages, you will see clearly that you want to be involved in stage 2. I’m not at all interested in getting in early when a stock is still in stage 1, and I definitely don’t want to hang around for stage 3, let alone stage 4.

history clearly shows that virtually every superperformance stock was in a definite uptrend before experiencing its big advances. In fact, 99 percent of superperformance stocks traded above their 200-day moving averages before their huge advance, and 96 percent traded above their 50-day moving averages.

It’s important to point out that a stock must meet all eight of the Trend Template criteria to be considered in a confirmed stage 2 uptrend. Trend Template 1. The current stock price is above both the 150-day (30-week) and the 200-day (40-week) moving average price lines. 2. The 150-day moving average is above the 200-day moving average. 3. The 200-day moving average line is trending up for at least 1 month (preferably 4–5 months minimum in most cases). 4. The 50-day (10-week) moving average is above both the 150-day and 200-day moving averages. 5. The current stock price is trading above the 50-day moving average. 6. The current stock price is at least 30 percent above its 52-week low. (Many of the best selections will be 100 percent, 300 percent, or greater above their 52-week low before they emerge from a solid consolidation period and mount a large scale advance.) 7. The current stock price is within at least 25 percent of its 52-week high (the closer to a new high the better). 8. The relative strength ranking (as reported in Investor’s Business Daily) is no less than 70, and preferably in the 80s or 90s, which will generally be the case with the better selections.

Within an overall long-term uptrend (the tide) there will be short- or intermediate-term price action (the waves) that consist of pullbacks and basing. These shorter-term moves may last from four or five weeks up to a year or more in many cases. Most commonly, base patterns forming within a stage 2 uptrend last anywhere from 5 to 26 weeks. During these basing periods, the stock will basically go sideways for a while, as if it’s catching its breath before making the next push higher. This sideways price is not to be confused with a stage 1 phase. The stock is now in a stage 2 uptrend, stairstepping higher from base to base. This will continue all along the stage 2 advance.

WHERE ARE WE ON THIS MOUNTAIN? THE BASE COUNT Switching metaphors, think of the movement of a stock’s price through the four stages of its life cycle as the outline of a mountain, from the flatlands to the summit and back to the flatlands again. As the mountain rises up the left side (stage 2), there are areas where the path or ascent plateaus for a bit. This is where mountain climbers would build a base camp, rest, and recharge, getting ready for the next phase of the climb to the summit. That’s exactly what happens with a stock. After a run upward, there is profit taking, causing a temporary pullback, during which the stock builds a base. If the stock is truly in the middle of something significant, the longer-term trend will resume. The short-term pauses allow the stock to digest its previous run-up so that it can move even higher as it emerges from a constructive consolidation period. At some point, the upward momentum ceases; the stock tires, and the top is put in. This is like reaching the summit, and there is no more mountain left to climb; now comes the descent. Generally, this occurs after three to five bases have formed along the way in a stage 2 uptrend. The later-stage bases coincide with the point at which the stock’s accumulation phase has become too obvious, tapping out the last of the heavy institutional demand. Bases 1 and 2 generally come off a market correction, which is the best time for jumping on board a new trend. As the stock makes a series of bases...

I never place much faith in my fundamental ideas about a particular company without confirmation from the market, namely, the price of the stock.

You want to get on board when institutional money is pouring into a stock and lifting it significantly higher. To do that, you need confirmation that this inflow is starting to happen before you invest.

To compound your capital rapidly, you must be where the action is; you can’t afford to have your money tied up in a stock waiting for what you think is a great fundamental story to get noticed by the rest of the world. I’m willing to give the first leg up in a stock to someone else in exchange for confirmation that the trend is definitely in stage 2 with some momentum building. The goal is not to buy at the cheapest price but to sell your stock for significantly more than the price you paid in the shortest period. That’s how superperformance is achieved.

HEED A TREND REVERSAL At some point your stock will reach its highest price and top out. This can occur with or without warning. Regardless of your fondness for or attachment to a particular security, it’s important that you learn to detect and, more important, respect a change in trend.

Companies will announce record earnings and try to create hype to keep their stocks up. Carefully watch the stock’s price action for valuable clues to which way institutional investors are leaning and, like a tree, bend with them. If you are inflexible and fight the powerful force of institutional money flow, you risk being snapped like a brittle twig.

When a stock shows signs of topping or, even worse, enters a stage 4 decline, you should trust what you see, not what you hear. Tune out the analyst and discount company hype.

Should you buy a stock on the basis of a brokerage house’s recommendation? If the stock is in a stage 4 downtrend, definitely not. Big brokerage houses love to recommend stocks that are down in price. Often these upgrades are based on valuation and completely ignore the fact that the stock price suffered a major price break. Often, stocks that are upgraded on the basis of valuation after a large price decline turn out to be good short candidates. Learn to do your own analysis and base your purchases on sound criteria, not because someone else says a broken stock is a good value.

Over the years I have analyzed tens of thousands of publicly traded companies. What I’ve discovered is that they generally tend to fall into one of six categories: 1. Market leaders 2. Top competitors 3. Institutional favorites 4. Turnaround situations 5. Cyclical stocks 6. Past leaders and laggards

My favorite type of stock to invest in—the area where I have made most of my money trading—is the market leader.

These companies are able to grow their earnings the fastest. An industry’s strongest players are usually number one, two, or three in sales and earnings and are gaining market share. Market leaders are easy to spot, but most investors have psychological difficulty deciding to buy them. The share prices of market leaders power up the most percentagewise in the initial stages of a market rally. They move into new high ground first. That unbelievable price strength causes most investors to think these stocks have run up too far; hence, most investors are afraid to buy the very best stocks capable of superperformance.

What propels them even higher? Institutions that know enough about a company and its future prospects provide the buying power. They are not concerned about how far the stock has already advanced but about where it’s going and what the prospects are for future growth. The best type of growth situation is scalable growth: a company gaining market share in a rapidly growing industry. The market for the company’s products or services is extremely large in relation to the company’s size, and those products and services are in high enough demand that the company can grow at a high rate for an extended period. These companies have superior products and services, and they are often part of a growing industry; although it is not necessary that a market leader be in a fast-growing industry or sector, it is certainly an additional plus if it is.

High growth industry, and industry leader

A company that is taking market share in a slow-growth industry can also grow its earnings quite nicely. What’s most important is that the company can make substantial profits. A good balance sheet, expanding margins, high return on equity, and reasonable debt are all signs of good management. Some market leaders grow earnings at a very healthy rate for extended periods in industries with percentage growth rates in the low to mid-single digits. However, a company that is taking market share or has a large portion of market share in a fast-growing industry can increase its earnings at a meteoric pace.

The main questions should be: What is the company’s competitive advantage? and Is the business model scalable? Then it’s a matter of whether management is executing successf...

WHEN EXPENSIVE IS ACTUALLY CHEAP Market leaders in the high-growth stage are almost always going to appear expensive. It only makes sense to value a rapidly growing company higher than a slower-growing one. Here’s the beauty about ultrafast growers: these companies grow so fast that Wall Street can’t value them very accurately. This can leave a stock inefficiently priced, providing a big opportunity. As long as a company can sustain significantly expanding sales and earnings, the stock price will follow—maybe not immediately, but stock prices do follow earnings growth over time. The faster a company can grow earnings, the more likely it is that its stock price will follow.

Another important consideration for the cookie cutter model (particularly if the business concept is relatively new) is a past track record of success in diverse geographic locations (Northeast, South, Midwest, international, etc.). You want to get evidence that the model is scalable. In addition, too much, too fast can be a red flag. For most companies, opening more than 100 stores per year is a number that is difficult to maintain. In 2006, Starbucks opened 1,102 more stores than it had the previous year; Starbucks’ stock price peaked and fell 82 percent over the next 24 months. By 2011, Starbucks had fewer stores open than it did in 2008. Other key metrics to consider include comparing sales per square foot and sales per dollar of capital invested per unit with other companies in the same business.

These “competitor” companies can also produce high rates of earnings growth and enjoy large-scale price advances, albeit inferior to that of the leader. Even so, the number two company in an industry can eventually take market share from the leader and in some cases take over the number one spot. The stock prices of top competitors can reflect this phenomenon, performing relatively well while the market leader digests its previous stock gains.

Always track the top two or three stocks in an industry group.

Big profits can be made in troubled companies that turn around. In purchasing a turnaround situation, you should look for companies that have very strong results in the most recent two or three quarters. You should see at least two quarters of strong earnings increases or one quarter that is up enough to move the trailing 12-month earnings per share to near or above its old peak. In looking at turnarounds, ask yourself: Are profit margins recovering, and are they at or close to the peak? Are the results based only on cost cutting? What is the company doing to increase earnings beyond cost cutting, productivity enhancements, and shedding losing operations? How much cash does the company have? Although a company can burn its cash, you can try to assess the burn rate and debt load to get an idea of how long it can last while running in the red. How much debt does the company have? Bank debt is the worst kind and is less favorable than bond debt. How long can the company operate while it works out its problems?

The most important questions to ask in purchasing a turnaround are: Is the stock acting well in market? and Are the fundamentals coming in strong? You want to see both.

Buying a cyclical after several years of record earnings and when the P/E ratio has hit a low point is a proven method for losing half your money in a short period of time. —Peter Lynch

How do you find which groups are leading? Follow the individual stocks. I like to track the 52-week new high list. The industry groups with a healthy number of stocks hitting new highs early in a bull market will often be the leaders. Your portfolio should consist of the best companies in the top four or five sectors.

Buying into the leading areas early in a bull market can lead to significant capital gains. Some groups start emerging late in a bull cycle and can lead during the next upturn after a bear market. It’s definitely worth investigating the industry groups in which the most stocks were resisting the decline and then subsequently broke into new highs while the market was coming off its lows or during the market’s initial few rallies.

The top relative strength leaders in these groups typically lead their group’s advance from the beginning and are likely to show the greatest appreciation. When you see a growing number of names in a particular industry making new 52-week highs (especially coming off a market low), this could be an indication that a group advance is under way.

I tend to let individual stocks lead me into an industry group or sector, taking more of a bottom-up approach as opposed to top-down. I have found that more often than not, the best stocks in the leading groups advance before it’s obvious that the group or sector is hot. Therefore, I focus on stocks and let them point me to the group. Not always, though. I still stay in touch with what is happening on an industrywide level, and if I see something that attracts my interest, I look at the stocks that make up the industry and sort them according to my criteria. I look at the strongest stocks first: the ones that have the best earnings and sales, are closest to a new high, and show the greatest relative price strength versus the market. This is where you find the real market leaders.

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WHEN THE LEADER SNEEZES, THE GROUP CAN GET A COLD Just as leading stocks can at times foretell a powerful group advance, keeping an eye on the top two or three companies in an industry group could provide a tip-off to when the group may be headed for trouble. It’s important to keep your eye on important leading names in the top-performing sectors. Often you’ll see an important stock in a group break badly, and the whole group will suffer. If one or more important stocks in an industry group top, that could be a warning that the whole group will soon run into trouble.

WHAT DRIVES SUPERPERFORMANCE? The stock market cares little about the past, including the status of a company. What it cares about is the future, namely, growth. Keep in mind that our goal is to uncover superperformance stocks: shares that will far outpace the rest of the pack. These stocks are the ones with the strongest potential, and they seldom are found in the bargain bin. They are going strong because of a powerful force behind them: growth—real growth—in earnings and sales. Why buy damaged merchandise? If your goal is to achieve superperformance in stocks, each company must earn its place in your portfolio by being an outstanding business. Superperformance stocks show their strength through their ability to improve and grow earnings, sales, and margins. These powerhouse companies report quarterly results that are better than Wall Street anticipates, with upside surprises that propel the stock higher. Don’t become enamored with a stock selling down in price because it has a well-known name. Many winning stocks may be companies that you never heard of before. Their best days lie ahead, not in the past. Regardless of a company’s size, status, or reputation, there is no intelligent reason for an investor to settle for an inferior track record in a marketplace filled with companies with outstanding fundamentals. Each quarter, earnings and sales reports provide a refreshed set of statistics with new names, as those with poorer prospects are often replaced with those with ...

WHY EARNINGS? In real estate, the mantra goes “location, location, location.” In the stock market, it’s earnings, earnings, earnings; after all, it’s the bottom line that counts. How much money can a company earn and for how long? This leads to three basic questions every investor should ask when it comes to earnings: How much? How long? and How certain? Profitability, sustainability, and visibility represent the most influential factors that move stock prices.

Key Cant stress this enough

Most of the big institutional investors utilize valuation models that are based on earnings estimates to determine a stock’s current worth or value. When a company reports quarterly results that are meaningfully better than expected, analysts who follow the stock must reexamine and revise their earnings estimates upward. This increases the attention paid to a stock. The upward estimate revision is going to raise institutional investors’ projected value of the company. When earnings estimates for a stock head up, shares, of course, become more attractive—and invite buying.

Be on the lookout for companies that are beating earnings estimates; the bigger the earnings surprise, the better.

The prospect of further surprises may lead to speculation by institutional investors in some stocks even before the earnings come out. Such a strategy can be profitable. An authentic earnings surprise for the quarter probably portends higher earnings in the next quarter as well. The mirror effect often holds true for negative surprises. Companies that miss earnings estimates often disappoint again in subsequent quarters. Because earnings surprises have a lingering effect, we want to focus on companies that beat estimates and avoid firms that have negative earnings surprises. One way to find candidates is to check to see if earnings reported in the last couple of quarters were better than expected.

Look for companies for which analysts are raising estimates. Quarterly as well as current fiscal year estimates should be trending higher; the bigger the estimate revisions, the better. At the very least, I like to see the current fiscal year or the next year’s estimates trending higher from 30 days earlier; if both are trending higher, that is even better. Although I won’t necessarily disqualify a stock as a buy candidate if it lacks upward earnings revisions, large downward estimate revisions are definitely a red flag.

Figure 7.4 Earnings maturation cycle In order to find your next superperformer, look for stocks that are in stage 2 with strong earnings, positive surprises, and upward revised estimates.

Big earnings will eventually attract the big players and create the conditions for big price performance. The length of time a stock remains in stage 2 depends on the company’s fundamentals, specifically, how long it’s able to continue its pattern of strong earnings growth. Some companies can keep this up for quite a stretch. To take advantage of this phenomenon, you don’t need to guess or predict, and you don’t have to settle for less than stellar performance in terms of fundamentals. Look for stage 2 uptrends supported by strong earnings growth, and you will dramatically increase your chances for attaining big success in stocks. Sometimes a company with a rocketing stock price may not be making much money, but the rising price means that investors are hoping that it will be profitable in the future. However, three out of four times, the very best performers will show meaningful earnings increases in the most recent quarter from the same quarter a year earlier. You should demand not only that the most recent quarter be up by a meaningful amount but that the past two or three quarters also show good gains.

To ensure that your stock is attractive to institutional investors, demand that a minimum level of current quarterly earnings performance be met before investing. Many successful growth managers require a minimum of 20 to 25 percent year-over-year increases in the most recent one, two, or three quarters. The greater the percentage increases, the better. Really successful companies generally report earnings increases of 30 to 40 percent or more during their superperformance phase.

In addition to large earnings increases that are better than analysts expect, I’m looking for earnings acceleration, meaning that the growth in earnings is larger than it was in a previous period. More than 90 percent of the biggest stock market winners showed some form of earnings acceleration before or during their huge price moves.

LOOK FOR EARNINGS SUPPORTED BY REVENUE In addition to strong, accelerating earnings per share growth, you want to see sales exhibit the same characteristics: strong quarterly growth and acceleration. It’s not uncommon for new market leaders to show triple-digit sales growth in the most recent two, three, or more quarters. In fact, some great stock market successes deliver large quarterly sales increases consistently for several years. For example, from March 2009 through December 2010, Netflix reported eight consecutive quarters of sales increases that accelerated from 21 percent to 34 percent; during that period, quarterly earnings averaged 45 percent. Netflix’s stock price advanced more than 500 percent. Home Depot made a 698 percent move from June 1982 to June 1983. Its sales grew 104 percent, 158 percent, 191 percent, and 220 percent, respectively, over the four quarters leading up to this major stock-price jump. In 2010, accelerating sales bolstered earnings and propelled shares of F5 Networks more than 500 percent. This is what really accounts for superior stock performance: strong earnings growth backed by brisk sales, not accounting gimmickry. If you demand that your stock selections not only show strong earnings but also show strong sales, you will increase your chances of latching on to a superperformer.

Generally, I look back one to two years to see if there has been some form of earnings and sales acceleration. Life is not perfect, and so if one quarter here or there doesn’t accelerate, it may not be a big deal. You can smooth out quarterly results by using a two-quarter rolling average over the past four, six, or eight quarters.

If a company is truly doing well, its success is unlikely to end overnight. A surprisingly good earnings report could be the beginning of a string of successful quarters. Strong quarterly results should translate into strong annual results. Just one or two quarters of good earning isn’t going to be enough to drive a stock’s price significantly higher for an extended period.