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

LOOK FOR A BREAKOUT YEAR You can go back two to four years or more to a record year and see if current earnings are breaking out above the previous trend. It can be a fairly significant event if earnings suddenly break out to the upside from a range that was established over several years. Finally, check the upcoming one or two quarters as well as the next fiscal year to see if earnings acceleration is expected to continue.

With turnaround situations, investors should insist that the current earnings be very strong (+100 percent or better in the most recent one or two quarters). If the previous results were dismal, the company should be doing significantly better percentagewise in light of easy comparisons. You could also insist that earnings and margins be at or close to a new high for added confirmation that the company is back on track.

Earnings AND Margin ns at all time highs?

In some cases, you can spot turnarounds and earnings acceleration by comparing the current annual growth rate or current quarterly results with the three- or five-year growth rate. A company that has been growing 12 percent a year and suddenly starts to show growth of 40 percent and then 100 percent could be a hot prospect.

DECELERATION IS A RED FLAG A company can be doing great with high-double-digit percentage growth and then “deteriorate” to mid-double-digit growth. For another company, growing by 20 or 30 percent may be a big improvement. However, for a company that had been growing at upward of 50 to 60 percent or more, a growth rate of 20 to 30 percent would be a material deterioration. Consider what happened with Dell Computer, which from 1995 to 1997 had grown its earnings per share at 80 percent annually and then declined to around 65 percent in 1998 and 28 percent in 1999. Although this was still decent growth, it was a material change and marked the end of the tremendous move in Dell’s stock price. The stock peaked in 2000. Ten years later Dell’s stock price was considerably lower, down more than 80 percent from its high.

In summary, institutions like to see the following: • Earnings surprises • Accelerating earnings per share (EPS) and revenues • Expanding margins • EPS breakout • Strong annual EPS change • Signs that acceleration will continue

ASSESSING EARNINGS QUALITY A COMPANY CAN GENERATE EARNINGS in various ways, some not so trustworthy; I prefer high-quality earnings. In other words, where did the earnings come from? Did the company post better results because of stronger sales? If sales were strong, was it only because of a single product or one major customer? In that case, the growth is vulnerable. Or are the surprisingly strong results due to an industrywide phenomenon or an influx of orders from numerous buyers? Maybe the company is slashing costs and cutting back. Earnings improvement from cost cutting, plant closures, and other so-called productivity enhancements walks on short legs. Such improvements can show up from time to time, but sustainable earnings growth requires revenue growth. Examining earnings quality gives you perspective and rationale before you commit your hard-earned money to a stock.

I’m looking for earnings that come from core operations, not from a one-time gain or an extraordinary event. Most of the time the difference between operating income and nonoperating income is clear-cut.

Some companies are habitual abusers of the one-time charge. If the one-time charge is showing up over and over, you should seriously question the earnings quality of even the largest and most respected corporations engaging in this practice.

if a company is reporting great earnings but is not paying much in taxes, be skeptical.

HITTING ON ALL CYLINDERS: THE CODE 33 When a company grows its sales at an accelerating rate (25 percent, then 35 percent, then 45 percent, and so on), this is great. Better still, though, is a company that accelerates its sales and expands its profit margins at the same time. This powerful combination can ignite earnings and fuel explosive stock price appreciation. The result is a condition in which the company can grow its earnings at a much faster rate than it could if sales or margins were accelerating only by themselves or if neither were accelerating. The best situation for rapid earnings growth is to be hitting on all cylinders as sales accelerate and profit margins expand simultaneously.

MOST OF THE BIG MONEY made in bull markets comes in the early stages, during the first 12 to 18 months. However, by the time a big advance asserts itself in the broad market indexes, many of the best stocks may have been running up for weeks in advance. The question then becomes how you know when to jump on board before an emerging rally gets away from you and the very best stocks leave you in the dust. The answer: follow the leaders. Top-performing stocks will lead the broader market averages at important turning points. As a bear market is bottoming, leading stocks, the ones that best resisted the decline, will turn up first and then sprint ahead—days, weeks, or even months before the Dow, S&P, and Nasdaq indexes put on their running shoes. These leading names will break into new high ground while the major indexes are just starting to come off their respective lows. At this point, overall market conditions still look bleak to most investors and the news is still for the most part negative and cautionary. Later, the rally broadens, pushing up the indexes, which propels the front-runners even higher. Then sentiment begins to shift from fear to optimism. By paying close attention to the market’s leading names, you can be in the best stocks before they are obvious to the public. This is nothing new to astute stock investors who know what to look for. The legendary Jesse Livermore built his fortune by trading in leading stocks in the 1920s and 1930s. I made 99 percent of my ...

The problem for most investors is that they fail to notice the important nuances and clues from leading stocks near turning points, and that causes them to lose perspective. Why? Investors are gun-shy after the market has been declining steadily. Just about the time the market is bottoming, most investors have already suffered large losses in their portfolios because they refused to cut their losses short. After a market correction, many investors are busy hoping to break even on the open losses they hold or are convinced that the end of the world is coming because they got crushed during the previous decline and refuse to acknowledge the buy signals individual leading stocks are offering. Making it even more difficult is the fact that leading stocks always appear to be too high or too expensive to most investors. Market leaders are the stocks that emerge first and hit the 52-week-high list just as the market is starting to turn up. Few investors buy stocks near new highs, and fewer buy them at the correct time. They focus on the market instead of the individual market leaders and often end up buying late and owning laggards. Adding to the distraction is the fact that the news media are usually wrong at major turning points. At a market bottom they’ll predict the end of the world, and at a top the same people will say you can’t go wrong investing in stocks. It can be very confusing if you listen to what people are saying instead of paying attention to what the stocks are t...

During the first few months of a new bull market you should see multiple waves of stocks emerging into new high ground; general market pullbacks will be minimal and probably will be contained to 3 to 5 percent from peak to trough. Many inexperienced investors will be looking to buy a pullback that rarely materializes during the initial leg of a new powerful bull market, which from the onset will appear to be overbought. Typically, the early phase of a move off an important bottom has the characteristics of a lockout rally. During this lockout period, investors wait for an opportunity to enter the market on a pullback, but that pullback never comes. Instead, demand is so strong that the market moves steadily higher, ignoring overbought readings. As a result, investors are essentially locked out of the market. If the major market indexes ignore an extremely overbought condition after a bear market decline and your list of leaders expands, this should be viewed as a sign of strength. To determine if the rally is real, up days should be accompanied by increased volume whereas down days or pullbacks have lower overall market volume. More important, the price action of leading stocks should be studied to determine if there are stocks emerging from sound, buyable bases.

Buyable bases in tfhes leading stocks?

Additional confirmation is given when the list of stocks making new 52-week highs outpaces the new 52-week low list and starts to expand significantly.

THE BEST STOCKS MAKE THEIR LOWS FIRST

Make a low early doesnt mean fall as much as thes market and stay low, but rather drop early, maybe a lot, but rebound quickly

To make big money in the stock market, you’re going to need to have the overall stock market’s primary trend on your side.

A strong market trend is not something you want to go against. However, if you concentrate on the general market solely for timing your individual stock purchases, you’re likely to miss many of the really great ...

The true market leaders will show strong relative price strength before they advance. Such stocks have low correlation with the general market averages and very often act as lone wolves during their biggest advancing stage. The search for these stocks runs contrary to the thinking of most investors, who often take a top-down approach, examining first the economy...

many of the very best leading stocks tend to bottom and top ahead of their respective sectors, whereas specific industry groups can lead a general market turn. Although it’s true that many of the market’s biggest winners are part of industry group moves, in my experience, often by the time it’s obvious that the underlying sector is hot, the real industry leaders—the very best of the breed—have already moved up dramatically in price. In the early stage of a relative strength leader’s uptrend, there may or may not be much confirming price strength from its group overall. This is normal. Often there will be only one or two other stocks in the group displaying strong relative strength. Therefore, it requires additional skill to pinpoint these stocks early on. As the leader’s trend continues to advance and eventually its industry group and sector begin to show signs of strength, the price advance of the market leader will do one of two things: it will continue its advance while the group propels it even higher, or it will consolidate in a sideways fashion and digest its previous gains while the group and other stocks i...

The stocks that hold up the best and rally into new high ground off the market low during the first 4 to 8 weeks of a new bull market are the true market leaders, capable of advancing significantly. You can’t afford to ignore these golden opportunities.

Market leaders tend to stand out best during an intermediate market correction or in the later stages of a bear market. Look for resilient stocks that hold up the best, rebound the fastest, and gain the most percentagewise off the general market bottom. This, too, will identify potential leading names. After an extended bear market correction, look for stocks that hold their ground or, even better, work their way higher while the general market averages trend lower. A series of higher lows during lower lows in the general averages is a tip-off that a potential market leader is in the making. The relative strength line of the stock should show steady improvement as the market declines. It’s important to study carefully the price action of individual companies with new positive developments and strong earnings per share during major market declines. Many of the most strongly rebounding stocks and the ones that hold up the best are likely to become the next up cycle’s superperformers.

1. A first wave of market leaders emerge and build bases in a stairstep fashion, as in the Humana example. 2. Stock set-ups proliferate while the original leaders give up relatively little ground and rebound fairly quickly from any sell-off. Leading stocks will generally advance 15 to 20 percent and then rest, during which time they may pull back 5 to 10 percent. 3. The majority of leaders should hold their ground. Even though there are bound to be some stocks that emerge and then fail, you don’t want to see most of the leaders that broke out come crashing down and not able to rally. 4. Volume on the major averages should also be watched for signs of distribution. If this is accompanied by increasing volume on down days versus up days, it may be too early, and you may need to revert back to cash for protection.

Emulex shot up 100 percent in only one week. This impressive strength was the initial tip-off that something big was about to happen with the stock. Such a surge in demand is often a reaction to a positive development that has recently surprised the Street or an indication that something is being anticipated. Next, the stock pulled back sharply, but it recovered very quickly in only a few days. The stock gave up little ground afterward. The price then moved into new high ground as the general market rallied off its lows. This was the green light to buy.

Often, stocks that hold up well during bear market corrections are in their own earnings up cycle. These stocks may benefit from strong earnings and sales, new products or services, or industry changes that positively affect the company. However, a stock’s price trend may be temporarily held back or muted by the weight of the bearish primary trend of the general market. This causes a stock’s price to decline, but not as severely as the prices of other stocks. These stocks are generally very resilient and bounce back into new high ground quickly off their lows. When the bearish market exhausts itself and turns up, stocks in their own earnings up cycle will blast off and advance significantly, in some cases for an extended period. On the flip side, stocks that are in their own bearish cycle may resist even a strong market and go nowhere. Often this is an indication of an unfavorable outlook, and these stocks should be avoided.

Each market cycle has a unique signature in the form of the price and volume action in leading names. Often a similar technical theme will be present. A growing number of stocks displaying positive, divergent price behavior during a general market decline can tip you off to where the next group of market leaders may emerge or what stocks are likely to blast off first when the market starts to rally. When you see this type of price action, it’s time to tune out the media and the gurus and concentrate on the facts: price, volume, earnings, sales, profit margins, new products, and positive industry changes. Look for the evidence stock by stock and employ the best criteria. Most of the time there will be more than just one stock in a particular industry group displaying this type of behavior. You should try to own the top one, two, or three names in the industry in terms of relative performance and earnings power. Look for the types of patterns and price action that are proliferating in the marketplace. This can help you understand what type of tactic will work best in the current cycle.

LEARN TO BUY LEADERS AND AVOID LAGGARDS As a general rule, I buy strength, not weakness. True market leaders will always show improving relative strength, in particular during a market correction. You should update your watch list on a frequent basis, weeding out issues that give up too much price and adding through forced displacement new potential buy candidates that show divergence and resilience. In addition to keeping your lineup of candidate buys current, this practice will sharpen your feel for the overall health and quality of the market and keep you focused on the very best companies. Things begin to get exciting as the broader market indexes start to bottom and begin the first leg up in a new bull market. At this point, you should concentrate on the new 52-week-high list. Many of the market’s biggest winners will be on the list in the early stages of a new bull market. You should also keep an eye on stocks that held up well during the market’s decline and are within striking distance (5 to 15 percent) of a new 52-week high. Conversely, every day there is a list of stocks to avoid printed in the financial newspapers: the 52-week-low list. I suggest that you stay away from this list and all of its components. The 95 best-performing stocks of 1996 and 1997 took just five weeks to surge 20 percent. On average, those stocks gained 421 percent. Among those 95 stocks, 21 jumped 20 percent within a mere week. Those stocks went on to surge on average 484 percent. In 1999,...

My own trading relies on charting to the extent that I would never bet on my fundamental ideas alone without confirmation from the actual price action of the underlying stock. First, I utilize charts to establish the prevailing trend of a stock’s price. In other words, technical analysis enables me to qualify candidates for my watch list. Then I use charts to time the entry of my trades.

Price and volume analysis can help you determine whether a stock is under accumulation or distribution (being bought or sold in size).

The key is not knowing for sure what a stock is going to do next but knowing what it should do. Then it’s a matter of determining whether the proverbial train is on schedule.

When one identifies the proper characteristics for a superperformance candidate, the risks become unambiguous. If a stock doesn’t act as expected, that’s a major red flag. After all, the stock has already met very elite criteria and has been deemed a strong prospect. If such a stock behaves poorly, that suggests a problem. Learning what to expect allows you to detect when a stock is acting correctly or incorrectly in the prevailing conditions. Because you know how something is supposed to perform, when it doesn’t perform that way, it makes the exit decision much easier.

The first mistake I see amateurs make time and again when using charts is ignoring the first step: the big picture. The first and most basic information that charts show us is the prevailing trend of a stock. We can see if it’s trending up or down or is moving in a sideways pattern (i.e., stage 1, 2, 3, or 4). Once we have established that the longer-term trend is up (stage 2) and see some evidence that a particular name is a candidate deserving of our attention, whether it’s a market leader, a turnaround situation, or even a cyclical, it’s time to concern ourselves with the best time to purchase the stock. At that point, we want to determine when the moment is right to pull the trigger and make our commitment to the position. Therefore, charting can play an important role in selection and timing.

My first advice about charting stocks is that you should not look at things in a vacuum. Most of the chart work I rely on is based on the continuation of an existing trend. This concept is fundamental to my approach. If you want to maximize compounding, you want to be where the action is and take advantage of momentum. You should limit your selections to those stocks displaying evidence of being supported by institutional buying. You’re not trying to be the first one on board; rather, you’re looking for where momentum is picking up and the risk of failure is relatively low.

To time my entry, I look for price consolidations, which are momentary pauses or periods of rest within the context of a prior uptrend. However, too often an investor will buy a stock because it has a “great” chart base but will overlook the f...

Going long a “great base” in a long-term downtrend is like saying you’re in good health by focusing on your low cholesterol reading when you have pneumonia. Although the cholesterol reading is good, you face a much more serious problem. The current chart pattern is only as good as where it resides within the context of its longer-term trend. If you are too early, you run the risk of the stock resuming its downtrend. If you’re too late, you run the risk of buying a late-stage base that is ...