Small Stocks for Big Profits E-Book

George Angell

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Wiley Trading Series
• Sprache: Englisch

Seitenzahl: 363

Veröffentlichungsjahr: 2008

Beschreibung

Praise for SMALL STOCKS for BIG PROFITS "George has done it again with Small Stocks for Big Profits. His in-depth experience is invaluable in helping traders explore stocks that are $5 or less, without getting caught up in the fly-by-night idea companies that plague this investment level. He shows you where to look for opportunity and more importantly how to lock in profits in this little understood investment arena. Impressive!" --Noble DraKoln, author of Winning the Trading Game In Small Stocks for Big Profits, George Angell outlines an effective strategy for finding up-and-coming companies with the potential of earning you incredible returns. Filled with in-depth insights and practical advice, this reliable resource shows you how using a combination of technical and fundamental analysis-along with other essential tools-can put you in a position to profit from the explosive growth of smaller companies with undervalued, low-priced stocks. Page by page, you'll discover how to incorporate this proven approach into your own investment endeavors as Angell discusses how to use it to select, place, and exit trade after profitable trade. Small, speculative stocks are quickly beginning to appear on the radar screens of investors around the world. If you want to make the most of your time in this lucrative market, pick up Small Stocks for Big Profits today and put its invaluable insights to work for you.

Leseprobe

Table of Contents

Title Page

Copyright Page

Preface

WHY ANOTHER STOCK MARKET BOOK?

THE SPECULATIVE VERSUS THE SURE THING: THE CRAY RESEARCH STORY

HIDDEN GEMS

NOTE

CHAPTER 1 - Making Money in Small-Caps

SMALL-CAPS: THE NEXT BULL MARKET

SEPARATING THE WHEAT FROM THE CHAFF

HIDDEN VALUE: THE SMALL STOCK’S SECRET WEAPON

THE VALUE INVESTOR

TIMING

SMALL STOCKS, BIG PROFITS

PAYING PENNIES, SELLING FOR DOLLARS

EVERY STOCK HAS ITS STORY

CHAPTER 2 - Getting Started in Technical Analysis

THE CONVENTIONAL WISDOM

WHAT IS TECHNICAL ANALYSIS?

WHERE TO BEGIN?

SUPPORT AND RESISTANCE

CHARTS AND TRENDLINES

BREAKOUTS

MANAGING THE BREAKOUT TRADE

CONTINUATION AND REVERSAL PATTERNS

THE MOST RELIABLE CHART PATTERNS

THE REAL VALUE OF TECHNICAL ANALYSIS

TIME AND PRICE

MOMENTUM

A WORD ABOUT SHORT SELLERS AND HOW THEY IMPACT A STOCK’S PRICE

CHAPTER 3 - Profitable Strategies

IDENTIFY SUPPORT

THE RULE OF THREE

THE MOMENTUM PLAY

CONTRARY OPINION

IDENTIFY THE CORRECT PHASE OF THE TREND

A PERSONAL OBSERVATION

FINDING GOLD AMID THE DROSS

THE BOTTOM REVERSAL

AGGRESSIVE BUYING

WHEN TO CUT AND RUN

STOCKS THAT TREND WELL . . .

. . . AND THOSE THAT DON’T

THE REBOUND THEORY

TIMING THE REBOUND

WHEN IS A STOCK READY TO BUY?

HOW TO IDENTIFY THE LOW-RISK BUY

CHAPTER 4 - Timing

SEASONALITY

HOW TO USE THE BULLISH CONSENSUS WITH SEASONAL PATTERNS

HOW TO CONSTRUCT AN OSCILLATOR

MOMENTUM ANALYSIS

TRADING FILTERS

STOPS

MOVING AVERAGES

MARKET TIMING: PRO AND CON

CHAPTER 5 - IPOs

THE BASICS

THE PUBLIC OFFERING PROCESS

HOW TO READ A PROSPECTUS

THE COOLING-OFF PERIOD AND ROAD SHOW

WHAT HAPPENS NEXT

CHAPTER 6 - Insider Buying

WHO IS AN INSIDER?

HOW TO TRACK THEM

SMALL STOCKS HAVE THE EDGE

CHAPTER 7 - The Selection Process

ASSET PLAYS AND CONCEPT STOCKS

GUIDELINES

NUTS AND BOLTS

MONEY MANAGEMENT

REVENUES AND EARNINGS

CASH FLOW

PRICE-TO-SALES

BALANCE SHEET BASICS

UNDERSTANDING RETURN ON INVESTMENT (ROI)

DEBT

CHAPTER 8 - Options

THE BASICS

THE TERMS OF AN OPTION

GETTING STARTED IN OPTIONS TRADING

HOW TO USE OPTION VOLUME TO PINPOINT MOVES

THE RULES

CHAPTER 9 - Your Roadmap for Success Tomorrow

BUY WHEN STOCKS ARE LOW-PRICED AND DEPRESSED

IDENTIFY FIRST LEG AND COUNTERMOVE

THE WORST-PERFORMING ISSUES

ALWAYS BUY AT SUPPORT

PRICE CAPITULATION

DEVELOPING A WINNING MIND-SET

AN INVESTOR’S CHECKLIST

THE LOOK AHEAD

About the Author

Index

Copyright © 2008 by George Angell. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey. Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication DataAngell, George. Small stocks for big profits : generate spectacular returns by investing in up-and-coming companies / George Angell. p. cm. Includes index.

eISBN : 978-0-470-43764-3

1. Small capitalization stocks. 2. Stocks. 3. Small business-Finance. I. Title. HG4971.A54 2008 332.63’22-dc22 2008014651.

Preface

About 10 years ago, I had the luckiest day of my investment career. I received a phone call from a fellow in Las Vegas who made a living investing in small-cap stocks. We discussed the markets for a bit, trading background information. Did I ever come out to Las Vegas? the caller inquired. Sure. I enjoyed an annual trip to the gambling capital. I liked to bet on sports and the occasional craps game. Indeed, I had a trip to Las Vegas already planned for the following month. He suggested I look him up. We could have lunch. I made a mental note of our conversation and went back to whatever I was doing.

Five weeks later, I took a cab over to his Las Vegas office just before noon. We had lunch. And, as our discussion about the markets continued, we later had dinner. The entire day had been taken up with talk of his—and now my—foremost investment passion, the buying and selling of small stocks. This was an eye-opening event for me. In the years that followed, we invested in approximately a half-dozen stocks. Each of them proved to be a winner. And I mean a big winner. One, a small Vancouver-based mining company known as First Quantum Minerals (FM.TO), later soared from just 80 cents a share (where we bought it) to over $100 a share! The other stocks—mostly mining, gaming, biotech, and oil issues—returned more modest gains, but never failed to at least quadruple or quintuple in value. He was a firm believer in loading the boat. Constantly buying up 9 percent of the shares of these little-known companies (in order to stay under the 10-percent reporting limits for insiders), he usually owned a larger piece of the company than the key officers and board of directors combined. Needless to say, he earned millions. I made less, of course, because my investment commitment was on a more modest scale. But just recently, one of his little gems rose a whopping 42 percent in one day on discovery of gold on its Ontario property. It is getting so that I’m not even surprised by these spectacular winners anymore. But I know one thing: I could never find anyone to pay me this kind of money that I’m making in small stocks.

What is his secret? There isn’t any secret. It is simply hard work. Being a confirmed dyed-in-the-wool value player, he seeks hidden value in everything he buys. Quite often, these hidden gems have value written all over them, but most hapless investors are too blind to the possibilities to risk taking a chance on an unproven, low-priced stock. You don’t believe me? Turn on CNBC and monitor the stocks that they highlight all day long. You’d be hard-pressed to find one that triples or quadruples in value over six months. Yet these kinds of percentage gains are routine in the world of small stocks. Moreover, for a variety of reasons, the bonanza in small stocks is just beginning. In the coming three years, we should see unprecedented gains in the prices of small stocks as entrepreneurs seek out new opportunities in the fields of alternative energy sources, biotech advances, and technology. These modern-day explorers will be requiring financing by issuing shares in new companies that will undoubtedly see their fortunes—and share prices—grow. We are only at the bottom floor, the very beginning, of this exciting time in the investment world.

For the would-be investor in these up-and-coming stocks, the challenge remains daunting. How do you pick a winner? The fact is: Many of these opportunities exist in start-ups, unproven companies that have never earned a dime before. Anyone can ask their broker to recommend a dividend-paying blue-chip stock. But how do you put a price on someone’s dream? Needless to say, there are people out there building a better mousetrap. I can remember back in the 1960s when a college professor told our class that “hi-fi” couldn’t get any more advanced. Recently, I purchased an iPod the size of a pack of matches that holds virtually my entire CD collection—a collection, incidentally, that occupies a sizable portion of the shelving space in my media room. Who says the better mousetrap builders aren’t out there today, utilizing new technologies that were unheard of even several years ago? The challenge, therefore, becomes one of finding these hidden opportunities and putting our money on the line. The payoffs will be impressive.

WHY ANOTHER STOCK MARKET BOOK?

I’ve been reading books on trading stocks, futures, and options for more than 40 years. Indeed, I’ve even written close to a dozen books on Wall Street. But not one of them prepared me for what I learned in the first two weeks as a pit trader on the floor of one of the Chicago exchanges. The theory is one thing; the reality of risking your money is quite another.

Not long ago, when I glanced through the pages of a number of investment books at my local bookstore, I noticed how useless most of the well-meaning advice was for the beginning investor. The books told the reader to diversify, as if that were the answer to finding the best stock. This, in fact, is known as the “spaghetti” technique, in which you throw a bunch of wet spaghetti against a wall to see what sticks. Similar investment books sang the praises of mutual funds or dollar cost averaging, in which you willy-nilly keep buying regardless of the wisdom of your stock selection. This latter piece of advice is given in hopes that the market will subsequently rise. What about not purchasing a bad stock in the first instance? There are a variety of ways in which stocks tell their stories. One is when a formerly quiet company suddenly experiences overwhelming share volume. There are other technical clues. But a stock’s story may be highlighted in something as simple as excessive insider buying by company officers and directors. These individuals, who are closest to the company, are often the ones who buy and sell significant blocks of shares just before a market-moving event. There are ways to read the footprints of the insiders for those in the know. One such good indication is worth a dozen guesses. When you think about it, you need only a few good stocks to make a significant amount of money.

In the pages that follow, I’ve tried to outline some of the best ways to find undervalued, low-cost stocks. If you are a believer in the conventional wisdom, chances are you will have to turn everything you’ve learned until now on its head. As in any business, the cream rises to the top; only the few win the lion’s share of the profits. The rest scramble for what’s left over. The reason for this rests with human psychology. It is not that most people want to lose money in the stock market—only that most people are so risk-averse that they almost guarantee a negative outcome. Given a ground-floor opportunity, most people would rather wait until their profit is a certainty—a virtual prescription for trading losses. Once everyone knows a stock is worth buying and has done so, it is inevitable that the stock will decline. Witness the enthusiasm for buying stocks at the top.

THE SPECULATIVE VERSUS THE SURE THING: THE CRAY RESEARCH STORY

Most of today’s stock market successes were created by companies that started small. The reason you keep hearing about the Microsoft millionaires is because they purchased or were given stock when the company was in its infancy—and dirt cheap. But the opportunity to make the real money in a stock like Microsoft is now over. Such a stock, which has undoubtedly minted hundreds of millionaires, is strictly a ho-hum affair today. The bloom is off the rose. The big opportunity has passed. The rule is you have to get there early.

The value of finding one good speculative stock comes home to me when I think of this true story that was told to me by a former New York University student who went into the brokerage business. After graduating from business school, my friend became a stockbroker in New York City. After working in New York for several years, he decided to take a position with a brokerage firm in La Jolla, California. New to the West Coast, he took what business came his way while building his book, which later consisted of strictly high-net-worth individuals willing to put up millions in investment funds. At any rate, a retired schoolteacher appeared in his office one day, looking to invest $10,000 in the stock market. The broker recommended an investment in an up-and-coming high-tech company known as Cray Research, a computer company. My broker friend explained that on the one hand Cray was a risky investment and the teacher could lose all his funds. On the other hand, the broker said, there was a considerable upside. At the time, little-known Cray traded on what was known as the over-the-counter market. This was a market for lesser-known stocks that didn’t qualify for the Big Board. Years later, of course, the over-the-counter market morphed into what is known today as the Nasdaq.

After careful consideration, the schoolteacher agreed to buy the stock and wrote a check for $10,000. The stock was purchased and placed in the teacher’s account.

Several years passed.

Focusing on high-net-worth individuals, the broker lost contact with the schoolteacher and began seeking out promising stock opportunities for his wealthy clients. His business grew and he prospered. Finally, after a number of very successful years, the broker decided he wanted to start his own public company and get out of the brokerage business. But before he could leave his job, he had to call all his clients and tell them about his impending move.

That’s when he called the schoolteacher.

“Oh, it’s you!” the teacher responded when the broker called. “I’m not interested in buying any more stock.”

The broker explained that he wasn’t suggesting the teacher buy more stock. He just wanted to tell him that he was leaving the firm and another broker would have to handle his account.

“What are you talking about?” the teacher demanded. “The stock went to zero. It is not even listed in the newspaper anymore.”

“Zero?” responded the broker. “What are you talking about? You own Cray Research.”

“Well, it’s not in the newspaper.”

“Not in the newspaper?” said the broker. “Go get the newspaper and bring it to the phone.”

The teacher did as he was told. The broker explained that the stock had split numerous times over the years and was now traded on the New York Stock Exchange—not over-the-counter. In fact, the teacher’s shares were now worth well over a million dollars. The broker explained that he would be happy to sell the shares and place the funds in a mutual fund. The teacher couldn’t believe his good fortune. For years thereafter, the broker received big baskets of fruit and candies every holiday season from his former client, who greatly appreciated his investment advice.

The broker later learned that the million-dollar bonanza changed the retired schoolteacher’s life. It was a story he told with a great deal of pride.

HIDDEN GEMS

Finding similar opportunities is what this book is about. Not long ago, I went back and checked the performance of some of the stocks I recommended in my book, The Best Small Stocks for 2007 (TradeWins Publishing). One mining issue, FNX Mining (FNX.TO) has gone from $10 a share to $30 a share. Zix Corporation (ZIXI), a stock that highlighted its potential by a number of volume spikes, has doubled in value this past year. Beas Systems (BEAS), a software maker, has risen smartly from under $14 to over $19 a share. Equinox Minerals (EQN.TO), a Toronto Exchange-traded mining issue, has risen from under a dollar to $4.70 a share. And, of course, Pelangio Mines Inc. (PLG.TO), which I purchased at about a dollar a share and was my stock of the year, is now trading above $4 a share. What these issues all have in common is that they were small, speculative stocks, with very little following in the investment community. They are now appearing on the radar screens of investors around the world. The key was identifying them before the crowd even noticed.

In the pages that follow, I spell out some of the key elements necessary to win in the market. Not only must you understand what stock to buy, but you must understand how to buy as well. Timing is everything in the market. Moreover, a premature purchase of a stock need not be a disaster. You can always average down, which is a time-honored tradition among stock market professionals.

I place a lot of emphasis in the book on entry techniques. The general rule is: The market will tell you when a stock wants to run. You simply must know what to look for. Moreover, once a stock tips its hand, it also offers you an opportunity to get aboard at a low-risk price—if you know what to look for. Take a quick look at Northgate Minerals Corporation (NXG). This was a stock that was a screaming buy at $2 a share (with virtually no downside risk). It is now trading at $3.35.

A lot of the book deals with time-tested support and resistance calculations. These are the same techniques that professional floor traders use—and you should as well. A stock forms a support pattern for a reason. Investors think the stock is a good value at that price. That’s why it makes so much sense to always know the support and resistance levels.

The issue of money management is addressed in a straightforward fashion. Anyone can be reckless and make money on a few lucky trades. But the professionals prefer to risk as little of their initial capital as possible, taking capital off the table and letting their paper profits ride. You’d be surprised how confident it makes one feel to know that regardless of the subsequent movement of the stock, you won’t be taking a loss—because you got your seed capital out on the first move up. In a nutshell, professional traders become very proficient at doing one simple strategy. Then they repeat that investment strategy over and over again. The low risk is the key to their success.

Every successful trader will tell you that he or she has made a lot of mistakes over the years. In this department, I am no exception. But I find learning from mistakes is one of the best teachers around. Success tends to breed overconfidence. But failure requires that you examine your shortcomings and do something about them—if you intend to survive. There are a number of red flags that serve as a warning that something is wrong. I discuss some of them in the book. Unfortunately, however, the real lessons very often have to be learned firsthand, as you will see if you trade stocks for any period of time.

Whenever possible, I’ve tried to illustrate the principle with an example of an actual stock. In many of the examples, if I’ve traded the stock, I’ll try to add my personal observations about what happened—for better or worse. I’m a big believer on stepping in when most other investors are heading for the exits. That’s because I’ve had years of experience watching people panic at precisely the wrong time. There is a certain mob psychology that exists in the markets. Learn to understand it and you can be the one person standing amid a scene of wholesale destruction. It is especially gratifying to buy a stock near the bottom of its move only to see the price later skyrocket. Timing, indeed, is everything. It is so important that I’ve devoted an entire chapter to timing alone.

The challenge for the investor is to understand a stock’s story long before the investment community becomes aware of its existence. In the beginning, you won’t always know what you have. But if you work at it, you will find that a company’s real value rests with its potential and not what the analysts and pundits are talking about. That’s how I bought First Quantum Minerals (FM.TO) for about a buck a share before it headed to over $100 a share. It was also how I spotted Gigamedia (GIGM) before it skyrocketed. Remember, every stock has its story. It is just a question of figuring out which one is going to prove a bonanza down the road.

For the novice trader, I’ve included a crash course in technical analysis. Knowing the basics of technical analysis is vital to becoming a winning investor. Understanding chart patterns and time and price calculations is also important if you want to understand when to buy a stock and—significantly—when to sell. I devote a section to the most reliable patterns to look for. But the thing to remember is: A professional rarely guesses about a stock because he or she knows where the stock is heading based on the price patterns, which are clearly knowable to the discerning investor.

The longest chapter is devoted to exploring those strategies that are most likely to help you win. There are a number of pitfalls that you have to look out for. As you undoubtedly know, differences of opinion make the market. But it is downright uncanny how inaccurate most Internet-based opinion makers can be. My experience in buying Best Buy illustrates this phenomenon completely—right down to the point that these experts were saying Warren Buffett didn’t know what he was doing. People love to buy a sure thing, of course. That’s why I’m often out of a stock long before its name ever appears on CNBC.

Stock selection is mostly about separating the weak stocks from the strong ones. For this reason, I cover how to develop trading filters and how to use them. You’d be surprised how fine-tuning your strategies can put you in the winner’s column almost immediately when you invest in a stock.

I devote a short chapter to the basics of capitalizing on initial public offerings. This is a specialty that may appeal to some investors, but, for most, it is better left alone.

One of my favorite topics is that of insider buying. When you have the combination of a rapidly falling stock price coupled with a massive buying program by someone within the company, it is almost always a sign that the next move is up. Shaking people out of the market is another time-honored tradition of the stock market. The problem is that if the “smart money” is buying, it is the worst possible time to sell. You’d be surprised how often the so-called fundamentals change overnight when negative news drags down a stock’s price. The insiders know what is going on within a company. For them, buying or selling the stock isn’t a speculative venture; they understand what is coming—sort of like when George W. Bush sold his shares in his small oil company right before the massive losses were announced. Fortunately, there is a way to track the footprints of the insiders.

Finally, there is a brief discussion of stock options and how to use option volume to pinpoint when to buy or sell a stock. You can also use options to obtain heightened leverage in a particular stock.

The “Road Map” chapter tries to tie everything together. Notice the price capitulation in Pelangio Mines Inc. at 30 cents. I own that stock, and today it is trading above $4 a share! Sometimes the best reason to trade small stocks is because it is simply so much fun! Here’s to profitable trading.

NOTE

While every effort has been made to report the names and prices of the companies listed in this book accurately, it is important that the reader understands that nothing written here is an endorsement or recommendation to purchase a particular security. The key to investment success is timing. With a manuscript written so many months before the finished book gets into the reader’s hands, it is impossible to present the current status of a particular stock as a buying or selling opportunity. Therefore, take the examples as they were meant to be used—as illustrations of specific strategies and nothing more. With a little work, the reader should be able to uncover his or her own examples.

Lastly, the material presented here is intended as a jumping-off place for the investor interested in buying and selling small stocks. It is not the final word. Neither the author nor the publisher should be held liable for investments made by readers of this publication since no legal, accounting, or other professional services are intended in this work.

CHAPTER 1

Making Money in Small-Caps

By almost any benchmark, small-cap stocks are the new value on Wall Street—and, increasingly, on its counterpart in Canada, Toronto’s Bay Street, where some of the highest fliers of the low-priced stock world trade. What’s more, in the years to come, you’ll find these hidden gems, these proverbial diamonds in the rough, leading the indexes higher. I say this with barely concealed enthusiasm because, given the current beaten-down investment climate, it is inevitable that the cycle will change and the small-caps will explode higher.

Small-caps present a ground-floor opportunity—one that doesn’t present itself every day. We all know that expectations are the highest at market tops. But right now, because market expectations are less than stellar, the conditions are ripe for the astute investor to gobble up low-price shares in dozens of beaten-down companies whose stocks are selling significantly below their true value. Cheap stocks, depressed stocks, penny stocks, small-cap stocks—whatever you want to call them, they are the next new big thing. The question is: Will you get on at the ground floor, or would you prefer to wait until these shares sell at penthouse prices?

SMALL-CAPS: THE NEXT BULL MARKET

It’s a simple premise: With the indexes already climbing to new highs, it is not a matter of if the next bull market will see a surge in small-cap stock prices, but when. Looking back, one can see plenty of historical evidence for continued explosive growth among low-priced stocks. Small-caps, for instance, have traditionally enjoyed spectacular gains compared with their higher-priced cousins. Over one recent 10-year period, small-caps outperformed larger-cap stocks by a whopping ten-to-one margin. As for percentage gainers, the small-caps invariably lead the pack. The top ten low-priced gainers increased in value by more than 261 percent over a recent year. During an identical period, the top ten S&P listed stocks gained just under 15.5 percent.

When you consider the numbers involved, you can see why investors prefer low-priced stocks. From an investor’s standpoint, you can take $5,000 and buy 5,000 shares of a $1 stock (commissions excluded) or 100 shares of a $50 stock. A 50-cent gain in the $1 stock would generate $2,500 in profit. That’s a 50 percent gain. The same 50-cent gain on the $50 stock, however, would generate just $50 in profit. To double in value, a $1 stock has to rise to only $2. To generate the same percentage gain, a $50 stock has to trade at $100 a share. Now ask yourself which is more likely to happen: a $1 stock going to $2 or a $50 stock going to $100?

The reluctance of investors to jump on the bandwagon of a higher-priced stock explains why successful companies often have two-for-one splits. By offering twice as many shares to their investors, companies can enjoy greater investor participation by halving the share cost from, say, $60 a share to $30 via a stock split.

Investor enthusiasm for small-caps is likely to grow for many reasons beyond the price alone. Smaller companies are more likely to be start-ups or in the early stage of their development. This allows greater upside potential. A seasoned company, on the other hand, has far greater difficulty in achieving the same level of growth as a new, smaller company. Accordingly, low-priced stocks can often double and triple in value while their big brothers have trouble attaining even a double-digit gain. It is not uncommon to see the stock of smaller companies increase in value by many hundreds of percent.

During uncertain times, however, these lower-priced companies are often ignored. People prefer something tried-and-true, perhaps a blue chip that pays steady dividends. The result is a lot of hidden value in the lower-priced issues. These are the shares we want to go prospecting for, sort of like digging up gold that lies hidden in the mine. Not surprisingly, many small-caps are indeed mining companies, their resources literally lying in the ground.

I found just such a stock several years ago when a friend recommended a little-known company trading on the Toronto Stock Exchange. Though its corporate offices were headquartered in Vancouver, British Columbia, First Quantum Minerals (FM.TO) was really an undiscovered asset-rich little copper-mining company in Zambia (see Figure 1.1). Its hidden value lay in its vast reserves still underground. The shares were then changing hands for just 80 cents Canadian. Within three years, a bull market in copper pushed the stock to more than $48 a share!

Although this stock has already made its run, you can be certain that many similar opportunities are out there. Moreover, the opportunities are not limited to just one sector or another. You might seek your fortune in mining or biotech or technology or dozens of other industries. There truly are opportunities everywhere!

SEPARATING THE WHEAT FROM THE CHAFF

In the pages that follow, I spell out a number of concepts and theories on how best to identify value in small stocks. I cover in detail the two most popular approaches to traditional stock market interpretation: fundamental and technical analysis. My approach is to find bargains based on price, value, and market activity. Whether you call it buying low, buying cheap, or simply buying depressed stocks, you want to find the overlooked company that promises an impressive return. We are not looking to flip stocks. Your time horizon could be several weeks, months, or even years. It all depends on how you can best capitalize on a legitimate growth spurt. For investors who know where to look, the highest profits come from small companies with big prospects, so that is the area where we will concentrate our efforts. I hope you will find the guidelines easy to understand and implement.

FIGURE 1.1 First Quantum Minerals Courtesy of the Toronto Stock Exchange.

You will learn how to evaluate and interpret performance: the best time to purchase—or sell—a given stock. You will also learn why some stocks fail to live up to their promise. You will discover the hidden pitfalls of investing—the most common mistakes made by just about every investor.

Over the years, I have looked at literally thousands of stocks. There are many stocks that, while they may look promising at first glance, upon analysis, don’t measure up to our chosen criteria. We look at them from both a fundamental and a technical viewpoint. From a sample of more than 1,000 stocks, for example, you might select just 50 for additional analysis. This number then might be cut in half, and you’ll ultimately end up with 15 to 20 high-probability selections. This task can be daunting, but it is necessary if you are to capitalize on the best opportunities.

What are the key criteria? You want to find small companies trading at attractive prices. So you might limit your study to stocks trading under $10 a share. You want the company to enjoy some measure of participation from the investment community. So you will take trading volume into consideration.

I try to avoid initial public offerings (IPOs) because they lack the price history that is crucial in making intelligent decisions. This is not to say there aren’t wonderful opportunities in the IPO market. There are. But you must know what to look for and when to take the plunge. You’ll find additional information about getting started in the IPO market in Chapter 5.

Then there are the all-important fundamental factors. What exactly does the company do? Does its business plan allow it to grow exponentially in the months and years ahead? Is its management sound? Does management have the experience to get a relatively new start-up off the ground? If the company has been in existence for a period of time, are there reasons for it to take off in the future? And so on.

On a technical level, a whole host of technical indicators measure whether a stock is performing correctly. I don’t necessarily rule out an underperforming stock. But we’ll want to know why the stock cannot pass muster on these vital benchmarks.

Learning what to look for takes time. Once you understand the key guidelines to stock selection, however, you’ll be able to make both sound and quick decisions concerning a stock’s viability.

HIDDEN VALUE: THE SMALL STOCK’S SECRET WEAPON

If you want to make a small fortune, goes the old saying, start with a large fortune. In the world of small stocks, however, the key to making a small fortune is hidden value. What does the company have that could make its shares explode in value? In the case of First Quantum Minerals, the key was its vast copper reserves in a country set in the middle of political strife. Although the Zambian authorities have become increasingly pro-business in recent years, the same could not be said for some of its neighbors, notably the Democratic Republic of the Congo (DRC). Just the possibility of a political coup from a hostile neighbor can understandably scare off investors. No one wants to invest in a company that might one day be nationalized.

At times, the clues to a stock’s potential can be subtle. While researching First Quantum, I learned that despite the possibility of neighboring government intrusions, the company had a good record in dealing with its employees. It operated a small hospital, for example, to provide its workers with health care. Didn’t it make sense to conclude that a company that cared for its workers might also look out for the interests of shareholders? No fly-by-night operation would go to the trouble to construct a hospital. This company planned to be around for a while—truly, a positive sign.

At about the same time, an interesting article appeared in the New York Times that cited a surge in the growth of private golf courses in Southern Africa. What exactly is the connection between golf courses and mining? It seems that during the political turmoil of earlier times, private golf courses had been shut down as their members fled Africa. More often than not, these private clubs’ membership included the managerial class of Africa’s leading firms. These management professionals were precisely the people needed to generate business revenue, yet they had been driven out of the region because of political unrest. Now they were returning. According to the Times article, the new pro-business climate was generating renewed interest in leisure activities in the region, golf being just one of them. With the European managerial class returning, a new day had broken.

This change was subtle perhaps, but it didn’t take me long to draw the logical inference. One, here’s a company with vast undeveloped resources. Two, the company actually seems to take an interest in the welfare of its employees. Three, the influx of quality management professionals was on the upswing, as evidenced by the boom in local golf courses.

The fourth major point was as yet unknown. What was the potential for metal prices—specifically, the price of copper? If this company had what it promised, everything was in place for a phenomenal investment. The worldwide demand for the red metal soared. Share prices for the Zambian copper company went from under a buck to over $26!

If you are looking for a similar bonanza, you have to sense the potential before it becomes evident. One place to look is at biotech start-up firms. Though obviously fraught with risk (almost all of these firms have no profits in the beginning), these companies often double or triple in price when a breakthrough drug or diagnostic cure is introduced or, better yet, approved by the regulatory authorities. Take the case of one such stock I owned last year. The biotech firm Biomira (BIOM) surged from 80 cents to close to $3 a share almost overnight following a favorable ruling on one of its drug studies (see Figure 1.2).

Another biotech Canadian firm, DiagnoCure (CUR.TO), specializing in the development of proprietary diagnostic tools, likewise had a meteoric rise, soaring from $1 to over $6 a share, when it introduced its proprietary prostate test kit (as shown in Figure 1.3). At the same time, the Quebec City-based Canadian firm partnered a deal with San Diego-based Gen-Probe, which specializes in distribution of medical diagnostic equipment. Just recently, Gen-Probe has become a darling of Wall Street, making new highs day after day. Can it be long before little DiagnoCure is likewise discovered?

These companies are examples of what an intelligent investor looks for in terms of value. Timing is critical if you are to participate in the lion’s share of the profits available in these and other stocks. But they illustrate the potential—if you are selective when you buy and sell. At the same time, remember that despite good intentions, even the best companies often encounter roadblocks and obstacles. Rare is the investor who hasn’t been knocked around and blindsided by an unexpected earnings report. Even the best companies underperform occasionally. So the road to profitability is not always a carefree course. If you concentrate on finding hidden value, however, you will find that what a company has often prevails in the end.

FIGURE 1.2 Biomira’s Surge

FIGURE 1.3 DiagnoCure’s Rise Courtesy of the Toronto Stock Exchange.

THE VALUE INVESTOR

Not long ago, I spoke with a friend of mine who is a private investor. His strategy: buy little-known companies with good fundamentals. A self-described value investor, he understandably wants to buy before a company’s story gets out.

“It always makes me a little nervous,” he explained, “if there is a lot of interest when I buy.”

His strategy is to buy shares in small, yet-to-be-discovered companies that have verifiable resources (mines and oil companies), emerging technologies (biotechs), or simply a rock-solid balance sheet in a hot sector (gaming). He may contact the CEO of a potential investment company and invite him over for lunch. When the CEO of a small company sees that someone is about to invest several million dollars in the company’s stock, you’d be surprised how receptive he can be to such an invitation. One such investor brings not just his personal capital to the table but also the capital of his well-financed friends. He supports the stock in the truest sense of the word.

Over lunch, the conversation invariably turns to the company’s hidden value.

“Mr. CEO,” the investor might say, “I’ve been looking for an opportunity and was wondering if you were interested in greater investor support.”

“Who wouldn’t be? The company is hardly on the radar screens of most brokers right now.”

“I understand, Mr. CEO. But without disclosing any inside information, what can you tell me about your mining operations at Silver Lake Ridge? What are the prospects, in your opinion?”

In this fashion, the sophisticated investor can gain a greater handle on the company, see firsthand whether the company’s story seems to make sense, and see if the two of them make a good fit. An enlightened management will make an effort to accommodate such a request from a credible source.

Why?

There are many reasons. As the holder of perhaps hundreds of thousands of cheap shares, the CEO wants to get the company’s story out there in front of the investment community. He may have a new IPO planned. He understands that his interests and the shareholders’ interests are the same.

From the investor’s standpoint, there may be questions he needs answered before he commits his capital. At this stage, the discussion might be just a fishing expedition. The investor might just want to get to know management first. Can he trust these guys? Do they seem upfront and honest? Do they have what they say they have? Are they just blowing smoke? What, in short, is the hidden value?

TIMING

Even the best stocks make lousy investments if you buy them at the wrong time. To decide when to buy—and sell—you must rely on technical price patterns. More art than science, technical analysis enables the astute investor to uncover a sleeping giant long before it springs awake. Several months ago, I performed a cursory analysis on several dozen stocks. Knowing my criteria, I quickly sped through the stock charts. Suddenly, I found what I’d been looking for: the classic bowl or saucer pattern. According to Figure 1.4, this little-known petroleum company was screaming, “Buy! Buy! Buy!”

By almost any measurement, little Abraxas Petroleum (ABP), trading on the American Stock Exchange, was poised to run. The chart pattern was a classic buy. The stock had done all the necessary sideways work. The next move was up. I bought it immediately.

Trading under $1.50 a share, the stock doubled in value in three months’ time. But that was just the beginning. It later traded up to $9.25 a share!

You have probably never heard of little Abraxas Petroleum and many of the other stocks that might be discussed in this book. But ask yourself this: When was the last time that Disney, IBM, Motorola, or Lucent—not to mention dozens of other high-profile shares—doubled in value in three months? Granted, these stocks were all darlings of Wall Street at one time. Lucent, which often leads the most active list, once traded over $80 a share. More recently, it has traded as low as $2. Rather than concentrating on the past glories of these well-known companies, why not seek out the new—and yet undiscovered—low-priced shares that might be in the headlines in the months and years ahead?

FIGURE 1.4 Abraxas Petroleum: Ready to Buy?

Small stocks routinely make percentage gains unheard of among larger stocks. In the past 12 months, the large-cap Dow stocks gained just 5 percent while the Russell 2000 index, which tracks the performance of small-cap stocks, registered a healthy 24 percent gain. Moreover, to the knowledgeable investor, they signal not just when and where to buy but exactly where to take profits as well. It’s all a question of timing.

Investors are a remarkably impatient lot. When they purchase a stock, they often think that the stock should understand that their investment should trigger rapid price gains. In the case of low-priced stocks, which are often in turnaround situations (often that’s why the price is low), a company’s shares may drift lower for months and even years before the company’s fundamentals change sufficiently for a sustained rally to begin. A distressed stock may take as long as one or two years forming a bottoming pattern on the charts. The good news is that this bottom pattern provides a strong foundation for the subsequent rally. But the investor must be patient.