My Method For Finding New Stocks
I was recently asked what my strategy was for finding new investment opportunities, particularly among penny stocks trading on the TSX Venture Exchange. Although I'm reluctant to share my secrets (mainly because I don't want to be responsible for anyone's losses if they do use my strategy), I realize that some people might be entirely clueless on how to proceed in narrowing down the field of potential stocks. So here is my preliminary method for finding new companies:
1. Stocks trading near their 52-week low;
The contrarian in me strives to find good stocks trading near their lowest point of the year. Ironically, this first criteria has been the most criticized since many people believe there's usually a good reason as to why a company would be trading at this level. In general, I would agree with their concern, and in most cases it's a better idea to stay away from out-of-favour companies. My theory, however, is that there will always be a few stocks that have been disproportionately beaten down and undervalued in the past year, and once the market realizes this, you will be glad to have beaten the rush.
2. Recent insider buying;
Let's face it, insiders usually know in what direction their company is heading. My (limited) experience has taught me that more often than not, these people buy and sell at the right time. It's not absolutely imperative that there be recent insider buying, but if I see recent selling I will always stay away.
3. Less than 35 million outstanding shares;
I'm not a big fan of companies that are constantly issuing shares in order to fund their projects. I much rather see a little debt than say 100 million outstanding shares.
4. Current ratio of 2 or higher (current assets/current liabilities);
This basically insures that the company will not go bankrupt any time soon since their near-term liabilities can all be covered.
5. Trading near or under it's Book Value;
In theory, a stock should trade at its book value, but in practice it is usually trading several times above it. A stock that is not far off its book value might prove to be worth examining, but you should never put too much weight on this criteria alone.
6. Price/Earnings, Price/Cash Flow, Price/Book Value, Price/Sales all relatively low (under 5 if possible);
I understand why some people aren't too concerned about these ratios. They only serve to outline the present state of the company's financials, and do not indicate what is coming in the future. Regardless, if a company has low ratios and has still taken a beating lately, it might be a sign that the stock is undervalued.
7. Reasonable daily volume (upwards of 30,000 shares on average);
Otherwise, you might have a lot of trouble getting in and out of the stock without modifying your targeted entry and exit points. Besides, a stock with very low volume is far too volatile for comfort -- it's not uncommon to see a stock price rise or fall +50% because a handful of shares were traded.
8. Even though it's trading near it's 52-week low, I like to see the first signs of an upwards trend;
There's a certain quote that always comes to mind when a chart indicates a downwards trend: "Never try to catch a falling knife". Basically, it means you should not buy a stock while it's on its way down, but rather wait until its trading horizontally or appears to be starting an upwards trend.
9. Check the bullboards to make sure the general consensus is positive.
You must be very prudent while reading the bullboards because some people are only trying to pump or short the stock. I usually just look for the community's overall feeling towards the company. For example, a company I recently examined met most of my criteria, but when I read the bullboards I noticed that pretty much everyone was fed up with the management and the new direction the company was taking. This was quite a turn off.
So there you have it, my method for narrowing down the field. It should be noted that you will be very hard-pressed to find a company that meets every single one of these requirements -- you will have to make some compromises here and there.
Once the field has been narrowed, I will examine the financial statements, management, charts, and all the rest before deciding whether or not to buy. You will have to figure out this part on your own. Good luck!
Please do your own due diligence, these are not recommendations.
1. Stocks trading near their 52-week low;
The contrarian in me strives to find good stocks trading near their lowest point of the year. Ironically, this first criteria has been the most criticized since many people believe there's usually a good reason as to why a company would be trading at this level. In general, I would agree with their concern, and in most cases it's a better idea to stay away from out-of-favour companies. My theory, however, is that there will always be a few stocks that have been disproportionately beaten down and undervalued in the past year, and once the market realizes this, you will be glad to have beaten the rush.
2. Recent insider buying;
Let's face it, insiders usually know in what direction their company is heading. My (limited) experience has taught me that more often than not, these people buy and sell at the right time. It's not absolutely imperative that there be recent insider buying, but if I see recent selling I will always stay away.
3. Less than 35 million outstanding shares;
I'm not a big fan of companies that are constantly issuing shares in order to fund their projects. I much rather see a little debt than say 100 million outstanding shares.
4. Current ratio of 2 or higher (current assets/current liabilities);
This basically insures that the company will not go bankrupt any time soon since their near-term liabilities can all be covered.
5. Trading near or under it's Book Value;
In theory, a stock should trade at its book value, but in practice it is usually trading several times above it. A stock that is not far off its book value might prove to be worth examining, but you should never put too much weight on this criteria alone.
6. Price/Earnings, Price/Cash Flow, Price/Book Value, Price/Sales all relatively low (under 5 if possible);
I understand why some people aren't too concerned about these ratios. They only serve to outline the present state of the company's financials, and do not indicate what is coming in the future. Regardless, if a company has low ratios and has still taken a beating lately, it might be a sign that the stock is undervalued.
7. Reasonable daily volume (upwards of 30,000 shares on average);
Otherwise, you might have a lot of trouble getting in and out of the stock without modifying your targeted entry and exit points. Besides, a stock with very low volume is far too volatile for comfort -- it's not uncommon to see a stock price rise or fall +50% because a handful of shares were traded.
8. Even though it's trading near it's 52-week low, I like to see the first signs of an upwards trend;
There's a certain quote that always comes to mind when a chart indicates a downwards trend: "Never try to catch a falling knife". Basically, it means you should not buy a stock while it's on its way down, but rather wait until its trading horizontally or appears to be starting an upwards trend.
9. Check the bullboards to make sure the general consensus is positive.
You must be very prudent while reading the bullboards because some people are only trying to pump or short the stock. I usually just look for the community's overall feeling towards the company. For example, a company I recently examined met most of my criteria, but when I read the bullboards I noticed that pretty much everyone was fed up with the management and the new direction the company was taking. This was quite a turn off.
So there you have it, my method for narrowing down the field. It should be noted that you will be very hard-pressed to find a company that meets every single one of these requirements -- you will have to make some compromises here and there.
Once the field has been narrowed, I will examine the financial statements, management, charts, and all the rest before deciding whether or not to buy. You will have to figure out this part on your own. Good luck!
Please do your own due diligence, these are not recommendations.
posted by Eric G. at 2:33 p.m.
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