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A Loosely Guarded Secret to Making Money In Momentum Stocks

June 27, 2008 – Comments (11) | RELATED TICKERS: IDSA , PDO , ERS

Despite numerous red thumbs in my CAPS portfolio, historically I have found my biggest trades are always on momentum stocks that end up going up several hundred percentage points or more within the timeframe of a year or so.

Today I'm going to share one of the secrets to uncovering these stocks with you.

The key to finding a momentum stock that can go multiples of its current price is to understand what kinds of new buyers will come in at higher prices.  Those new buyers are what's going to push that sweet stock up many-fold.

A good bet is to focus on stocks where the earnings are going to show sizeable gains compared to prior year comparisons.  Especially good finds are stocks that are in sectors that are hot, or could get hot very soon.  The best are stocks with low floats, remember the Legend of Taser?

After that, there's one other little secret.  Say it with me: "Eye Bee Dee".   Not getting it?  Say it again.

You see this thing carries a listing of the top one hundred stocks in the country.  It is followed widely by mutual funds, hedge funds, individual investors, and momentum investors of every variety.  A trip to this sacred list is often what will take an ordinary ho-hum stock to the stratosphere.  Say it again.  "Eye Bee Dee".

The exact details of what it takes to make this sacred list are a closely guarded secret, but legend has it that some of the requirements are at least a 90 rating on earnings strength, at least 80 on relative price strength, a couple years worth of positive earnings, and at least a $15 price tag.

Naive investors and traders who are unaware of this sacred list will be shorting these same stocks just as the big money is about to start pouring in.  At this point you probably want me to the name list.  I won't do that and I'm asking the peanut gallery to hold on to this loose secret too. 

Let people use their imagination for cryin' out loud! 

Let's take a look at a recent example: PDO.  The company reports good earnings and suddenly the stock makes a jump.  It hits the magic $15 number, has all the other criteria, and is anointed to the sacred list.  Wham-o! $15 to $45 in a month.  Behold the power.

How about another one or two?  Go back and look at ERS.  This boring aluminum company hits the list sometime in January of 2006.  From $15 in January it's $30 in March, $45 in April, and $60 in May.  Holy guacamole!

I can't even start thinking about HANS without kicking myself for the run I missed. 

There are plenty of other examples, and of course plenty of examples of failures too (ERS is now a $4 stock).  But hey, I'll take some losses for a shot at a double, triple, or more.

Now let's take a look at a sleeper from the red-hot steel/metals sector that might be next: IDSA.  IDSA made a brief debut on the sacred list for a brief stint last year.

This year the fundamentals are much, much stronger than last year, and I suspect this stock will make itself on to the list again the second or third week of August.  Be warned however!  IDSA has a float of just 2 million shares, and the stock has only a $50 million market cap.  That means it will be highly volatile and bid/ask spreads will be wide.

Let's look at the fundamentals: IDSA recycles ferrous (steel) and non-ferrous (aluminum, copper) metals.  Pricing in all of these markets has been unbelievable.  Steel prices, for example, have ripped higher from about $250/ton mid-last year to over $600/ton this year.  Aluminum and copper are also very firm.  As an added bonus, recycling is a green business saving lots of energy and sure to be a favorite of the socially responsible types.

IDSA has turned a profit for at least each of the last 17 quarters.  Guidance for the current quarter is for $.42-.44 eps, the company's best quarter in years.  By the end of this year they will have added a new high capacity steel shredder, allowing them increase volumes substantially (someone's got to recycle all the old fuel inefficient GM cars). 

The current trends in iron ore, steel capacity, and steel demand indicate that steel prices should continue to be firm for at least a few more months.  If you believe Nucor's CEO, steel prices are going to be firm for years to come.

The new shredder and continued firm steel prices should keep the company nicely profitable.  The latest guidance puts the company on an annualized earnings rate of $1.44 this year, more than double last year's earnings.  At $15 that's a forward P/E of around 10, which is much less than acquisition-happy competitor and sacred-list member Metallico (MEA).  IDSA is also cheap on a price/sales basis, trading nearly half the multiple of MEA.  And yes, IDSA has a clean balance sheet!

The real key here is... say it with me?  "Eye Bee Dee."

Once IDSA reports its numbers in August, the earnings ranking should easily jump over 90 (from a current level in the mid 80s).  If the price continues to stay over $15 and near its 52 week high, it will easily carry the relative strength the momentum hounds crave.  That should get the stock on the sacred list of 100, and that's where the fun should really begin.

Besides its low float, what can really take this stock for a ride is that the valuation is very attractive, especially once you consider that their capacity will be expanding through the back half of the year.

Summarizing the above into my profit equation, I get:

Low Float + Attractive Valuation + Strong Earnings Growth + Strong Price Action + Eye + Bee + Dee + 100 + Crazy Momentum Investors = IDSA as a possible multi-bagger.

That's my equation for profit, please keep in mind that I could end up being very wrong, and then the stock may get punished quite severely.