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By Leo Fasciocco, Syndicated Investment Columnist
December 2003 - Some people have a natural inclination to be bargain hunters. They want to find a "marked down" price on something they believe will grow in value.
Many ladies have a habit of bargain hunting for clothes and household items. They sometimes bring that same mentality to the stock market. They find a "comfort zone" in buying stocks they think are bargains. Some men lean to that kind of approach too.
Bargain hunting for stocks in a bull market is a worthwhile endeavor. There are several approaches that work well that are linked to (1) technicals, (2) valuation and (3) market timing, or all of them.
There are also some do's and don'ts that can help you avoid being lured into buying a "lemon."
The classic bargain-buying play is to purchase a stock that has good fundamentals and has pulled back within an overall up trend. The stock of a company with a good earnings outlook going out for the next four or five quarters means it has good potential to remain in an up trend for some time. Thus, the technical, or price pull-back taking place in that kind of stock can be seen as a simple pause within the up trend.
The reason is usually "profit taking." Some mutual funds or institutions tend to sell a portion of their position in a stock if it grows to a certain percent of the portfolio. They are not selling because of any problem. It is just a portfolio allocation decision based on their particular rules. This selling can trigger some selling by others too. Nevertheless, the stock eventually resumes its up trend.
Guitar Center Inc. (GTRC) is a typical bargain play showing now (mid-November) what could well be a "normal” pull-back.
The company operates 100 stores selling guitars, amplifiers, drums and professional audio equipment. One analyst who recently visited one of the stores in the Phoenix area told me the place was very crowded. Business was humming! This year, Guitar Center should post a 34 percent increase in earnings to $1.47 a share from $1.09 a year ago. Next year, analysts project a 23 percent rise in net to $1.80 a share.
The stock sells with a price earnings ratio of 20, which is reasonable. Guitar Center stock rose from $17.60 at the start of this year and reached a peak of $37.10 by late October. The stock has since pulled back to $29. Is this a good bargain price? Well, the stock has retraced 22% from its peak. It is also at a point that it could find technical support because it formed a base on the way up at 28 to 30 back in July.
Technically, that area is a prior "congestion zone." One can also use momentum indicators, such as the Stochastic Oscillator or Commodity Channel Index, to study the historical pattern of prior bottoms. These indicators are available as chart tools with eSignal. Valuations J.P. Morgan Partners and FMR (Fidelity) each own approximately 13 percent of Guitar Centers. That is excellent sponsorship, showing that the stock has the backing of two giant financial houses.
Valuation measures can be used to spot bargains too. One method is called GARP -- Growth at a Reasonable Price. The idea here is to buy stock in a company whose earnings growth is well above its price-earnings ratio and whose stock price has pulled back within an up trend. Station Casinos Inc. (STN) runs casinos in Las Vegas catering to the locals.
It operates Palace Station, Boulder Station and Texas Station. The company is expanding aggressively. One employee of the firm told me that business was very strong in November. Station's earnings this year will climb 75 percent to $1.22 a share and next year 39 percent to $1.71 a share. The stock's price-earnings ratio is only 24 based on this year's earnings. That is well below the earnings growth rate going out through 2004.
The stock ran up from 21 six months ago to $33.50. It has since pulled back to 29.
Market Timing A third way to spot potential bargain plays is to be aware of industry stock rotation in the market. This year, the stock market has been rotating in a general way, with technology stocks advancing and then pulling back, while during the same sequence, medical stocks do just the opposite. The trick here is to go bargain hunting for some of the leading issues in the group that has moved lower.
You again want stocks with good earnings growth. UnitedHealth Group Inc. (UNH) is a leader in the HMO sector. It pulled back from 55 in mid-October to 48. It is poised to turn and advance. The key to buying bargain stocks on rotation is to be aware of the leading groups for this bull market and the best stocks in the group.
Semiconductors are top performers in technology. A key stock to watch there for a pull-back would be OmniVision Technologies Inc. (OVTI) or even big cap play Intel. Corp. (INTC). There are other sector plays to watch for as potential bargains on pull-backs too. Of course, buying a stock as a bargain play is no guarantee that it will turn and move higher. One must always be watchful of any change in fundamentals both for the stock and the industry. You should always have a protective sell strategy in place.
Mr. Fasciocco's articles appear on www.tickertapedigest.com. He is an independent contributing writer for several national publications. He is also president of Corona Investment Management. To get a free trial subscription to the Ticker Tape Digest Pro Report, which comes out daily on the web with midday updates, send an email message to freetrial@tickertapedigest.com. Mr. Fasciocco can be reached by email at leo@tickertapedigest.com.