How I Select My Stocks

Investment Strategy

How I Select My Stock Picks

by Marco den Ouden

This article was published in the May 16, 2004 edition of the Break Out Report.

This may seem like an odd thing for a newsletter writer to say but…the purpose of my writing is for you to become skilled enough that you don’t need to subscribe to this newsletter! At heart I am a teacher. And I want to teach my readers principles of investing that they can use to become successful investors on their own. I’ve even thought of using it as an advertising slogan – “Our goal is to have you cancel your subscription!” It’s just off-beat enough to get prospective subscribers to check us out.

Luckily, I don’t know everything about investing and am constantly learning myself. And I am always looking for ways to improve my own investing skills. And so I will always have new ideas to pass on to my readers. Ideas such as the Kelowna Boys Strategy for writing index options which I covered in Volume 1, #8 and #20 and review once more in this issue.

But for this article I want to explain how I select the stocks for coverage in this newsletter. It’s a fairly simply method that any net savvy person can use and it costs next to nothing.

As you know, I’m a big fan of William O’Neill and his CANSLIM approach to investing. One of the biggest insights I got from O’Neill is his discovery that stocks hitting new highs tend to go higher and stocks hitting new lows tend to go lower. This leads to the contrarian view that instead of “buy low, sell high”, an astute investor should “buy high, sell higher”.

So this leads to the first step I follow in looking for a stock to invest in.

1. Look for stocks hitting new highs.

One of the special features of the Subscriber Only area of our website is my weekly New Highs Report. Every week I list the stocks that hit new 52 week highs on the TSX in the previous week, ranked by Hi/Lo Ratio. This is the ratio of its 52 week high to its 52 week low. Stocks with a Hi/Lo Ratio of between 1 and 1.5 have just begun their journey to multiple gains. Stocks with a ratio between 1.5 and 2.5 are showing solid strength with potential for further gains. Stocks with a ratio higher than 2.5 have had a spectacular run and could be a Microsoft going on to further substantial gains.

To get the New Highs list for free, go to the same source I do – Globeinvestor.com. In my opinion this is the best financial resource for Canadian investors on the Net. You’ll find a link in a box labeled Market Action in the left hand menu.

Clicking here brings up a menu that lets you narrow the search to a specific exchange (they cover US as well as Canadian exchanges) and even a specific industry. The default is the Toronto Stock Exchange and all industries so I just click Go to bring up results. Then I click on Weekly Highs at the top of the chart that comes up to bring up the New Highs for the week.

The table that comes up lists stock and symbol, the date the 52 week high was attained and the high and low for the year. The stock name and symbol are linked for each. Clicking on the symbol will bring up today’s statistics including open, high, low and close, EPS, P/E, Dividend Yield and more. Clicking on the company name brings up the company snapshot. This includes a brief description of the company as well as the revenue and earnings numbers for the last three years as well as return on equity, trailing twelve months data, a link to the corporate website and more.

We now proceed to the second step:

2. Check the snapshots looking for stocks with revenue and earnings growth.

I don’t even consider stocks that have current losses. This narrows the field considerably. I prefer stocks that have increasing revenues and earnings for the last three years but make occasional exceptions for stocks with a drop in revenue or earnings in the second year but rebounding strongly in the third. A loss in the first year is also acceptable if earnings show up in the following years and grow in the third. Of course, the very best showing is revenue and earnings growth of more than 25% for each year.

That brings us to the third step:

3. Look for stocks with strong earnings growth in the most recent quarter.

You’ll find a link for News in a menu box at the upper right of each page. Click on it and it will bring up news items gleaned from the Globe and Mail itself as well as from Canada Newswire and other news services. Scan the headlines for the most recent quarterly report. Click on that headline and look for the current earnings per share and the EPS for the same quarter the year before. I look for current earnings that have grown by 25% or more.

Now there’s just one more thing I do before making a selection.

4. Check the stock’s chart.

I look at the stock’s chart to see if there is some consistency to the stock’s up trend. I try to avoid stocks with erratic and volatile patterns. Although I use the Investor’s Toolbox for charts, there are numerous free resources on the Net including BigCharts.com and Stockcharts.com. Both allow you to check indicators such as Stochastics, MACD and Moving Average. Globeinvestor’s charts are rather elementary though its Globeinvestor Gold premium service has such indicators.

From the stocks that meet these criteria I select two to profile. Sometimes while researching them further for the write-up, I discover a problem and discard the stock for an alternate choice. But basically that’s it!

The TSX had a sharp drop on May 7^th and again on the 10^th. I checked out the weekly New Highs for both those days and came up with 16 possibilities. Next I compiled the data into a spreadsheet to compare them. The stocks that came up in part 2 of my search included Advantage Energy Income Fund, Canadian Natural Resources, Enghouse Systems, GSW Inc. , Ketch Resources, Pason Systems, Penn West Petroleum, Real Resources, Resolute Energy, TUSK Energy, Viracocha Energy, Celtic Exploration, ZCL Composites and Northway Explorations. The very best numbers were for Viracocha Energy, but the news told me that it was subject to an upcoming merger and so it wouldn’t be around much longer. Advantage and TUSK had losses in the most recent quarter. Canadian Natural Resources, Penn West, Real Resources, Resolute Energy and Ritchie Brothers had declining earnings in the most recent quarter.

After the dust had settled I opted for one industrial pick with solid growth and one that happens to be in my book, the 50 Best Science & Technology Stocks for Canadians. You’ll find them profiled on pages 6 and 8.

Disclaimer