Screening for Big Gainers Pulling Back Sharply

TK All-Star posted on 11/16/12 at 09:04 AM

Alan Brochstein looks for victims of tax-gain selling

This is the time of year when I usually begin to focus on beaten up stocks that have been poor performers. Typically, mutual funds and individuals move to recognize losses for tax purposes as year-end approaches. Additionally, many professional investors like to get rid of the dogs so that their year-end reports don’t have to highlight their mistakes. This behavior has been studied by academic researchers, with the term “January effect” having been coined years ago to describe why these beaten up stocks rally after the New Year. Less discussed is the opposite behavior of investors hanging onto the winners to defer capital gains by selling after year-end and to look “smart” when they list their year-end holdings.

2012 is not the normal year. While I believe that we can still see some traditional tax-loss harvesting, many advisors are recommending that their clients book their gains by selling this year and avoid potentially higher capital-gains taxes next year. I am not in a position to judge whether or not this strategy is worth pursuing, as there are many variables, the most important of which is that it’s unknown that rates will even rise. What I can do is observe that many leading stocks over the past few years have seen intense selling since the election. The reelection of Obama most likely increased the odds that the prior short-term reductions in capital-gains tax-rates and taxes on qualifying dividends will disappear in 2013.

Thinking about this idea of people selling strongly performing stocks for non-fundamental reasons leads me to believe that there could be a good opportunity to enter some of these winners under pressure. With this in mind, I used Baseline to run the following screen:

·       Member of Russell 3000
·       Market Cap > $500mm
·       Two-Year Price Return > 60%
·       Price vs. 52-week High < 80%
·       Price vs. 50-day Moving Average < 90%
·       Earnings Estimates Revisions for Next Year > 0%

What I am looking for among the 2000 companies with market capitalization greater than $500mm that are in the Russell 3000 index are stocks that have increased 4X relative to the S&P 500 over the past two years but that have pulled back at least 20% from their 52-week high. Additionally, I restricted it to stocks trading at least 10% below the 50 day moving average. Finally, for a fundamental check, I wanted to make sure that analysts weren’t decreasing their earnings estimates for next year. Here are the 8 that made the cut:

The companies that made the list aren’t recommendations.  As always, you should do your own investigation before purchasing any stock.

I have sorted the list by forward PE, from lowest to highest. I have also included some additional information, including the ratio of the current PE to the 5-year average. Most of the companies are trading below that average. I also included projected growth-rates for 2013 earnings. Note that they are all expected to increase, with the lowest at 12% and several above 20%.

Questcor (QCOR) is the only stock on the list that is down in 2012. This pharmaceutical company, which markets one drug, is very controversial. Most recently some insurance companies have restricted reimbursement.

Cirrus Logic (CRUS) is linked to its customer, Apple (AAPL), so it may be selling off in sympathy. The 7PE is as low as it has been for this company and doesn’t reflect the $2 per share of cash on the balance sheet. Group (WWWW) provides internet services to small and medium-sized businesses. While the growth has been robust lately, it’s important to consider that a large part is due to an acquisition a year ago that left them with about $700mm in debt and 60% more shares than before the acquisition.

Select Comfort (SCSS) makes those “sleep-by-number” mattresses (disclosure: I own one!).  Its peer, Tempur-Pedic (TPX), is down more than 50% this year amidst competitive pressures that have led to sales declines, and I think that it has dragged down SCSS in sympathy. The forward PE is similar to the S&P 500, but the stock is cheaper than it appears due to having no debt and almost $3 per share in cash. With a balance sheet like that, its shareholders can likely sleep well at night!

Ross Stores (ROST) was overextended and has now corrected. Unlike their rival TJX (TJX), they are focused almost entirely on the United States with their value offering.  The PE ratio is a bit above average, but it seems reasonable relative to the expected growth. In my view, this may be the best example of the phenomenon I have described in terms of selling off solely because holders are taking gains.

The Medicines Company (MDCO) markets three different proprietary pharmaceuticals into the hospital market and also markets ten generic drugs. In May, it signed a global collaboration deal to market one of AstraZeneca’s pills, Brilinta, in the United States. This company has a massive cash hoard net of debt of over $5 per share.

BroadSoft (BSFT) is a 2010 IPO that broke its $9 price but found its footing. The company provides software and services to enable “Unified Communications,” which is a fancy way of saying fixed and mobile voice and data over the internet through a single management system (a cloud play). It’s a very volatile stock, but, to me, it looks like it is sitting above support near 30, having filled most of the gap that followed its Q2 report in early August.

Finally, Alexion Pharma (ALXN) was the best stock on the NASDAQ in 2011 and is having a great year. This biotech is focused on ultra-rare disorders and, markets Soliris, which is approved for two diseases but is under study for additional indications. They own the worldwide rights as well. Like ROST, the stock was overextended and ripe for profit-taking.
In contrast to most years, when I look for winning stocks on sale in early to mid-January, the likelihood of potentially sharply higher long-term capital gains taxes  has most likely pushed up the time-frame to the last 45 days of the year. The screen today is designed to identify some potential opportunities with certain fundamental and technical characteristics. Remember, screening is just the first step in any investment process.

Alan Brochstein
Founder, Invest By Model and AB Analytical Services
TradeKing All-Star Commentator

Disclosure:  No position in any stock mentioned

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Posted by TK All-Star on 11/16/12 at 09:04 AM


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