"Don't chase hot stocks." It's advice that any good value investor has heard hundreds of times, and it's good advice -- in the right context. Indeed, chasing a hot stock that has been surging solely on hype and speculation rather than fundamentals is a dangerous game, as is chasing a hot stock whose valuation has soared to bloated heights.
But while dangerous on its own, momentum can actually be a powerful ally when accompanied by strong fundamentals and good valuation. Several of history's greatest investors, including gurus like James O'Shaughnessy and Motley Fool co-creators Tom and David Gardner, have used strategies that target strong momentum stocks that have good fundamentals and reasonable valuations. And right now, my Guru Strategies have a keen eye on one high-momentum stock that they think fits that bill: Florida-based property and casualty insurer HCI Group (HCI).
Yes, HCI took a hit last week in what seemed to be a reaction to it becoming the first admitted homeowners insurance carrier to provide flood insurance in Florida since major flood insurance reforms occurred in 2012. But the longer-term trend for the firm's shares has been up, up, and up. I wrote about the stock back in July, when my Peter Lynch-inspired strategy triggered a Trade Alert on HCI. Shares went on to gain more than 35% during the three-month alert, and continued to rise throughout 2013.
But even after those big gains, my strategies don't think HCI is done. In fact, on Christmas Eve they triggered another alert on the stock, and this one is particularly intriguing. Generated by two of my best-performing growth strategies -- my Martin Zweig and Motley Fool-based models -- this alert is a relatively rare one. But in the 22 previous occurrences, the stock triggering the buy signal has gone on to gain an average of 29.1% over the coming six months vs. an average of 2.4% for the S&P 500. In only three of those 22 cases has the stock failed to make money. Both the overall average return and the accuracy rate are among the best of any of the alerts I use.
Of course, that is no guarantee that HCI will gain 30% in the next six months -- in the stock market there are no guarantees. And, to be sure, there are risk factors for HCI. The firm is, after all, a P&C insurer in Florida, where a rough hurricane season can wreak havoc. But as I noted back in July, HCI has an advantage going for it: After the state's insurer-of-last-resort grew too large, Florida officials called on it to divest a substantial portion of its policies, allowing firms like HCI to pick and choose from some very profitable policies. Moreover, my Fool- and Zweig-inspired models think that HCI's growth story and valuation are too much to pass up -- and they are hard to impress. Right now, the Zweig model has strong interest in just three other U.S. stocks; the Fool model has strong interest in only two besides HCI.
Just what do these two strategies like about HCI? Its impressive growth, for one thing. The Zweig model likes specifically that growth has been strong over the long term and accelerating more recently. Over the long-term, it has grown earnings per share at an impressive 31.7% pace (using an average of the three-, four-, and five-year rates). That accelerated to an even-better 95% in the three quarters before the most recent quarter, before jumping again to a whopping 319% in the most recent quarter. The Fool model, meanwhile, is particularly concerned with recent growth, wanting to see both EPS and sales up at least 25% in the last quarter. In addition to that huge earnings number, HCI grew sales at a 74% clip last quarter, so it passes with flying colors.
The Fool-based model also wants to see high and rising profit margins, attractive valuation, and good momentum. HCI's margins have risen from 7.90% two years ago to 10.62% a year ago to 18.50% this year, and it has a PE-to-growth ratio of just 0.26, meeting the first two requirements. It misses the model's relative strength target of 90, but not by much -- its RS is 88.
The Zweig model, meanwhile, wants to know that a company is growing its top line as well as its bottom line, and with long-term sales growth over 50% HCI passes muster. And while it's willing to pay a premium for strong, quality growth, the model has its limits -- a stock's trailing 12-month P/E should be no more than three times the market average, and never more than 43. At 8.3, HCI's is actually well less than the market average of about 15. (My Zweig model doesn't include a specific relative strength target, but, interestingly, Zweig often talked about not going against the broader market's momentum, coining the phrase "Don't fight the tape".)
We'll see what HCI has in store for us over the next several months. With stellar financials, cheap shares, and a lot of momentum, history hints that it should be more gains.