Using Graphs to Identify Technology Stocks' Growth Phases

by: John Tobey, CFA

In "Screening for Technology Stocks: 30 Finds to Consider," we were left with a list of 30 possible "new" technology stocks. Now we need to decide which are worth further analysis and consideration.

When studying any high growth companies (including technology), starting with their stock price graphs is worthwhile. Here’s why and how …

Why graphs can provide useful information

"Technical analysis" (vs. "fundamental analysis") is sometimes derided as silly, similar to reading tea leaves. That criticism is valid for practices that attempt to divine the future from the past – as if a hidden message is to be found in a stock’s past movements.

However, looking at a stock’s graphs can reveal some important information, particularly if we are examining a subset of fundamentally attractive stocks (like the 30 that passed our screening). Because a stock graph is a visual presentation of investors’ actions, we can see the amount of trading and its effect on the price over time. For a growth company, we can determine its stock’s "phase" to better understand its potential return and risk.

How to define a growth stock’s phase

There are four phases in which a growth company’s stock can perform well. All relate to a stock’s "all-time-high," which, to me, is the key indicator in defining a growth stock’s phase.

Note: I define the all-time-high price as the highest level the stock reached on a previous uptrend. Between then and now, a downtrend has occurred, with the stock now trending up again.

Phase #1: Recovery – Stock is rising following a downtrend. Price is well below its previous all-time-high, but the uptrend is strong.

Phase #2: Approach – Stock is nearing its all-time-high. Because that price is typically a strong barrier, the stock’s uptrend can stall or even reverse at this point. Or, positively, it can rise above.

Note: As a growth stock rises from a previous low, ownership will begin to shift. Value investors will be selling as the stock nears its all-time-high, moving on to their next lower-priced opportunities. Growth investors, watching the company’s new growth, will be buying, but also watching to see if the stock can rise above the all-time-high. Traders will be focused on the stock’s behavior around the all-time-high and whether it can move to phase #3.

Phase #3: Breakout – The stock has risen and established itself above the previous all-time-high price. This point is very important. It’s where we can now say, "This stock (company) is better than ever." In addition, it’s where every shareholder is showing a gain.

Phase #4: Run – The stock has now moved well above the all-time-high. With no barriers above or below, it is free to run (and drop) based on a pure combination of fundamentals and investor enthusiasm.

Example of all four phases: Apple (NASDAQ:AAPL)

Since Steve Jobs returned to Apple in 1997, Apple’s stock has had two complete cycles (all four phases). It is now in phase #4 of its third cycle. The following three graphs show the picture: (1) all history, (2) the previous cycle, and (3) the current cycle.

Apple - history
(Click to enlarge)

Apple - previous cycle
(Click to enlarge)

Apple - current cycle
(Click to enlarge)

Classifying the 30 stocks into their phases

Here is the list of the phases for the 30 screened stocks. (Actually 27 because I scratched three for the reasons noted.)

Technology stock listing
(Click to enlarge)

In summary:

Phase #1 (recovery) = 9 stocks

Phase #2 (approach) = 4 stocks

Phase #3 (breakout) = 5 stocks

Phase #4 (run) = 9 stocks

Next step: Now it gets personal

As I described above, different investors will hold a growth stock in each phase. Value investors get uncomfortable with a "fully" priced stock in all-time-high territory. Growth investors range from lower risk to high risk. And then there are the traders – not in it for the long haul.

So ... Knowing your goals and comfort level, you can use your own analysis on those stocks in the phase(s) that you prefer. I will be doing the same and reporting the results.

Disclosure: I am long AAPL. In process of analyzing the other stocks listed