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Back in my younger years, I remember playing this Pitfall-like video game that required jumping across pits of lava to the next 'safe' platform, only to be met by blasts of fire and a flying assortment of sharp metal objects. The market is delivering a similar obstacle course for the average investor to navigate. After jumping over the lava-like pits of 2008/2009, we are met by the fiery flames of the sovereign debt compounded by the sharp slice of the S&P downgrade. As we stare down a field full of explosives and falling objects in the equity markets, where can we invest?

While common sense dictates a flight to safety, such as large defensive stocks, one unorthodox approach has yielded excellent results when back-tested.

Uncommon Sense in Growth Stocks

This uncommon sense approach involves trading growth stocks, which are usually associated with higher risk in bad markets. What sort of growth stocks are we looking for?

First, we look for very high price to book value stocks (this is the typical Fama-French ratio for determining value vs glamour or growth stock). The price to book value needs to be higher than last year. We exclude micro-cap stocks and over-the-counter exchanges. Positive earnings from last year and last quarter are required. We also ask that cash per share be higher than debt, and the trailing 12 month interest coverage ratio be above 2.00. There is one final rule we will discuss at the end of the article. Over the past 2 years this back-tested result has earned a total of 117%.

Why might this approach work? While this scan trades glamour stocks, which often crash heavier in market corrections, it also asks for increasing price-to-book values - which helps isolate stocks as they are coming into favor. Few stocks make the criteria in extended choppy markets, and this number increases during trending bull markets when growth stocks do best. As the price is not tied closely to fundamentals, this approach may highlight stocks that will pop on investor sentiment, even during bad markets.

Which stocks make the cut as of now?

Ticker Name
ALXN Alexion Pharmaceuticals, Inc.
AMZN Amazon.com, Inc.
EL The Estee Lauder Companies Inc.
IDXX IDEXX Laboratories, Inc.
IDCC InterDigital, Inc.
ESI ITT Educational Services, Inc.
FIZZ National Beverage Corp.
PCLN priceline.com Incorporated
ROL Rollins, Inc.
TNH Terra Nitrogen Company, L.P.
TJX The TJX Companies, Inc.
USNA USANA Health Sciences, Inc.
WBSN Websense Inc.
ACN Accenture Plc
NFLX Netflix, Inc.
CRM salesforce.com, inc.
HLF Herbalife Ltd.
CMG Chipotle Mexican Grill, Inc.
MA MasterCard Incorporated
CVLT CommVault Systems, Inc.
IPGP IPG Photonics Corporation
ATHN athenahealth, Inc
ULTA Ulta Salon, Cosmetics & Fragrance,
VRTS Virtus Investment Partners, Inc.
CBOE CBOE Holdings, Inc

When to Buy

It is important to consider support levels when timing your purchase of these fundamentally screened stocks. Due to the recent market correction, many of these stocks are near or at support levels.

  • ALXN is trading just above $50 support
  • ATHR is at support around $50 as well
  • CBOE is at $22 support
  • CVLT is trading dangerously down on heavy volume but near $30 support
  • EL is above $87.50 support
  • ESI above $68 support
  • IDXX above $72.50 support
  • ULTA roughly at $50 support
  • VRTS prices just above $52 support
  • WSBN at low, low support of $19

Some of these stocks are trading on exceptional strength such as TNH, FIZZ, and possibly MA and even TJX. These are the stocks worth focusing on as investors are strongly supporting them despite market mayhem. Their trading over the past 9 months has also been quite strong.

It is also worth noting that despite the growth stock status (high P/B ratios), 9 of the stocks still offer dividends. These implied dividend yields include:

  • MA (0.20%)
  • IDCC (0.60%)
  • EL (0.80%)
  • TJX (1.4%)
  • HLF (1.5%)
  • ROL (1.5%)
  • ACN (1.7%)
  • CBOE (2.%)
  • TNH (8.7% based on ex-div date that just passed).

Dividends can be tricky. During bad markets you might prefer a glamour stock to preserve cash. Yet on the other hand, it can attract value investors that may choose to ignore capital losses in exchange for an income payout. Small dividends, such as those given by MA, likely have little influence on trading.

The Final Rule

But there is one final trading rule that impacts whether you want to buy or not; market timing.

Stock market timing strategies come in many sizes, shapes, and colors. A basic one-rule technique that is used by this strategy is to buy when forecasted market earnings are trending up. When future earnings estimates are being broadly slashed, it may be time to sit on the sidelines until analysts begin to see growth in net earnings. You can do this my using moving averages on the S&P 500 expected earnings for this and next year. Unfortunately, by my calculations, these have turned downwards and this suggests going to cash. In fact, by using 3 and 15 week moving averages on the earnings forecast as a signal, July 22rd would have been our last day in the market while it traded at 1345. The risk averse investor will watch these stocks and wait for a market timing signal suggesting to buy again.

Some investors will choose to follow the analysts lead and not invest at all, while others will merely limit the amount of money they put into the market. While I am still gravely concerned about the current market, if you are the type of investor that wants to stay invested at all times, then I suggest digging deeply into the 25 stocks listed above and picking the few that meet your rigid fundamental and technical criteria. Are you particularly bullish on one of the above stocks? Give us your two-bits.

Source: An Uncommon Sense Growth Strategy For Bull And Bear Markets