Earnings season can be quite tricky, as the quarterly reports often reverse price trends that are present going into the release or extend existing trends. This is a great time to examine stocks that are overbought (or oversold for that matter) to reduce the odds of wishing for the present price in the future.
There are many reasons one might develop “holder’s remorse”, including, but not limited to, a disappointing report, a disappointing outlook, a short-seller exodus going into the number followed by re-shorting or holding onto a stock ahead of itself instead of redeploying into a more attractive one (opportunity cost).
With these potential risks in mind, I wanted to identify stocks that should be examined for potential sale. Using StockVal, I examined domestic companies with current market caps in excess of $500mm that are up in excess of 20% in 2007 and at least 50% above their 52-week low. I also restricted the price to a minimum of $10. I excluded all stocks that weren’t at least 1.8 units “overbought”, which is a measure of the deviation of the short-term price from a longer-term trend. An important factor I employed was the FY2 estimate percentage change over the past 12 weeks, restricting it to a maximum of 20%. Why? In order to eliminate any stocks with prices up solely due to rapidly improving earnings prospects. Finally, I removed any stocks that have received merger bids (not surprisingly, a pretty reasonable percentage). The resulting list contains stocks from a broad cross-section of the economy and varying market-caps.
These aren’t automatic “sells”, but rather a list of companies that should be double-checked. Many of these stocks will continue to rally despite being “overbought”, and many will solely pause while they digest the short-term move. Some, though, will create “holder’s remorse”. How confident are you in the story? How much downside are you willing to assume if the report corrects the “overbought” condition? Are the short-sellers covering and driving up the price? The alarm has sounded; make sure your monitoring system is connected!