How Individuals Can Gain An Advantage Over Institutional Investors

by: Robert Mann

Focus on Stocks With Long Bases That Are Seasoned But Out Of Favor

Exciting new issues that may have involved scientific breakthroughs or involve a stock in a new business category often have risen to amazing heights after going public. The individual investor may find it difficult to get shares prior to public trading. Those individuals buying in the aftermarket may have paid too much. Some of the best issues have huge percentage stock price increases in their first year of trading, only to disappoint investors over time. The tremendous opportunity addressed in the company's business plan may have cost more to execute, resulting in losses rather than gains over a period of years. The hot new stock may decline up to 90% from its peak stock price. These stocks may then trade in a low price range for four to eight years only to disappoint all of its investors.

These stocks sometimes earn the label, " shadow stocks", because they are low priced and virtually ignored by all institutions. These issues may still have the opportunity original investors recognized, but after 6, 10, or 20 years the company has survived and now is seasoned.

Buy Before Institutional Interest Grows

Many institutions do not own low priced stocks. Stocks with bases under $5 listed on the NASDAQ or NYSE historically have done very well over time. A base is defined as a period where a stock hits a low point and does not go below this point for a period of about three years while continuing to trade in a narrow range.

A Stock Candidate Is Best When at Least One Institution Owns It

Institutions may wait until the opportunity becomes clear and present. The individual investor may simply take the risk at a low price when the opportunity is not clear, but the price level is stable. If the opportunity is recognized later, the price may rise to a whole new level.

The Key To Successful Investing Is Buying Low

The key element is buying low. The idea of buying low is often ridiculed by investors who lose money. How do you define what is low? For the purposes of this discussion, if a stock has been in the base range for two years or more, trading between a low point and a high point, the low point would be considered the low price. Because actually buying at the ultimate low may be difficult, buying in the first quartile of the range is good enough. Example: If the low is four and the high is eight ( 8-4=4 and 4/4 = 1 + 4 = 5), $5 would be considered an optimal price.

Look For Triggering Events

Usually as these stocks emerge from the lowest price area, you may be able to determine one or more triggering events that put the company in the spotlight and bring other investors, institutions, analytical coverage, etc. Seeking Alph is an excellent way to monitor these events. You may add to your holdings prior to these events to increase your reward. Make sure you follow the company's shareholder communications and PR releases to be aware of the company's agenda. Know when the company is giving presentations. Know when earnings will be released. Know when the company is planning equity financing.

Invest Long Term

Institutions have remarkable advantages over individual investors in the short term. The long base concept requires a holding period of three to four years depending on the time the stock remains in the base level after purchase. Once a stock has broken above the base range, generally a three year holding period is optimal. The historical results of this methodology were published in 1978 in a study entitled, "Non Random Profits", written by Robert K Mann and Ray Hanson Jr. The study looked at stock data from 1936-1977.

Basic Research Is Necessary

You must determine that your selected stock has great potential. The company you select could be working on a new biotech product, could be a leader in an industry that is out of favor or could be a new type of company in a brand new category. Find out what investors were thinking when the stock was hot. Does it still have this potential? Look at the financials. Don't select stocks that are heavily indebted. Make sure the company is properly capitalized. Don't expect to know the company will be successful when the price is low. You must buy and take the risk to reap extraordinary rewards. Institutions will want to know more. Your advantage is to be able to act before the institutions. Watch for triggering events after you own the stock.

Why The Long Base Method Works

It works because it helps investors buy low. The authors of Non Random Profits state, " The concept of cyclicality implies predictability and predictability when applied to stock prices implies profits-- consistent Non Random Profits." This statement does not mean there is not risk. Risk is inherent in any equity investment. An investment strategy may have a great history, but all investors know past performance does not guarantee future results. Individual investments may result in losses rather than profits. Investors use risk management tools like diversification, cash management, option protection and other techniques to manage risk. The most difficult issue is to overcome human nature and hold positions during discouraging periods.

Speculative Pharmaceutical Stocks That Have Long Bases Today

Prophase Labs (NASDAQ:PRPH), Pluristem Therapeutics (NASDAQ:PSTI), Merus Labs Intl (NASDAQ:MSLI), Acadia Pharmaceuticals (NASDAQ:ACAD), Rigel Pharmaceuticals (NASDAQ:SGMO), Enzon Pharmaceuticals (NASDAQ:ENZN), Urologix Inc (NASDAQ:ULGX), Neurocrine Biosciences (NASDAQ:NBIX), Theragenics Corp (NYSE:TGX), Palomar Med Technologies (NASDAQ:PMTI), Meridian Bioscience Inc (NASDAQ:VIVO), Progenics Pharmaceuticals Inc (NASDAQ:PGNX), PDL Biopharma Inc (NASDAQ:PDLI), NPS Pharmaceuticals Inc (NASDAQ:NPSP), Peregrine Pharmaceuticals Inc (NASDAQ:PPHM), Sangamo Biosciences Inc. (SGMO), Lexicon Pharmaceuticals (NASDAQ:LXRX), Opexa Therapeutics Inc (OPXA), Threshold Pharmaceuticals (THLD), Telik Inc (OTCQB:TELK), and Novagen LTD (NASDAQ:NVGN).

The Potential Rewards

The study, 'Non Random Profits', published in 1978 identified 647 stocks with long bases from 1936 to 1977. During this forty one year period the stocks identified had a median gain of 300%, an average gain of 466%, and 9 out of 10 stocks rose 100% or more. From 1936 to 1977 there had been 10 generalized buy periods, roughly every four and a half years, where large numbers of qualifying issues could have been purchased. Since publication from 1977 to 2012 there have been numerous issues that have qualified with similar results. Today, there are hundreds of stocks with long bases for your research.

Disclosure: I am long PRPH. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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