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Follow The Stock Leaders To Profits

Zacks Investment Research

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February 02, 2013 - Follow the Stock Leaders to Profits - By Zacks Investment Research

Big institutions run the markets. Their decisions lead to big moves in stocks, both up and down. I have witnessed several examples of one big institution following another and buying the same stock.

This is what really drives stocks higher.

Not every big investment that institutions make draws these follow on trades. There are, however, some common elements that I have found and want to share with you.

Leadership Matters

This idea almost goes without saying, but it really is the foundation of getting in on a stock that has potential for a follow on investment. The idea is simple. The first investment must come from one of the best.

Who are the best? Well they are the institutional investors with the best track records. The greatest prestige. They are the stuff of lore and legend. Billy-Joe-Bob Asset Management is not an example of a leader. SAC Capital, Citadel, Lone Pine Capital are examples.

They lead the market not just in compensation for their employees. They lead the market in returns and assets under management. They are big for a reason; they are the best.

It's Not About Profitability

The top money managers don't limit their focus to just a few companies. Stocks that are losing money are just as investable as those with a stellar earnings history. The idea is more about growth and the trajectory of earnings rather than their absolute level.

Being more growth focused, I rarely interacted with value based shops. By definition, they will look to own stocks that do have positive earnings. The value shops will also share common elements and have follow on investments.

Block Trades

Institutional investors use huge trades of 10,000 shares or more to transact business. They have to use these big sizes because they are often moving millions of shares worth tens or hundreds of millions of dollars.

These block trades are sometimes hard to see in stocks that have significant trading volume. But they can stick out like a sore thumb on a stock that isn't that heavily traded.

Block trades act as digital fingerprints that show that the big institutions are interested in a stock. The timing and frequency of block trades support the idea of a position being built.

Right Sized

When I talk about size, I am not referring to the market capitalization of the stock. I am talking about the percentage of shares outstanding held by institutions.

When I see a number higher than 93%, I think there is almost no chance that a buyer of 5% or more will be stepping in to absorb most of the last 8% of the stock out there.

I want to see a number that is low, but not too low. Ghost Rider didn't get to do his fly-bys of the tower because "the pattern is full." It rarely pays off to be a maverick in the investing world, and looking for a follow on is almost as anti-maverick as you can get!

Research Is a Tool

Most people believe that investment bank research is fully independent. Yes, the days of an investment banker telling a research analyst what rating to assign are over, but if you think research is 100% independent then you are naïve.

When I was an equity research analyst, the rest of the firm would always call research a "cost center" but a necessary one. Institutional investors, at least the biggest ones, use research departments as a tool. If you tracked institutional investments and subsequent ratings or estimate increases, you may be shocked to learn that there is a high degree of correlation there.

Research relies on trading commissions now more than ever. The source behind the biggest trading commission dollars are the biggest institutional investors.

Follow On Success

After watching nearly every institutional 13G and 13D filing over the last nine months, I have seen patterns. Patterns of buying and selling. Even patterns of follow on investing from other institutions.

We have owned several stocks that had big buyers step in after we already took a position. Needless to say this cleared the path to huge gains. More stock was purchased, which bid the price up. The likelihood of increased ratings or estimates also helped draw in other investors.

Even now, there are two stocks in our Follow The Money Trader service that have seen follow on investments. One stock moved higher by more than 15% following the second institutional purchase. The other has seen a steady build to a 10% gain. In both instances, the time horizon has been less than a month.

When Is It Imminent?

When the stars align, we get a stock that is bought by a leader. It has great growth prospects over the next 12-18 months. There will be room for other institutional investors to come into the stock, or be "sized right." The stock could likely see new coverage or better ratings from research analysts. After that, it's a matter of looking for block trades to tell us when to expect to see the next 13G or 13D filing.

Follow the Money

At Zacks, we track institutional investors from their earliest filings to spot their best stock moves. We want to get in before they move in all their money, and before other institutions follow them. This initiative was years in the making and it monitors a vast, ever-changing database to detect these stocks, and then filter them even further through our proprietary indicators.

In fact, Zacks Follow the Money Trader has just uncovered a software stock filled with the promise of "smart money." As editor, I will pull the trigger on this trade Monday morning.

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