To screen and analyze the most promising post-IPO stocks, we first group our newly IPO’d stock candidates by vintage year. For instance, in the year 2014 there were 291 US-listed IPOs. From this list of 291 stocks from the class of 2014, we can rank them by year-to-date performance (through June 4, 2015). Here’s the Top 10 stocks from this ranking:
Eagle Pharmaceuticals (EGRX) up 371.9%
Recro Pharmaceuticals (REPH) up 194.4%
Capnia (CAPN) up 191.6%
Pfenex (PFNX) up 163.8%
EHI Car Services (EHIC) up 122.3%
Corium (CORI) up 121.6%
Cheetah Mobile (CMCM) up 118.9%
Sage Therapeutics (SAGE) up 114.8%
Innocoll AG (INNL) up 110.6%
Adeptus Health (ADPT) up 104.5%
Once we have this list of stocks, it won't do to simply know which have performed the best this year. To get a best sense of how each stock has done recently, and to determine whether it is a good buy, one has to devote the time in analyzing the stock chart of each one.
To do so, we fall back again on the tried and true methods of Investor’s Business Daily. IBD’s founder, William O’Niel, long ago developed a series of chart patterns which illuminated for him the best setups for stock performance. All stocks trade through one of these patterns in any given year, and identifying them is extremely useful in picking high-percentage entry points for good price performance. While not foolproof, it has stood the test of time in its effectiveness. If you are unfamiliar with the IBD method of analyzing a stock chart, we direct you to this link for a good tutorial.
During a recent podcast of the IBD Investing Show, host Matthew Galgani shared with his listeners a handy way to organize a list of stocks by their chart pattern. He identified five types of chart patterns, which he uses to organize every stock on his watchlist. They are: strong and extended, nearing a buy point, testing a moving average, basing, and broken.
This is an ingenuous method, and one we’ve adopted. We use this method to key on those stocks which either are near a buy point or are testing a moving average. In fact, we’ve devised our preferred ranking of these five groups. They are, in order of priority:
1st choice stocks: Nearing a buy point
2nd choice stocks: Testing a moving average
3rd choice stocks: Strong and extended
4th choice stocks: Basing
5th choice stocks: Broken
If we analyze the 291 stocks which comprise the Class of 2014, we find that only 60 stocks are nearing a buy point. 60 more are testing a moving average. 50 are strong and extended (meaning they are close to their 52-week highs and arguably the best performers). The rest are either correcting in a base pattern or are broken and are trading in their own bear market.
You may ask, “Why not concentrate first on the strong and extended stocks?” The reason has to do with odds. One never knows how far and how long a breakaway stock will run. Ideally you want to buy a stock near an attractive entry point (an IBD buy point), but if you buy an extended stock, the buy point moment has passed and you run a high risk of catching the stock just before it ends its run and corrects in a base. From IBD’s analysis of countless stock winners over the past 70 years, investors have much better odds of trading into a good return if they use appropriate buy points, depending on the sort of base pattern the stock is completing. Again, refer to this link on IBD base patterns.
For this reason, we analyze the 291 stocks of the Class of 2014 once a week to identify those that are nearing a buy point. This is a laborious process, but we are seeking to find the post-IPO stocks that are poised for breakout moves. It’s the first and best screen for these possibilities.
Once we have identified the stocks nearing a buy point, we rank them by their IBD Composite Rating. This rating is a combination of IBD’s EPS growth rating (on a scale of 0 to 100), and IBD’s relative strength rating (on a scale of 0 to 100). The strongest stocks have Composite Ratings at or close to 99. For a discussion of this rating, visit this link.
Once we have ranked the stocks of the Class of 2014 by their buy point and by their Composite Rating, we then build a Discounted Cash Flow Model for the Top 10 highest ranked stocks. This analysis requires a deep-dive analysis into each company, with our own 10-year projections for revenues, expenses and margins, and a calculation of the net present value of the resulting free cash flows to derive an Intrinsic Value per share. A Discounted Cash Flow model is replete with assumptions, and our assumptions are inherently imperfect, since they must be made with subjective views on how large the company’s addressable market is, how much market share the company will capture, and how profitable its business model will be over the long term. The reason we do this is to ground our stock expectations in some framework of reality. It might only be OUR version of reality, but at least we have done the heavy lifting necessary to form an intelligent opinion about the company’s potential valuation.
Click here for a discussion of our DCF model techniques.
Once we have computed an Intrinsic Value per share for our Top 10 stocks within the Class of 2014, which are all nearing a buy point, we will then compute what we call a GSL Power Rating. This value is simple to explain. Merely add the IBD Composite Rating of the stock with its upside percentage to our DCF Intrinsic Value.
For instance, let’s assume XYZ Inc. IPO’d on June 30, 2014. It is in our Class of 2014 stocks. Last week we identified this stock’s pattern to be approaching an IBD buy point. We looked up its current Composite Rating in IBD and found it to be rated at 95. We used this rating to rank the stock versus all others that were screened to be near a buy point, and we found it to be the third best stock on our list.
We then analyzed the company’s earnings and calculated a DCF Intrinsic value per share. We found that our Intrinsic Value per share was 75% higher than the current market price.
Lastly, we simply add the stock’s IBD Composite Rating (95) with our projected upside percentage to Intrinsic Value (75), and thus arrived at a GSL Power Rating of 170 for this stock. We then rank this stock among the other Top 10 stocks according to our GSL Power Rating, and trade accordingly.
Over time, we prefer to limit our trading portfolio to no more than 10 stocks. Our initial positions are no more than 8% of our portfolio. If we use the Top 10 stock screening approach we just described across a wide universe of post-IPO stocks, we feel we are best positioned to find future market leaders early, before they make their biggest runs.
As noted several times throughout this website, William O’Neil’s great insight is that market leading stocks will usually have periods of maximum performance in a relatively compressed timeframe, usually lasting no more than 1.5 to 3 years in length. If an investor is to catch these sorts of moves before they occur, the best approach is to screen these candidates by their chart patterns first, and then prioritize and rank them with fundamental factors and assumptions.
Using this two-step approach, we screen stock candidates every week, and endeavor to publish our Top 10 stock candidates on the Seeking Alpha website. If you are interested in following our latest Top 10 stock candidates, be sure to subscribe to Seeking Alpha and follow us.
Thank you for reading this article to the end. We appreciate your time and attention and hope that you found it useful.
