Is That Stock Too High to Buy?

by Paul Goodwin on March 07, 2014
originally from Cabot Wealth Advisory
Stock Market Video

Is That Stock Too High to Buy?

This Week’s Fortune Cookie

In Case You Missed It

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In this week's stock market video, Mike Cintolo discusses the market's encouraging resilience during the Ukraine news earlier this week, though he's keeping his eyes open for more shakeouts in the days ahead. But to him that's all to the good—the odds favor the next pullback or two being buyable, and he highlights a handful of stocks he's aiming to jump on during any weakness. Click below to watch the video! 

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Is That Stock Too High to Buy?

Earnings season is now just a pleasant (or painful) memory as the last of the emerging market stocks have finally announced their quarterly results. And when March ends, the whole agonizing process will start again.

For most of us, the end of earnings season means that our blood pressure is returning to normal and we’re either enjoying the nice portfolio bump that accompanies good results or licking our wounds after investors gave an underperformer a trip to the woodshed.

But chances are good that you came through without major damage. As of the end of February, with 97% of all stocks having reported, 71% of the stocks in the S&P 500 beat their EPS estimates and 63% exceeded their revenue estimates. (And just FYI, information technology stocks boasted an 82% beat rate, while only 60% of energy stocks managed to top their consensus estimates.)

So, there are a lot of stocks out there that have charts that look like this.

This is Athenahealth (ATHN), a company that has been helping medical practices in the U.S. by automating their billing, insurance claims and reimbursement activities, among other things. Athenahealth enjoyed a great earnings report on February 7, and you can see the gap up and the huge bump in volume that accompanied it.

This chart shows three positives that make ATHN a potential good buy. First, the stock’s blastoff came after a tight 16-week consolidation. Second, trading volume on the day of the move was more than triple its usual rate. Third, the stock got a big boost in momentum from the good news, fueling a continuing rally that pushed it from its February 7 close at 174 to as high as 202 in February 26.

I got several questions from my subscribers after ATHN’s monster move, all of them wanting to know if it was still buyable. (I also got questions about other breakout stocks like ICPT, JLL and TSLA; these comments apply to all of them.) The overarching message is this: Even though a stock has busted a huge move higher, you haven’t “missed it.” It’s just a question of finding a reasonable buy price. Investors have signaled their approval of the company and its good news, and that’s a valuable signal.

So where does it make sense to buy ATHN? The first answer is to wait for a pullback, probably below 190. The stock has begun to chop around, possibly signaling another consolidation phase, and ordinary volatility will probably pull it back to a price that will give you a little margin for error.

The second answer is to buy ATHN right where it is, but to start your position with a smaller-than-usual buy—say a half of your usual dollar amount—and then look to average up when you get a profit cushion of 10% or so. The third answer is to wait for the 25-day moving average (the red one) to catch up with the stock and then jump in. There’s nothing magic about the moving averages, but experience shows that leading growth stocks do frequently either find support or get a little energy boost at their 25- or 50-day moving averages, especially if it’s the first test of those lines within a few months.

Much of how you choose to buy depends on how you see yourself and how you tolerate risk and how long your investment horizon is. If you are a cautious investor and want to hold ATHN for a long time, you should look for a pullback below 190 as a buy point. A more aggressive investor might buy the stock right where it is and use a stop down around 160, near the top of the earnings gap. That’s a loose stop, which is appropriate for the strong market conditions we’ve been experiencing.

I have to point out that there’s always a possibility that Athenahealth will get some kind of shock—maybe the company’s CFO resigns or a competitor snags a big contract or whatever—and the stock will move just as strongly down as it moved up after earnings. So setting the loss limit should always be part of your routine for buying ATHN or any stock.

There are no certain ways to make a perfect buy every time. Sometimes you’ll grab a stock on a pullback and the pullback will turn into a free-fall. Or you’ll buy the day before the ideal correction.

But if you follow these guidelines for buying after big breakouts, you’ll put the odds a little more in your favor.

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Here’s this week’s Fortune Cookie. Remember, you can always view all previous Fortune Cookies here and Contrary Opinion here.

Paul's Comment: One of Cabot's strongest principles of growth investing is that there is no percentage in trying to figure out what the market is going to do tomorrow or next week or next year. Our market timing is aimed solely at figuring out what the market's direction is right now and making investing choices accordingly. When you stop worrying about what might happen, it frees you up to get in sync with what is happening.

Tim’s Comment: Furthermore, life typically teaches us that trouble comes from things we are not worrying about. At Cabot, we've found it much less stressful—and far more rewarding—to simply listen to the message of the market and individual stocks and follow the trends.

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In case you didn’t get a chance to read all the issues of Cabot Wealth Advisory this week and want to catch up on any investing and stock tips you might have missed, there are links below to each issue.

Cabot Wealth Advisory 3/3/14—Tesla Motors and Morgan Stanley

Cabot Stock of the Month head Tim Lutts explores the role of “the unforeseeable and the incalculable” in Tesla and other stocks and why fundamental analysts don’t have all the answers. Tim also gives the ninth in his series on Disruptive Stocks: HomeAway (AWAY).

Cabot Wealth Advisory 3/4/14—Market Leader in the Medical Device Industry

Nancy Zambell, editor of Investor Digest and Dividend Digest, writes in this issue about the thriving medical device industry, its huge prospects in emerging markets and its merger & acquisitions opportunities. Stock discussed: Medtronic (MDT).

Cabot Wealth Advisory 3/6/14—The 10 Most Popular Dividend ETFs

Chloe Lutts Jensen, chief analyst of Cabot Dividend Investor, comments on the 10 most popular dividend ETFs whose yields range from 2.5% to 6.7%, with varying potential for price appreciation. She also give a bonus emerging market small-cap ETF.

Have a great weekend,

Paul Goodwin
Chief Analyst of Cabot China & Emerging Markets Report
And Editor of Cabot Wealth Advisory


Paul Goodwin can be found on Google Plus.