Supernova Stocks User Guide
Table of Contents:                                       Supernova Stocks
What’s the Market   ...
By Charles L. Norton, CFA
                                                                            and Allen R. Gillesp...

all, what good is sales growth if it’s not making its way   our research and we will always dis...
By Charles L. Norton, CFA
                                                                               and Allen R. Gill...

Finally, we may sell if a stock shows signs of a climax
top, which is a huge price move after t...
By Charles L. Norton, CFA
                                                                                       and Allen...
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Supernova Stocks User Guide

  1. 1. Supernova Stocks User Guide Table of Contents: Supernova Stocks What’s the Market User Guide Doing? . . . . . . . . . . . . . 2 S upernova Stocks is unlike many other newsletters that are written by financial reporters with little or no real world investing expertise. On The Fundamentals and the contrary, Supernova is written by professional money managers Valuation . . . . . . . . . . . 2 that actively manage investors’ money, while also writing for Supernova Stocks. Finding the Business In fact, the stock selection process used here at Supernova is how these sea- Driver. . . . . . . . . . . . . . 3 soned pros generate ideas in their investment business, where they have mil- lions of dollars at stake. Their process, developed over years of experience, And Finally, the has proven to be successful in getting in early on stock market winners. Technicals . . . . . . . . . . 3 I’ll let Supernova Stocks Editor-in-Chief Charles Norton explain in his own words below the process by which he and Managing Editor Allen Gillespie How to Buy: Average identify stocks that have supernova potential. First, though, let me take a Up, Not Down . . . . . . . 4 minute to explain what you can expect from us at Supernova Stocks. You’ll get three Special Reports in addition to this one, which we hope you’ll You Own It, Now enjoy and profit from. Check back often as we’ll add new Special Reports What? . . . . . . . . . . . . . . 4 throughout the year. The editors of Supernova Stocks, Charles and Allen, both of whom are CFA Investment Policy & charterholders, are constantly doing research to uncover the next big stock Trading Restrictions . 5 market winner. Twice a month, subscribers to Supernova Stocks will receive a new issue with two of their freshest ideas. Sometimes the stock they discuss may be a timely buy, and other times it may be a stock worth watching as a possible future investment. Each com- pany write-up will detail, at length, the company’s fundamentals, the busi- ness driver, and the stock’s technical condition. Twice a month, you’ll hear from these two proven money-makers exactly why they think these stocks could generate huge gains for your portfolio. Not only that, but you’ll learn all about their stock selection process, valuable lessons you can apply to your own investing. In each issue you’ll also get an update on some of the companies followed by Supernova Stocks. Better-than-expected earnings reports? Insider buy- ing or a new product launch? You’ll find all this news and more in this sec- su per no va tion of the newsletter. 1: The explosion of a very large star in Finally, the model portfolio will show all of the stocks that Charles and which the star may reach a maximum Allen have recommended buying, and each stock’s return since their pur- intrinsic luminosity one billion times that of the sun chase. 2: One that explodes into prominence or We hope you enjoy our work at Supernova Stocks, and we hope our stock opportunity picks help you achieve investing success! Source: Merriam-Webster — Ian Wyatt, Publisher
  2. 2. By Charles L. Norton, CFA and Allen R. Gillespie, CFA Supernova stocks share common traits: they’ve gener- lesser extent, the Dow - to generate a big-picture opin- ated large and sometimes accelerating sales and earn- ion of the market’s trend. At the beginning of each ings growth and are expected to have continued growth issue of Supernova Stocks, we’ll briefly discuss our in future periods; they are leaders in a leading industry market view. group; they are under-owned but beginning to attract institutional attention; and there is a fundamental That’s not to say that there aren’t stocks that go up in change in their business that serves as a catalyst to bear markets. It just means that the truly spectacular continue (or increase) growth. moves - the 500% to 1000% gains and more - generally come during bull markets. But we’re of the belief that In his classic book about Jesse Livermore, there is always something working. Our job is to identi- Reminiscences of a Stock Operator, Edwin Lefevre fy what’s working and share it with you. says, “Nowhere does history indulge in repetitions so often or uniformly as in Wall Street…The game does Even in bear markets, there are certain industry groups not change and neither does human nature." Indeed, or global markets that perform well for a period of when it comes to finding the next big stock market time. We’re equal opportunity investors – regardless of winners, studying past stars is a great starting point. a company’s size, sector, exchange, or index member- Evaluating the charts and stories of previous leading ship, if it meets our criteria, we’ll consider it for invest- stocks, and applying those lessons to today’s market, ment. Eventually, however, even the best performing can help uncover some true gems. sectors give in to the strong forces of the broad mar- ket’s correction. One concept that we’ve learned from studying the char- acter of market-leading stocks that is often overlooked It is during this period, usually when the broad market by many investors is that leading stocks can trend is in a bear phase, that future market leaders start base higher for long periods of time. As William O’Neil building, preparing for their next launch. Until then, explains in his classic book, How to Make Money in the sidelines may be the best place to be. Supernova Stocks, “The hard-to-accept great paradox in the stock Stocks is a long-only newsletter, but that certainly market is that what seems too high and risky to the doesn’t mean our model portfolio will always be fully majority usually goes higher and what seems low and invested. In fact, in bear markets we may be in all cash cheap usually goes lower.” This philosophy means that waiting for a more favorable environment. we don’t shy away from a stock because it’s “up too much,” and we don’t bother trying to bottom fish The Fundamentals among the laggards. and Valuation Of course, even using previous leaders as a guide to picking future winners will not prevent us from Thousands and thousands of stocks trade each day. selecting a dud every now and then. In fact, I can Our mission is to sift through all the stocks out there in promise you that we will have our fair share of order to find gold: the select few that could be the next lemons. However, sound portfolio management rules market winners. Our process begins by using quantita- are the cornerstone of the Supernova process. tive screens to narrow the field of possible investments Disciplined risk management is absolutely crucial for to only those companies that meet our stringent funda- investing success. Realizing when it’s time to sell is mental criteria. just as important as learning when (and what) to buy. This criteria include strong quarterly and annual sales and earnings growth, and the higher the better. Ideally What’s the we look for accelerating growth over the past three quarters, although that is not a requirement. Not only Market Doing? does a company have to exhibit a nice track record of growing both their top and bottom line, but we also Because most stocks move in the direction of the mar- like to see expectations that this growth will continue. ket, many of the biggest winners of all time occurred during a bull market in the broad market. Therefore, Another thing we look for in this initial process is we monitor the health of the major stock market strong and improving profitability, as measured by indices - the S&P 500, the Nasdaq Composite, and to a return on equity and expanding profit margins. After 2 To Subscribe Call 866-447-8625
  3. 3. all, what good is sales growth if it’s not making its way our research and we will always discuss it in our com- down to the bottom line? We prefer to see companies pany write-ups. That’s not to say that we only buy with a solid return on equity and a few consecutive cheap stocks or if we consider a stock to be expensive, quarters of margin expansion. we won’t buy it. In fact, many stocks that turned into supernovas seemed expensive before they took off, and We also focus on the leading industry groups and look we don’t want to miss a potential huge market winner for the top few companies within these groups. Most regardless of its perceived valuation. But knowing what stocks move in tandem with the other stocks in their the valuation is helps us judge the amount of risk industry, and often companies with lagging fundamen- involved. In general, the higher the valuation, the tals will move higher just because their group is greater the risk. advancing. These “sympathy” plays are of no interest to us at Supernova. That is, we are searching for the Finding the cream of the crop: the most dominant, fundamentally superior companies in the leading industry groups. Business Driver Steadily growing institutional sponsorship is another Now that we’ve narrowed the universe of possible important attribute favored for stocks that we select. investments down to a manageable number, it’s time to Institutional investors like mutual funds, hedge funds, go through them one by one, trying to uncover the corporate pension funds, bank trust departments, and driver of each company’s growth. Quantitative screens university endowments move the market, not the indi- are very useful in quickly filtering through thousands of vidual investor. It doesn’t take very much buying inter- stocks to find ones that warrant a closer look. But now est by one or more of the large institutions to drive a it’s time to roll up the sleeves and start digging for the stock higher. gems, the great fundamental stories. After completing quantitative screens, the real detective work begins. There is a fine line here, though. Some stocks, like Microsoft and Cisco, are “over-owned.” That is, so What we are looking for in this stage is the “story": the many institutional investors own these stocks that catalyst that will likely propel the stock to new highs. there are not enough potential new buyers around to These growth drivers could include a new product move the stock to new highs. So we look for a few insti- launch, a new management team that has the experi- tutional sponsors with steadily growing demand, but ence to take a business to the next level, or a macro not stocks that are already overowned. We also moni- event that is having a dramatic impact on an entire tor the track record of the institutional holders that industry, like new legislation or new technology. already have a position in the stock, because we prefer Whatever the case, it is this catalyst - and our analysis to be shareholders alongside the better performing of it - that separates a supernova stock from an average funds that have had previous success in finding emerg- stock. ing leaders. This is a laborious process that includes going through Finally, we’ll look at the valuation. There are a lot of piles of annual reports and SEC filings, reading sell ways to measure a stock’s valuation, and different types side research reports and news stories, listening to con- of companies lend themselves to different methods of ference calls and management presentations, and determining value. speaking with other investment managers and analysts. While it may be arduous, the rewards make it all Sometimes we’ll look at a stock’s value based on a worthwhile. Even then we’re still not done with the number of different metrics compared to its historical process. valuation. Other times, we’ll compare a stock’s current market value to the theoretical value generated using a And Finally, discounted cash flow model. Sometimes an earnings growth rate relative to its price/earnings multiple the Technicals model (a frequent barometer of “growth at reasonable price”, or GARP, investors) is better. Finally, compar- After this stage, companies will fall into one of two cat- ing different valuation metrics relative to a firm’s egories. First, there are the stocks that passed the industry group peers is another approach we often use. quantitative screen but lack a compelling story. These Whatever the case, valuation is an important part of warrant no further attention and are pretty much dis- To Subscribe Call 866-447-8625 3
  4. 4. By Charles L. Norton, CFA and Allen R. Gillespie, CFA carded because, while they passed the screen, there is However, for the purposes of this newsletter, in order no major fundamental change in the company’s busi- to simplify things when we recommend a stock for the ness. The other group is comprised of stocks that meet model portfolio, in most cases the full position will be all of our stringent fundamental criteria and have a taken at once. Sometimes we will start smaller, though, great catalyst that we think can drive the stock higher. if there is greater risk in the stock. These stocks go to the final step in the process, an analysis of the chart - or technical analysis. You Own It, The stocks that have made it to the final stage are the Now What? ones that we will be writing about, twice a month. If a stock is extended because it has already made a large While the decision of what we buy - the uncovering of advance, then it will go on our watch list and we may the potential supernova stocks - is primarily based on write about it, but we will not buy it immediately in the the fundamentals, the sell decisions tend to be based model portfolio. If, on the other hand, a stock has off the technicals. Of course, if the fundamental story formed a base, or consolidation, and is breaking out of changes, that is also a reason to sell. But in most cases, that pattern, then we will write about it and buy the by the time that is apparent, it is too late. In our opin- stock in our model portfolio. ion, technical analysis is the most effective way to spot a stock that may be topping, and to sell before a com- What we’re looking for is a base of at least 5 weeks. Once pany’s fundamental slowdown becomes apparent. a stock emerges from this base on heavy volume, this indicates an increase in demand that is disrupting the Once we own a stock, we continue to monitor its price supply/demand equilibrium present during the consoli- and volume action daily. Many times a stock will dation period. We will look to enter as the stock trades break out, only to pull back to its pivot point, or buy above the highest point in the base, or the pivot point. point, on light volume. That is acceptable and we remain patient during these brief pullbacks. The four types of base patterns that we look for are the cup-and-handle, the double bottom, the flat base, and However, heavy-volume selling pressure is a cause for the ascending base. All of these various chart forma- concern. This signals to us that institutions are net tions will be described in greater detail when we write sellers and enough professional selling, or distribu- about them. tion, can be powerful enough to knock down even a fundamentally sound company. Rallies in light vol- How to Buy: Average ume also make us uneasy, as it shows a lack of insti- tutional interest despite its recent break-out. Up, Not Down So excessive distribution or lack of accumulation One last note on buying stocks. In the real world, would be a cause for concern because both are signs when we are investing on behalf of our clients, we typi- of weakness and may lead us to sell a stock. If the cally don’t buy a full-sized position all at one price level fundamental story remains intact, we would keep it or on one day. We will start with a smaller position and on the watch list, and if it provides a better entry after see how the stock behaves. If the market confirms our building another base, we can always get back in. research and the stock begins to move higher, we will then add to the position and build it up as the stock Another reason we would sell a stock is a technical continues to increase (but not too far above the pivot failure, like falling out of a base on heavy volume or point). breaking down out of a bearish chart pattern, which signals a possible change of trend. Again, we would If, on the other hand, the stock moves against us and watch the stock and look for a better opportunity to we end up being wrong, we will frequently cut bait, tak- get back in after the stock forms another base. ing a loss on a smaller position. We typically won’t average down - we prefer to build our position as the We may also sell a portion of a position once we are stock moves higher. up 20% to 30%. Our philosophy is that there’s noth- ing wrong with taking a little money off the table, but In your own investing, we would recommend this we’ll only trim the position to lock in some profits, process, sometimes referred to as “pyramiding.” and keep the remainder invested for the long haul. 4 To Subscribe Call 866-447-8625
  5. 5. Finally, we may sell if a stock shows signs of a climax top, which is a huge price move after the stock is Investment Policy & already extended out of its base. Climax runs often end in exhaustion and mark the top in a stock after an Trading Restrictions explosive move, and we will sell into the overwhelming As full-time money managers, occasionally Allen and I increase in demand. We will discuss signs of a climax will discuss a stock that we have a position in at our top, sometimes called a “blow-off” top, in greater detail money management firm, GNI Capital. In addition, the in future reports. publisher of Supernova, Ian Wyatt, might personally own a stock that we’re highlighting. Supernova is a full By far, the most important rule that we follow above all disclosure newsletter: at the end of every company others is our maximum loss rule. If we ever get down write-up, we will disclose our position in the company. 10% on a stock, we’re out, no questions asked. To us, this means that we misread something and the market In addition, there are certain periods of time when is telling us that we are wrong. As William O’Neil has essentially, our hands are tied and no one affiliated said, “The whole secret to winning big in the stock mar- with Supernova Stocks can trade in the stocks that we ket is not to be right all the time, but to lose the least are discussing. For the five trading days preceding pub- amount possible when you’re wrong." lication and the three trading days following, we are forbidden to buy or sell the stocks in the newsletter. If there’s one thing we’ve learned over the years, it’s That means if we don’t already own a stock in this peri- that the market is the ultimate arbiter of right and od, we are unable to buy it and you, as a subscriber, wrong, and when the market is telling you something, will have a head start on these fresh ideas. If we do you had better listen. We’re certainly humble enough own it, then we can’t sell it (or buy more) during this to admit our mistakes and get out if we are down 10%. window. Then it’s time to go back through the file and look at it through neutral eyes. Sometimes when you own a stock Supernova’s mission is to identify explosive superstar it is human nature to only see things in a positive light stock market leaders that have the greatest profit even though some negatives may be right there in front potential, and we believe that our process gives us an of you. edge in finding these stocks in their early stages. Welcome to the Supernova community - we hope you So 10%, we’re out. Our philosophy is that you can enjoy our service and that it helps improve your per- always get back in, but having a disciplined sell rule sonal investing results. means that you are nearly guaranteed never to lose 20%, 30% or more (with the exception of gap down openings). In some cases, if we can tell we are wrong before losing 10%, we will just get out and re-evaluate our analysis. To Subscribe Call 866-447-8625 5
  6. 6. By Charles L. Norton, CFA and Allen R. Gillespie, CFA Disclaimer Supernova Stocks LLC Supernova Stocks is published by Supernova Stocks, LLC ("SNS"). SNS is neither a regis- 611 Pennsylvania Avenue SE, #417 tered investment advisor nor a registered broker/dealer. Readers are advised that this publication is issued solely for information purposes and should not to be construed as an Washington D.C. 20003 offer to sell or the solicitation of an offer to buy any security. SNS does not purport to be a complete analysis of every material fact respecting any company, industry, or security. Toll Free: 866-447-8625 Although the opinions and statements included herein are based on sources believed to be reliable and in good faith, no representation or warranty, express or implied, is made as to Local: 202-986-6333 their accuracy, completeness or correctness. Fax: 202-318-0362 Web: We encourage subscribers to consult with independent financial advisors with respect to any investment in the securities mentioned herein. Any opinions, projections and predic- E-mail: tions expressed in this profile are statements of judgment as of the date of publication, are subject to change without further notice, and may not necessarily be updated or reprinted Editor-in-Chief: Charles L. Norton, CFA in future publications or elsewhere. Opinions, projections and predictions contained here- in are those of the author(s), and are not an assurance or guarantee of actual results. Managing Editor: Allen R. Gillespie, CFA Likewise, prior performance may not be indicative of future results. Neither SNS nor its Publisher: Ian Wyatt members, managers, officers, employees, or consultants accept any liability whatsoever for any direct or consequential loss arising from any use of this newsletter or its contents. SNS and its members, managers, writers and employees do not accept compensation from the companies discussed within SNS. From time to time, SNS allows public issuers or third parties acting on their behalf to redistribute content published by SNS relating to that issuer. Under these circumstances, the issuer or a third party acting on their behalf may spend a significant amount of money to redistribute a SNS report on the company. SNS and its members, managers, writers and employees, and their families from time to time positions in the securities of the companies discussed within SNS. Such positions will be disclosed at the end of each article and are subject to change without notice. Full disclo- sure of any relationships with public issuers or third parties acting on their behalf, and a list of companies followed by SNS in which its members, managers, writers and employ- ees, and their families own shares, is disclosed in detail at the SNS web site at on the Disclaimer and Disclosure pages, or is available upon request by phone or in writing. SNS is not intended for residents of the United Kingdom. Subscription rate: One year with twelve electronic issues, on-line access, and e-mail alerts, $249.00 Copyright © 2005 Supernova Stocks, LLC. For subscription information contact our sales representatives at: (866)-447- 8625 or on-line at All rights reserved. # To Subscribe Call 866-447-8625