Counting Bases Mike Scott Base Counting and Price

Counting Bases Mike Scott

Base Counting and Price Target Setting

Preferred Stocks to Own • Liquidity: Average Volume * Price > $20 M-$40 M+ per day – Minimum price $15 (NYSE), $20 (NASDQ) • Top notch fundamentals – Triple-digit EPS gains – 3 quarters of EPS acceleration – 3 Quarters of Sales acceleration – 3 Quarters of increasing Institutional Sponsorship – 1%-3+% Demand-Supply Ratio – ROE + Pre-Tax Margin > 50% • Satisfactory responses to three questions: – Is this the very best stock I could own? – Is this stock sponsored by quality institutions? – Where is the stock in its cycle (base stage, earnings date)

Why Count Bases • After a stock moves up they typically consolidate (base) for weeks or months before they make another move • New investors are required to keep a stock rising • By the time a growth stock forms its third or later stage base it is known by most investors • At some time we run out of sufficient new buyers to continue the advance

Evolution of a Stock Cycle 4 th Stage Base A 3 rd Stage Base Bear Market Decline “ 3 -Waves Down” a b Prior Rise 2 nd Stage Base 1 st Stage Base c Successful test of low > 20% A

5 4 General Market Follows Through 3 Bear Market Decline 2 1 a b c Positive Test

Count bases on a weekly chart • Bases begin on the first down week of a consolidation pattern • The base continues until the price breaks out of a legal buy point (pivot point) • Only count bases that are long enough 1 9

Base Counting Rules • Start the base count when the stock is investment grade. Typically when the top of a base forms above $10, makes profit and demonstrates clear demand. Artistic license okay. • Count each base that forms 20 -30% or more above a prior base (buy point to top of next base) • Count bases of 7 weeks or longer (there are exceptions such as 5+ week flat base that gets deeply undercut) • A bear market resets the count for all stocks after the market begins the next bull market • Any undercut of a prior base resets the count • A stock that breaks out and fails below the bottom of its base resets the count • A 2/3 decline from a prior high resets the count • A base of 12 months or longer resets the count The first base that forms after count has been reset is first stage

MA Tops at $320 after 4 th Stage Base O’Neil Studies have shown that big leaders tend to expand P/E from a 1 st stage base by 130% before topping PE = 46 +155% 18 -months to 2 years typical

Pay Attention to the First base in a New Bull Market • For P/E Expansion Price Target Calculations only consider the first base in a new bull market • The last bear market bottom was 3/09/2009 • In rare cases a leading stock will breakout of a 1 st stage base in advance of a bear market low (BIDU, NFLX)

Base Counting Example Tops at $72 with a failed 4 th stage base 2 1 st > $10 Obvious Institutional Sponsorship

Bull Market Starts Should we start here or here? Bear Market Decline a b c Positive Test

NFLX Base Count 4 or 5? 1/28/09 e. IBD

What is VIT Base Count?

VIT 1% above PT < $10! Volume Discovery!

What is the Current Base Count?

Base Undercut Reset Breakout and undercut

LULU Resets the Count Current 2011 EPS est. is 1. 57, I don’t chase moving estimate targets

Breakout Failure Reset Breakout First Stage Base Fails below base

Long Base Reset

Setting Price Targets • Experience has shown that small and mid cap leadership stocks tend to top after the P/E ratio has expanded on average 130% from its original first stage base • Large Cap stocks tend to top after the P/E expands 98% • P/E expansion is effective for setting working targets based on extensive historical studies of winning stocks • Use this as a possible means to stay in a position when a stock is making its early moves and not sell out too early • P/E expansion is useful to amplify sell rules: stock approaches sell target and is showing weakness

Price Target Algebra • 130% expansion and high school algebra… – P/E = 10; 1 st stage – Expanded P/E = 10 + 130% of 10 – Expanded P/E = 10 + 1. 3 * 10 = 10 * (1 +1. 3) – Expanded P/E = 10 * 2. 3 = 23 – Use 1. 98 for non-growth stocks…

P/E Expansion Method • Step 1 Determine the Target P/E = P/E @ Pivot * 2. 3 Original first-stage base only, institutional grade stocks only (if non-growth use 1. 98) If later stage, estimate initial P/E at 1 st stage breakout by using the sum of the trailing four quarters of earnings (TEPS) at the time of the initial breakout: P/E at Pivot = 1 st Stage Pivot Price / TEPS • Step 2 Identify estimated earnings per share 18 -months to 2 years out (Market. Smith) • Step 3 Determine Price Target Multiply Target P/E by estimated Earnings

NFLX Base Count 4 or 5? 1/28/09 e. IBD EPS est. 18 -months to 2 years from 1 st stage base breakout (earlier est. was 4. 39

Not a growth stock, use 98% (1. 98) expansion factor Step 3. Price Target = 1. 67 * 1. 98 * 10. 2 = 33. 7 Step 2. EPS + 2 years = 1. 67 Step 1. 1 st Stage Pivot = $9. 98 P/E = 9. 98/0. 98=10. 2 EPSTTM = 0. 98 3 -Waves Down Bear Market reset Can you hold here?

GMCR has not achieved PT If market allows GMCR has room to run Tight Closes

FFIV Climax Top +7% above PT

FFIV Short Position