Cruising the 52-Week Highs
It’s not easy finding positive trends among the volatile market sentiment, but it is easy to get distracted—with news on rampant inflation, an incoming recession, the re-emergence of COVID-19, the Russian-Ukraine conflict, and so on.
However, there are good opportunities if you know where to look. So instead of bowing down to the uncertainty roiling global markets, we think it’s a good time to reflect on one strategy we’ve been using to hunt for the next great investment.
This approach starts with a simple rule . . .
Resist temptation to just buy the lows
It’s tempting to overdo it when it comes to buying stocks that are now at 52-week or multi-year lows. While many of these companies may present great value when run through the appropriate metrics, they can also be taking a breather before . . . more lows.
There are countless examples of this in the last couple decades. Cannabis, uranium, tech, oil—sectors where buying the low seemed like a good idea as it was a suspected “pause” in the bull market. Only to have another plunge and another low. And then another.
There’s no shame in having a couple of these stocks in your investing history. We’ve all done it, and at the time buying the low after a massive selloff seemed prudent.
There are a couple key styles of investing to understand. One is bottom-up, where we look for beat-up stocks with strong fundamentals. This is the style that is prevalent now, as most everything is beat up. With patience and a good strategy—based on criteria we have covered—it can absolutely make you great money.
Looking for top performers
The other approach we take is top-down. This approach borrows heavily from momentum investing, which generally relies on buying stocks that have had high returns over the past several months to a year, with the idea that these high returns are there for a reason.
We take this one step further and refine it, looking particularly for stocks that meet our investing criteria (revenue growth, profitability, shares outstanding, etc.), have been through a significant decline, and have recently hit their 52-week highs for the first time.
The thesis is quite simple: these are companies that have already sold off and are now gaining traction among deep-pocketed value investors, who are generally the first movers that usher in waves of capital.
There are many places to start your search. To keep it simple, you can check out the NASDAQ 52-Week Hi/Low list, which not only gives a daily result but also a good idea of what sectors may be emerging.
Be warned, however, that this strategy may hurt your head.
Psychology works against you
At first, buying something that has hit a 52-week high may sound a bit counterintuitive. After all, shouldn’t you sell a stock that is reaching a high? Aren’t you just getting sucked into a FOMO trade? Isn’t the idea to buy low and sell high?
If it’s a stock that’s riding on hype, the answer is likely yes—although a convincing argument can be made that even the “bad” stocks in a sector will lift with the rising tide of institutional investor interest.
In a paper called “Psychological Barriers, Expectational Errors and Underreaction to News,” Justin Birru of Ohio State University provides compelling evidence that stock prices at 52-week highs create a psychological barrier that most investors have a hard time getting beyond.
Anyone who has bought high can likely relate to this feeling. It also often involves buying things that retail investors aren’t comfortable or familiar with. This can be another sign that you are onto something.
Finding big potential
Using this approach, we have seen interesting trends including the slow awakening of the life sciences market, which has seen a number of unknown companies hit 52-week highs.
This is particularly appealing considering the beating the sector has taken. Scores of biotech, pharmaceutical and health care providers have been devastated over the past 12+ months. And there are many stories out there of biotech’s trading below net cash value, with the sector so despised stocks are trading more than 60 – 70% down.
So not only have these companies already been through a big drop, but they also present strong fundamentals and, most importantly, they are starting to attract larger investors. It doesn’t look like much when a company that has flatlined for a year has a blip up that makes it hit a high, but that is often the sign of something significant going on behind the scenes.
The sector ETF, XBI, has begun a gradual climb from its May lows, reflecting the emerging interest. As value investors step in and buy the mid- and large-cap companies in this space, the ETF will attract deep value investors who prefer to buy a basket over individual stocks. The ETF then must step in and buy the stocks to ensure it maintains its percentages. The result is that the sector goes up.
At the same time, this is also one of the lowest IPO markets in the last three decades, and we are seeing increasing M&A activity in the life sciences sector, as companies are getting bought for less than the cash they have. Both could feed a bull market as they lower the supply of companies in the market.
We have been buying some of the components of the XBI in response to the signals the market is giving us, but long-term we really want to accumulate the biggest movers, which could be some of the more unknown Canadian smallcaps. We’ve got one that fits our criteria and will be talking about it soon. So stay tuned!
“We’ve found one that meets our bottom up approach, meeting our fundamental criteria and is in one of sectors that is seeing strong turn around and capital flows”
Keep looking up
Staying optimistic and committed to your investment strategy is always the key to success in a turbulent market like this. At the same time, it can pay to recognize that while markets are down overall there are bright spots.
We think that a 52-week high, momentum strategy could help investors identify potential breakout sectors, such as life sciences, which contain a large number of good companies that are starting to attract money.
It’s an inevitable cycle that always repeats, with value eventually finding its way to the areas where a pricing mismatch is most apparent. It also involves forgetting the last hot sector, acknowledging that the leaders of the last bull market are rarely the leaders of the next one. And, of course, doing your due diligence before stepping in and starting a position.
We look forward to providing you with more insight on our approach as we cruise the 52-week highs in the coming weeks. Until then, best of luck navigating these turbulent times!