August 28, 1998

Using the Double

By Louis Corrigan (TMF Seymor)

As Double-dealers, Rick Aristotle Munarriz and I are always checking the deck for those stocks that have left investors royally flush. We want to find out which ones have the cards for the future and which ones have just been bluffing. We try to determine what aces these players have pulled from their sleeves and how many more they have left.

The hand may still prove quicker than the eye, but the practiced observer of these Doubles should get a little better at picking the players prone to claiming at least one good-sized pot. Even better, learning why some stocks double can help you determine which ones can claim the pot over and over and over again. Some Doubles are often great candidates to double again (Jackson Hewitt).

We also don't mind pointing out lowlife jokers that try to pick your pockets while stacking the deck with hype. Keeping your money out of the hands of shady characters is a prerequisite for creating wealth. Shooting down these dubious outfits by shorting them can be a rewarding public service, too. Some Doubles are Troubles just waiting to happen.

The essence of a Double is a rising stock price -- up 100% or more over the last six to twelve months. These are stocks that score a 90 or better on relative strength (RS) measures, meaning that they've recently outperformed at least 90% of other stocks on the market. All kinds of stock-picking strategies, including William O'Neill's CANSLIM method and the stock screens created by our own Robert Sheard, rely on back-tested data showing that stocks that have done well are more likely than other stocks to continue to do well. The Double highlights exactly these stocks.

But price momentum alone is no guarantee of a bright future. To get a handle on where these players might be going, Rick and I look at the developments that handed them a full house. We try to determine how one might have spotted that jack or queen that helped instigate the company's reign in Doubleville.

What, then, makes a Double? Stellar earnings that trump analyst estimates are one sign of a stock worth investigating. But even when analysts have turned a blind eye to a would-be prince, we common folk can look for rising profit margins or for retailers delivering fashionable gains in same-store sales. Hot new products or hot new markets also produce their share of Doubles. Also, while management changes or major acquisitions can leave companies reshuffling their operations for a time, both can eventually produce revitalized businesses with enhanced focus or improved market opportunities.

Of course, all kinds of special situations can produce Doubles if companies play their cards right. Many industry consolidators can squeeze out fat price gains as long as they can use their relatively expensive stock as currency (Consolidated Graphics). Biotechs often produce a Double on word of a successful clinical trial, approval from the Food and Drug Administration, a licensing deal with a major pharmaceutical firm, or just the promise of one of these (Closure Medical). Then there are the Troubles on the brink of disaster that right themselves with the help of new management, an upswing in the economy, or just better focus on managing a business rather than growing it (Best Buy).

As with the Trouble, sometimes one Double (Yahoo!) ought to point you to other players in the same industry (Excite). Other times, a Double (Amazon) should raise doubts about another firm working the same niche (CDnow). In many cases, though, stocks that appreciate a great deal in a short period are tied to companies that analysts continue to underestimate (DELL). It's often smarter to trust the company's actual results rather than Wall Street's projected numbers.

While it's better to be lucky than good, luck tends to run out for the outfits that stack the deck. Calling a Double's bluff can be a profitable way to turn the tables on a desperado disguised as one of Cezanne's salt of the earth cardplayers. Screening the Doubles for short candidates over the last year or so, you might have discovered a rogues' gallery (ErgoBilt, Visual Edge Systems, HumaScan). As in strip poker, watching a Double lose its shirt can be fun. Happily, the markets produce a chorus line of exhibitionists.

Not all Doubles, then, will make good investments in the future. Indeed, we try to find some that definitely won't, unless you care to buy low and sell high in reverse order. But as we count the cards, Rick and I hope to deal out some investment ideas that today may look twice as expensive as they did six months ago but may look downright cheap relative to where they'll be a year from now. Even better, just reading these stories should help school you in the anatomy of a Double so that someday soon you can invest in them before we write about them.

To that end... ante up!