Sometimes, you've just got to ask the Internet a seemingly silly question to see where it takes you. I find that it doesn't necessarily take you where you intended to go, but as Dirk Gently might have said, it gets you some awfully useful information anyway.
Cued by a phrase I must have read or heard, I wanted to know what somebody, somewhere, was claiming to be the "ultimate buy signal." Between a quick Web search and landing on the appropriate Wikipedia page, I got a very interesting answer. I discovered the "Ultimate Oscillator."
I won't go into the whole theory of this particular buy signal, but Wikipedia explains the payoff in these terms:
"A buy signal occurs when:
- Bullish divergence between price and the oscillator is observed, meaning prices make new lows but the oscillator doesn't.
- During the divergence, the oscillator has fallen below 30.
- The oscillator then rises above its high during the divergence, i.e., the high in between the two lows. The buy trigger is the rise through that high."
There's more, but that's enough for me to know it isn't my cup of tea.
Whence, the Ultimate Oscillator
The Oscillator comes from one Larry Williams, who (according to Wikipedia and Williams' own website) has lived an incredibly fascinating life. He is one of the best-selling authors of technical analysis and commodities trading. His daughter is actress Michelle Williams of Dawson's Creek fame. He twice ran for the U.S. Senate from Montana. He sells his techniques through a four-hour video seminar available for the low price of $1,695.
He's since been arrested in Australia, was released on $1 million bail, and is awaiting extradition to the United States on tax-evasion charges.
I mean, that's just a very full life.
Buying in the absence of an ultimate signal
I don't know that allegedly avoiding taxes (Williams is defending himself on the basis that there has been a mistake), even if proved, would necessarily undercut the validity of any statistical model, but I'll admit that it certainly doesn't increase my trust in the model and its reported riches.
I'm just one of those people who believes you should invest your hard-earned money only for the long term and only into businesses you fully understand, rather than trading with a holding period of hours or days on the basis of the lines on a stock chart that are independent of such things as sustainable competitive advantages and growth opportunities.
But working for the Motley Fool Hidden Gems service, it behooves me not to just find fault elsewhere, but to offer alternative solutions. So I thought about what it is that we, on the Hidden Gems team, would consider the ultimate buy signal, even if we would never put it into those terms. (We eschew the word "oscillator" as well.)
There are a number of us working to find, cover, and review the stocks that are ultimately recommended, so you wouldn't get us all on the same page about the exact weighting and order of what comprises a perfect buy opportunity. But there would be communal agreement about a list like this:
- Wide and growing market opportunities.
- Sustainable competitive advantage (economic moat).
- Misunderstood business situation or opportunities.
- Significant founder/insider ownership stake.
- Strong returns on invested capital.
- Solid balance sheet.
- Cash flows as good as or better than net income.
- Buying back shares.
- Small market cap.
- Attractive valuation.
You're not likely to ever find every one of these criteria in one company at the same time, but it is certainly possible to find combinations of these "buy signals" at once. We're focused strictly on small caps (they have significantly higher historical returns than large-cap stocks), but some companies (large caps among them) that have met a significant number of these criteria in the recent past have included Valero (NYSE: VLO ) , First Marblehead (NYSE: FMD ) , Blue Nile (Nasdaq: NILE ) , Brookfield Asset Management (NYSE: BAM ) , Coach (NYSE: COH ) , J.M. Smucker (NYSE: SJM ) , and WD-40 (Nasdaq: WDFC ) .
Identifying companies that fit some combination of those factors has been working out for us and our subscribers. The returns are 46% versus 16% for the market. We'll never seek to charge $1,695 for two months of our service, as Williams apparently does (actually, you can try our service totally free with a risk-free 30-day trial), but maybe that's because we haven't yet found the "ultimate buy signal."
What we have found are a number of promising long-term investment opportunities that have significantly improved on the market's returns.
We hope you'll join us in looking for the next ones.
This article was originally published on March 6, 2007. It has been updated.
Bill Barker does not own shares of any of the companies mentioned in this article. First Marblehead is a Hidden Gems and Inside Value recommendation. Brookfield Asset Management is a Global Gains recommendation. The Fool has a disclosure policy.