The Ultimate Buy Signal

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 claimed was 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 a best-selling author on the topics 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, low price of $1,695.

He's 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 believe you should invest your hard-earned money only for the long term and only in 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 -- which are independent of things like sustainable competitive advantages and growth opportunities.

But working for the Motley Fool Hidden Gems service, it behooves me not just to 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 in 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 constitutes a perfect buy opportunity. But there would be communal agreement about a list like this:

  • Wide and growing market opportunities.
  • Sustainable competitive advantage (i.e., 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.
  • Share buybacks.
  • 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 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 of the larger companies that have met a significant number of these criteria in the recent past have included Gannett (NYSE: GCI  ) , Honeywell (NYSE: HON  ) , Disney (NYSE: DIS  ) , Simpson Manufacturing (NYSE: SSD  ) , Forward Air (Nasdaq: FWRD  ) , UST (NYSE: UST  ) , and Nucor (NYSE: NUE  ) .

We'll never 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 March 6, 2007. It has been updated.

Bill Barker owns shares of Disney. Simpson Manufacturing is a Hidden Gems selection. Disney is a Stock Advisor pick. The Fool has a disclosure policy.

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