Many investors assume that by the time a stock starts to rebound, they've already missed their chance to turn a profit. But in fact, it's often okay to be a little tardy to the party.
Sometimes, stocks continue trending upwards even after the good news has been priced in -- meaning investors can buy high to sell even higher.
This investment philosophy, known as momentum trading, has historically outperformed the widely-espoused "buy low, sell high" strategy. So why does it work?
Because investors are, by and large, an emotional lot, and their behavior usually runs contrary to conventional investing wisdom.
All of this means they have a hard time staying away from a good rally -- everyone wants in, and no one wants to be left out. When this happens, a stock's price can be pushed well beyond its fair market value. So momentum investors who bought high still have time to cash in on the profits.
Of course, momentum alone isn't enough -- any potential investment must also have a track record of profitability. That's why we're only focusing on companies that have higher profit margins than their competitors.
To compile this list, we started with a group of rebounding companies. All of the stocks mentioned below lagged the S&P 500 in 2010, but they've all outperformed the benchmark index in 2011.
To refine the list, we looked at gross and net profit margins to identify the most profitable companies. (Click here to access free, interactive tools to analyze these ideas.)
1. NetEase.com (Nasdaq: NTES): The stock declined from $37.62 to $36.15 in 2010, a price return of -3.91%. Contrast this to the stock's performance in 2011, gaining 46.0%. Trailing 12 month (TTM) gross margin at 71.55% vs. industry avg. at 69.25%. TTM operating margin at 46.2% vs. industry avg. at 27.67%. TTM pretax margin at 46.78% vs. industry avg. at 26.36%.
2. Petrohawk Energy (NYSE: HK): The stock declined from $23.99 to $18.25 in 2010, a price return of -23.93%. Contrast this to the stock's performance in 2011, gaining 44.16%. Trailing 12 month (TTM) gross margin at 55.82% vs. industry avg. at 33.27%. TTM operating margin at 20.98% vs. industry avg. at 15.26%. TTM pretax margin at 22.26% vs. industry avg. at 15.97%.
3. Healthways (Nasdaq: HWAY): The stock declined from $18.34 to $11.16 in 2010, a price return of -39.15%. Contrast this to the stock's performance in 2011, gaining 28.41%. Trailing 12 month (TTM) gross margin at 29.06% vs. industry avg. at 20.92%. TTM operating margin at 11.02% vs. industry avg. at 8.54%. TTM pretax margin at 11.17% vs. industry avg. at 6.96%.
4. Amerisafe (Nasdaq: AMSF): The stock declined from $17.97 to $17.5 in 2010, a price return of -2.62%. Contrast this to the stock's performance in 2011, gaining 26.06%. Trailing 12 month (TTM) gross margin at 18.13% vs. industry avg. at 17.9%. TTM operating margin at 17.72% vs. industry avg. at 14.58%. TTM pretax margin at 17.1% vs. industry avg. at 13.45%.
5. Telecomunicacoes de Sao Paulo (NYSE: TSP): The stock declined from $24.97 to $24.47 in 2010, a price return of -2.%. Contrast this to the stock's performance in 2011, gaining 21.49%. Trailing 12 month (TTM) gross margin at 56.34% vs. industry avg. at 50.45%. TTM operating margin at 21.11% vs. industry avg. at 15.84%. TTM pretax margin at 21.74% vs. industry avg. at 14.38%.
Interactive Chart: Press Play to compare changes in analyst ratings over the last two years for the stocks mentioned above. Analyst ratings sourced from Zacks Investment Research. Note: The numbers on top of items represent the forward P/E ratio, if available.
Kapitall's Eben Esterhuizen does not own shares of any companies mentioned.
