In today’s feature article, contributor Tom Carr shares the basics of one of his proven strategies for identifying profitable short-term trades. And we’d do well to pay attention. Among Tom’ recent winners are Zendesk (ZEN), up 39.5% in less than three months, and Spotify (SPOT), up 23.1% in four weeks.
— Bob Bogda, Editor
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One of my favorite investment strategies for finding profitable short-term trades can be broken down into four easy steps:
1. Find the strongest sector in the market with the greatest potential for price appreciation going forward over the next quarter
2. Call up a list of all stocks in that sector that are trading with sufficient volume and market capitalization
3. Drill down on the list to eliminate all well-known “marquis” names
4. Find the strongest names that remain – the “under the radar” plays – and do further due diligence on those
Now, there are many ways to work through that first step. I won’t give away the details of my process here, but I can suggest consulting Zacks Investment Research (which categorizes sectors based on earnings estimates revisions) and Investor’s Business Daily’s MarketSmith software, which ranks sectors based on relative strength.
One sector that rises to near the top in both these services is the semiconductor-fabless sector. Semiconductors, or microchips as they are sometimes called, are what drive the tech economy from the ground up. They are in everything from phones and Fitbits to solar farms, supercomputers, and the servers that build out the cloud. Fabless refers to the manufacturing process. A company that produces and markets semiconductors but which does not actually make them in-house is called a “fabless” (“fabrication-less”) company. Currently, there are 31 companies that fit into that niche sector.
Of the 31 fabless companies – this is step two – there are nine that are trading at a market cap under $400 million (too small for my selection process), of which four are genuine penny stocks. We can eliminate those little guys so that we keep our risk well-managed. There are four more stocks that trade on very light average daily volume (I like to see at least 500,000 shares trade daily), so they also are off the list. We want liquidity because liquidity means institutional sponsorship as well as ease of entry and exit. This culling now leaves us with 18 companies.
In step three, I go through the list and eliminate all those that are just too familiar. These are the stocks that every fund owns, that suck up all the air on the chat boards, and which get plenty of attention from analysts. I don’t want any of these because I’m looking for the next Big Thing, not the current Big Thing. On this list are stocks like Nvidia (NVDA), Broadcom (AVGO), Qualcomm (QCOM), and Advanced Micro Devices (AMD). These are all great companies, but they attract too much attention from both bulls and bears to make for a successful short-term trade. We can do better.
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In the final step, I took what remained – 14 companies – and drilled down into the numbers. Once I did this, there was one stock in the group that really stood out: Monolithic Power Systems (Nasdaq: MPWR).
Founded in 1997 in Kirkland, Washington, Monolithic designs and markets integrated power semiconductors. These are the chips that control the flow of power and regulate voltage in electronic devices, computers, car guidance systems, and medical equipment, among other things. Trading at a respectable market cap of $13.5 billion, Monolithic is profitable, has no debt, and grew sales and earnings last quarter 54% and 84%, respectively (quarter on quarter). Margins are massive (19.8% profit and 55.1% gross), and return on equity is a healthy 18.4%, suggesting that management has positioned the company in the sweet spot of the niche sector, given its strong pricing power and efficient use of assets.
Monolithic Power posted a massive beat-and-raise quarterly report back on October 29, as the company earned an adjusted $1.69 per share on sales of nearly $260 million. The company also raised its mid-point estimates for the fourth quarter to $224 million from $197 million, and raised earnings estimates by $0.08 per share over expectations. All good stuff, indeed. But what really impresses is the impact this report made on the analysts who follow the stock.
After earnings, MPWR now has a buy or better rating from the nine analysts who cover the company. By comparison, Nvidia has 27 analysts with three at “hold” and one at “sell.” Advanced Micro Devices has 20 analysts with six at “hold” and one at “sell.” More impressively, just two weeks ago MPWR received an “outperform” rating from 5-star analyst Rick Schafer of Oppenheimer. Schafer has issued 90 ratings on MPWR over the years, a whopping 98% of which went on to profit over the next 12 months to the tune of a 36.5% average ROI per rating.
“MPS’ diverse structural growth story, led by cloud, 5G and auto remains intact and resilient,” said Schafer in a note to clients. Schafer reiterated his price target of $350 as well.
Also chiming in after the conference call was another 5-star analyst, Quinn Bolton, of Needham. Bolton has issued 40 ratings on MPWR with 92% of them going on to profit at an average pace of over 28% average return on investment per rating. “MPS is well-positioned for continued growth driven by its high-growth end markets and share gains,” said Bolton, who kept his buy rating and upped his price target to $350 from $275.
Action to Take: Consider buying MPWR up to a price of $330 in your short-term aggressive portfolio, with a view to selling at a price of $365 or in two months, whichever comes first.
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