The simple answer is yes. Some publications suggest that buying stocks less than $12 or $15 is very risky. This is true but it’s not as risky if simple investing rules are implemented such as cutting losses quickly. (Note – I will pound this one rule into your head as long as I run this community – cutting losses quickly is the single most important rule to successful investing).

William O’Neil and IBD recommend buying stocks above the $12-$15 threshold. I also recommend this to novice investors as higher priced stocks usually don’t have the extreme volatility that some lesser priced stocks have, due to smaller floats. Personally, I am comfortable in my philosophy and have strict rules in buying and selling all types of stocks at all price levels so I feel that I can take on the added risk.

If you read MSW closely, you will notice that many sub $15 stocks are highlighted on daily screens, weekly screens and case studies. Even IBD will include sub $15 stocks in their charts, sector highlights and New America articles. Buying stocks under $15 does present higher risk but a closer study into our screens will reveal that a solid chunk of our All-Stars have started their triple digit up-trends when they were still below $15. A closer look at the IBD 100 will also reveal that a good portion of these stocks broke out while they were still under the $15 threshold.

You must do what is most comfortable for you. When I first started teaching this philosophy on the internet, I told new investors to stay above $12 and I still believe that this is good advice. As a novice investor becomes more experienced and has endured a few losses and cut a few losers quickly, they can start to take on positions with more risk. I don’t advocate buying stocks under $5-$6 except in very specific cases.

If you go back and study the weekly screens, you will notice that 7 of the top 10 MSW All-Star stocks of 2004 started their runs below the $15 threshold. I highlighted these stocks on weekly screen over and over as they advanced from these sub-$15 levels. (2004: ALDN, NGPS, ELOS, DHB, ESMC, TRGL, DCAI).

As your investing experience grows and you start to review past trades, only you will be able to determine if sub $15 stocks are right for your portfolio.

Piranha

…I use the P/E ratio as a secondary indicator for buying and selling stocks but I don’t use the ratio in the same a manner as many value investors teach. I will explain the difference in my methodology for using the P/E ratio to your advantage.

Many value investors will pass on a growth stock that has a P/E ratio higher than a predetermined level. For example, they may discard all stocks that have a ratio of 15 or higher, no matter what industry group they come from. Some investors will discard any stocks that have P/E ratios above the industry group averages, concluding that they are grossly overvalued. I am not saying that this method doesn’t work, because it does but it will not work when you focus on buying young innovative small cap stocks that are growing at tremendous rates, rates that “big caps” can no longer sustain.

I have never passed on buying a stock due to its P/E ratio being too high. What is too high? Too high to one investor may be low to another investor. This is the same logic that I use when speaking of stock’s prices. One problem that have with some value investors is their lack of understanding of the movement of the P/E ratio line on a chart. As a stock begins to move 100% or 200% from its pivot point, the P/E ratio will also move higher over the course of time. Plotting the P/E ratio on a chart will show you how much of a gain the ratio has made as the stock continues its up-trend.

Value investors that pass on buying stocks with P/E ratio’s above a certain threshold have missed some of the biggest winners of all time (the 10-baggers as Peter Lynch would say). Analysts frequently downgrade stocks when their P/E ratios cross what they believe to be fully valued thresholds.

Some things in life are worth more than other things although they offer the same use, such as a car. I tend to use this example often but I would rather own a Mercedes for $50k over a Pinto for $10k. They will both take me where I want to go but I value the amenities that the Mercedes gives me and the added comfort, quality and style that comes with the luxury vehicle. The same holds true for stocks, certain companies offer greater appeal and are valued at higher ratios than their competitors. The best materialistic things in life, including growth stocks, are usually bought at a premium.

The P-E ratio uses a stock’s current price and divides it by total earnings per share over the past four quarters. For example, currently GDP has a P/E ratio 51.06 with a share price of $24.00. Its last four quarters of EPS add up to $0.47. Its P-E ratio is $24.00 divided by $0.47, or 51.06. MSN Money Central has the P/E ratio listed at 51.30.

Growth stocks usually sport higher P/E ratios than the rest of the general market, even at the start of up-trends. A high P/E ratio typically means that the stock is enjoying strong demand. If a stock climbs in price from 40 to 60, its P/E ratio also gains 50%. Even though the P/E ratio may be high according to some analysts and value investors, the stock may be about to breakout from a cup-with-handle and go on to double from this point. Would you want to miss out on a possible 100% gain because the P/E ratio is too high?

Investor’s Business Daily conducted an excellent case study in 1996-97: “The 95 best small- and mid-cap stocks of 1996-97 had an average P-E of 39 at their pivot and 87 at the peak of their run-ups. The 25 best large caps of those years began with an average P-E of 20 and rose to 37. To get a piece of these big winners, you had to pay a premium.”

When I purchase a stock, I note the current P/E ratio and chart it along with the price. Historically, P/E’s that move up 100%-200% or more while the stock is advancing, usually become vulnerable stocks and can start to become extended and flash sell signals. It holds true for a stock with a P/E starting at 15 and going to 40 or a stock with a P/E of 50 and going to 115. Don’t skip over EXCELLENT companies that are growing at amazing clips because of a high P/E ratio. What may seem high now, may be low later on! Earnings and Sales are much more important. Price and volume are the most important. The P/E ratio is just a secondary indicator that can be used to further analyze the stocks in your portfolio.

Always use price and volume as your first line of offense and defense. From this point, turn to some dependable secondary indicators to confirm your original analysis and then make a decision. I would never throw out a stock because its P/E ratio is too high. Take GOOG for example, every value investor missed the 100% gain that this stock boasted after the release of its IPO. Growth stocks are expensive for a reason, don’t forget the analogy to a Mercedes.

Enjoy the Weekend,
Piranha

…I cringe every time I hear a novice investor tell me that they only purchase low priced stocks because they offer higher potential gains. A common phase I hear is “I like to buy $1 and $2 stocks because they can double easily and I will make a 100% profit”.

My reaction is to always let these people know that “stocks are priced low for a reason, just as stocks priced high are there for a reason”.

Like anything in life, quality is never offered at a discount. When I am in the market for a car, I don’t expect to purchase a Mercedes for the price of a Pinto. No pun directed towards Pinto car owners as I am just providing an example.

Stocks are valued at their current market value or perceived value under the current situations. A $1.00 stock is trading at this level because it is only worth this much in investor’s eyes. A stock priced at $50 or $100 is trading at these levels because of a quality that the lower priced stock does not have. Institutions, such as mutual funds, will not purchase a stock at $1 based on strict internal rules and fund guidelines. Stocks, similar to the ones on our All-Star list move based on vast amounts of support from institutions that have the buying power to propel prices 100%, 200% or more in less than 12 months.

A quick study of stock market history will prove that the majority of stocks priced at $2 or less will be de-listed or bankrupt before they ever give an investor a triple digit return. High quality stocks are typically representative of high quality companies that usually have innovative products or services that are increasing revenues and earnings thus peaking institutional interest. I have seen more stocks double or triple from the $20-$50 range than any other price level during the past five years.

A stock going up 25% in one month’s time is the same whether it is from $5 to $6.25 or $60 to $75. It happens every year. The novice investor is usually hesitant to buy a stock that is priced at $50 or more as it looks too expensive to the untrained eye. What’s expensive to an uneducated investor may be a bargain to an educated investor.

Always buy the stock that presents the highest probability of success based on both fundamental and technical analysis. The price should never matter nor should the lot size. A 25% gain will always be the same whether you buy a $2 stock with 5000 shares or a $100 stock with 100 shares.

I agree that the chances for a quick 25% gain on a $5 stock seems greater than a 25% gain for a $100 stock but it’s also much greater for a 25% slide on the $5 stock than it is for the $100 stock. Your downside protection is limited with a low priced stock as it can move quickly and present you with an illiquid position that a higher quality stock may not present.

Here is a very basic example:
If you buy a $2 stock and it gains $1 in two months, you now have a 50% gain. But, if the stock falls $1 in two weeks, you now have a huge 50% loss in your portfolio, a number that usually devastates most traders.

If you buy a $60 stock and it gains $30 in two months, you will have a 50% gain. Now, if the stock starts to fall rapidly and is now down $10 in a few days, you still have a chance to sell the stock within 10% of your purchase price and prevent further loss and devastation to your portfolio. You, the investor will most likely be able to spot negative action or red flags and get out quickly enough without the sudden 50% drop that the lower priced stock could blindside you with.

Don’t buy a stock based on low prices or a quantity of shares. Always buy a stock based on quality looking towards the fundamentals and technicals and the price and volume action. Study our archives and look at the number of stocks that have gone on to tremendous gains from the $20, $30 and $40+ levels.

As you can see on every weekly screen, we don’t discriminate against $10 stocks or $100 stocks. We list every stock that has the highest potential to present a gain.

Piranha

Just an interesting article that I would like to add to the blog:

George Soros of New York-based Soros Fund Management earned an estimated $750 million in 2003, making him No. 1 in the latest ranking by Institutional Investor’s Alpha of the world’s most highly paid hedge fund managers.

Junk-bond specialist David Tepper of Chatham, New Jersey-based Appaloosa Management takes second place, earning an estimated $510 million in 2003, followed by James Simons of Renaissance Technologies Corp. in East Setauket, New York, who pulled down $500 million.

Soros regains the top spot in Alpha’s third annual ranking of top hedge fund earners after falling off the list last year, when Bruce Kovner of New York-based Caxton Associates led the pack. This year Kovner ties for fifth place with Steven Cohen of SAC Capital Advisors in Stamford, Connecticut.

Both earned $350 million in 2003, according to Alpha estimates. They trailed fourth-ranked Edward Lampert of ESL Investments in Greenwich, Connecticut, who earned $420 million last year by Alpha’s reckoning.

The wealth being created by hedge fund managers is simply staggering. Never have so few made so much so fast. The lowest earner on Alpha’s 2003 ranking took home $65 million in 2003. Seventeen managers pulled down nine figures — $100 million or more — compared with just seven in 2002. The average take-home pay for the top 25 in 2003 was $207 million, nearly double 2002’s $110 million.

The top ten earners in the hedge fund industry in 2003 were:
1. $750 million George Soros, SOROS FUND MANAGEMENT
2. $510 million David Tepper, APPALOOSA MANAGEMENT
3. $500 million James Simons, RENAISSANCE TECHNOLOGIES CORP.
4. $420 million Edward Lampert, ESL INVESTMENTS
5. $350 million Steven Cohen, SAC CAPITAL ADVISORS
5. $350 million Bruce Kovner, CAXTON ASSOCIATES
7. $300 million Paul Tudor Jones II, TUDOR INVESTMENT CORP.
8. $230 million Kenneth Griffin, CITADEL INVESTMENT GROUP
9. $150 million Daniel Och, OCH-ZIFF CAPITAL MANAGEMENT GROUP
10. $145 million Leon Cooperman, OMEGA ADVISORS

Hedge fund managers overwhelmingly run private operations and guard their secrecy. Alpha’s formula for determining which hedge fund managers earned the most was based on two key factors: their share of the fees generated by the funds they managed, and their gains on their own capital in the funds.
These numbers were arrived at based on knowledge or estimates of the firms’ capital at the beginning of the year, their performances, their fee structures and managers’ ownership stakes. Publicly available sources were used, as well as the Institutional Investor’s Alpha Hedge Fund 100 ranking of the biggest hedge funds (April/May 2004), which lists capital positions and fund performances. In making these judgments, II tried to choose conservative estimates.

I have received almost two dozen e-mails asking where institutional numbers can be found such as the ones I placed on the most recent case study. These numbers can be obtained by any investor on numerous websites on the internet for a fee to that specific research house. I personally use the numbers from Vickers Research as I have told many of you individually through e-mail. Several types of accounts can be purchased through Vickers Research depending on the amount of information that the individual investor is looking for. The fees vary greatly and can become quiet expensive for the novice investor. A standard research plan for their services can range between $100-$200 per month and higher. I do not have any affiliation with Vickers and have never endorsed their products. I am just spreading the knowledge and allowing everyone in the community to research one of the many research houses in the country that collects institutional data each year.

Daily Graphs, a sister company of Investor’s Business Daily, also offers basic institutional sponsorship numbers on their charts but they lack in expanded detail. The complete package for Daily Graphs does cost over $1000 per year. Each tool can be purchased a la carte for a smaller fee but I don’t have the details in front of me at the moment. You all can venture to their website for the price structure.

Research tools can become very expensive for the novice investor that is not making a significant amount of money in the market. I would suggest to hold off and not purchase these tools until you are making a consistent profit using the tools on the web that are currently free such as earnings and sales on numerous websites. This additional information will be overwhelming if you have not mastered the basics of investing taught through our philosophy. I made consistent profits early on in my investing career without ever looking at institutional numbers but I now study these numbers and use them to help me make buy and sell decisions. I suggest one step at a time. I added that case study to let you know that the learning process never ends and you will always find new tools to add to your arsenal.

As I say on the FAQ page of our website, MSW is not affiliated with any company within the financial industry or any company in any industry for that matter. We use several tools from many companies around the country to produce our screens and case studies but we do not interact or corroborate with anyone at these companies. I do not accept links on this website and I do not want banner ads plastered on any of my pages as I would like to keep the site clean of any outside influence. The only links that I do provide are for books that I strongly recommend or free websites that allow you to use financial data or charts.

Piranha