A Time-Tested Way To Earn Outsized Gains
If you want to start an instant argument, find adherents of technical analysis and adherents of fundamental analysis, and then ask them which investing approach is better.
The technical analysts will tell you that a close read of a company’s financial statements won’t help you know if a stock represents a timely investment. The fundamental analysts will counter that simply looking at a series of trading charts only tells you where a stock has been, not where it is going.
With all due respect, they are both wrong.
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The real secret to successful investing is the marriage of both approaches.
In fact, I’ve singled out a pair of factors — one from each camp — that can be used in tandem to deliver robust gains. It’s an approach that has led me to bag triple-digit gains, often in a matter of months, with stocks that represent a range of industries.
I want to walk you through this two-pronged approach, what I call the “Maximum Profit Score,” so you can profit from my strategy.
It’s All Relative
The term relative strength is simple and transparent. It’s a measure of how a stock (or sector) is trading, relative to the broader market. When the market is flat or rising, any stock that is increasing in value at a rapid pace scores high marks in terms of its relative strength. (It works the other way, too.)
Investors may question the wisdom of buying a stock after it has already become popular with the crowd. The “cow is out of the barn” they might say. Yet technical analysts know that such stocks tend to follow Isaac Newton’s dictum that an object in motion tends to stay in motion. In other words, a rising stocks often keeps on rising.
After many years of trading stocks and managing portfolios, I’ve concluded that relative strength is the most dependable way to pinpoint winning trades.
And I’m not alone. Many academic studies have drawn a similar conclusion. James P. O’Shaughnessy, author of “What Works on Wall Street,” studied 46 years of market history and concluded that “relative strength significantly outperforms” the stock market. His study found that using a relative strength-based system would have beaten the market by an average of 3.65% per year over the past 83 years.
Few strategies have such a large trading edge.
I specifically look for stocks with a relative strength rating above 70, which means that they have outperformed 70% of the companies in my database during the past six months. Having this parameter ensures I’m only buying the market’s best-performing stocks.
The Perfect Mate
Still, it may seem foolhardy to simply buy any stocks in a vacuum, ignoring other external factors that determine the relative appeal of a stock. For example, a stock with a high relative strength may obscure the fact that a company’s underlying financial health is poor.
#-ad_banner-#What makes for healthy financials? Rapidly growing sales? A robust dividend yield? Low levels of debt? Sure, those metrics help, but I think you should stay focused on the single-most important determinant of fiscal health: cash flow.
Since cash is the lifeblood of any business (companies need positive cash flow to finance their dividend and invest in new opportunities), it stands to reason a company that is growing cash is in a better economic position to continue growing its business than one that isn’t.
Said another way, dividends, share buybacks and investments in future growth — all the things shareholders desire from successful companies — start with positive cash flow.
This leads me to the second vital criteria of my system: cash flow relative strength. As its name suggests, companies with high cash flow relative strength aren’t merely generating steady and strong cash flow, they are seeing strong growth in this all-important metric. Specifically, I’m looking for companies growing cash flow faster than 70% of all other companies in my database.
Bringing It All Together
Once I’ve filtered the universe of stocks in my database through these two criteria, we’re now ready to compute a company’s Maximum Profit Score. Simply combine a stock’s relative strength rank in price over the past six months with the relative strength rank of the company’s cash flow growth. The average of these two numbers is our Maximum Profit Score.
Since each of these figures can range from 0 to 100, the highest possible Maximum Profit Score is 100. For example, if a company has grown cash flow faster than 75% of all companies, and its stock has outperformed 80% of all other stocks, it would have a Maximum Profit Score of 77.5 ((75 + 80) / 2).
Here’s the rub: for a stock to be considered, both metrics must be above 70. It’s hard enough to score high on one of those criteria, let alone both. And though you can use various screening tools that help you identify stocks with a six-month relative strength above 70, you won’t find a similar easy way to find stocks with a strong cash flow relative strength.
That’s what my research team and I are here for. We dig into company after company to find only those with growing cash flow. You can’t simply take a quick glance at a number. You need to read the financial filings to be sure that cash flow isn’t being doctored by external factors, such as a rapid drawdown of accounts receivable, or a reduction in inventory.
The Maximum Profit Score isn’t simply an academic notion, either. It’s a proven, time-tested way to deliver outsized profits. Since launching my Maximum Profit newsletter, it’s easily been StreetAuthority’s best-performing newsletter, delivering gains of 39%… 46%… even 181% — all in less than 13 months.
As a special gift to StreetAuthority readers, we’re offering a special limited-time discount to new subscribers to my premium newsletter, Maximum Profit. If you’d like to learn more about my system and how to put it to work for you, simply go here.