Counting Bases Mike Scott

Base Counting and Price Target Setting

Preferred Stocks to Own Liquidity: Average Volume * Price > $20M-$40M+ per day –Minimum price $15 (NYSE), $20 (NASDQ) Top notch fundamentals –Triple-digit EPS gains– 3 quarters of EPS acceleration –3 Quarters of Sales acceleration –3 Quarters of increasing Institutional Sponsorship –1%-3+% Demand-Supply Ratio –ROE + Pre-Tax Margin > 50% Satisfactory responses to three questions: –Is this the very best stock I could own? –Is this stock sponsored by quality institutions? –Where is the stock in its cycle (base stage, earnings date)

Why Count Bases After a stock moves up they typically consolidate (base) for weeks or months before they make another move New investors are required to keep a stock rising By the time a growth stock forms its third or later stage base it is known by most investors At some time we run out of sufficient new buyers to continue the advance

Evolution of a Stock Cycle Bear Market Decline “3-Waves Down” Successful test of low 1 st Stage Base Prior Rise > 20% 3rd Stage Base 2nd Stage Base 4 th Stage Base A A a b c

Bear Market Decline a b c Positive Test General Market Follows Through

Count bases on a weekly chart Bases begin on the first down week of a consolidation pattern The base continues until the price breaks out of a legal buy point (pivot point) Only count bases that are long enough 1 9

Base Counting Rules Start the base count when the stock is investment grade. Typically when the top of a base forms above $10, makes profit and demonstrates clear demand. Artistic license okay. Count each base that forms 20-30% or more above a prior base (buy point to top of next base) Count bases of 7 weeks or longer (there are exceptions such as 5+ week flat base that gets deeply undercut) A bear market resets the count for all stocks after the market begins the next bull market Any undercut of a prior base resets the count A stock that breaks out and fails below the bottom of its base resets the count A 2/3 decline from a prior high resets the count A base of 12 months or longer resets the count The first base that forms after count has been reset is first stage

MA Tops at $320 after 4 th Stage Base O’Neil Studies have shown that big leaders tend to expand P/E from a 1 st stage base by 130% before topping PE = % 18-months to 2 years typical

Pay Attention to the First base in a New Bull Market For P/E Expansion Price Target Calculations only consider the first base in a new bull market The last bear market bottom was 3/09/2009 In rare cases a leading stock will breakout of a 1 st stage base in advance of a bear market low (BIDU, NFLX)

Base Counting Example 1 st > $10 Obvious Institutional Sponsorship Tops at $72 with a failed 4 th stage base 2

Bear Market Decline a b c Positive Test Bull Market Starts Should we start here or here?

NFLX Base Count 4 or 5? 1/28/09 eIBD

What is VIT Base Count?

Volume Discovery! < $10! VIT 1% above PT

What is the Current Base Count?

Base Undercut Reset Breakout and undercut

LULU Resets the Count Current 2011 EPS est. is 1.57, I don’t chase moving estimate targets

Breakout Failure Reset Breakout Fails below base First Stage Base

Long Base Reset

Setting Price Targets Experience has shown that small and mid cap leadership stocks tend to top after the P/E ratio has expanded on average 130% from its original first stage base Large Cap stocks tend to top after the P/E expands 98% P/E expansion is effective for setting working targets based on extensive historical studies of winning stocks Use this as a possible means to stay in a position when a stock is making its early moves and not sell out too early P/E expansion is useful to amplify sell rules: stock approaches sell target and is showing weakness

Price Target Algebra 130% expansion and high school algebra… –P/E = 10; 1 st stage –Expanded P/E = % of 10 –Expanded P/E = * 10 = 10 * (1 +1.3) –Expanded P/E = 10 * 2.3 = 23 –Use 1.98 for non-growth stocks…

P/E Expansion Method Step 1 Determine the Target P/E Target P/E = Pivot * 2.3 Original first-stage base only, institutional grade stocks only (if non-growth use 1.98) If later stage, estimate initial P/E at 1 st stage breakout by using the sum of the trailing four quarters of earnings (T EPS ) at the time of the initial breakout: P/E at Pivot = 1 st Stage Pivot Price / T EPS Step 2 Identify estimated earnings per share 18-months to 2 years out (MarketSmith) Step 3 Determine Price Target Multiply Target P/E by estimated Earnings

NFLX Base Count 4 or 5? 1/28/09 eIBD EPS est. 18-months to 2 years from 1 st stage base breakout (earlier est. was 4.39

Step 1. 1 st Stage Pivot = $9.98 P/E = 9.98/0.98=10.2 Bear Market reset EPS TTM = 0.98 Step 2. EPS + 2 years = 1.67 Step 3. Price Target = 1.67 * 1.98 * 10.2 = 33.7 Not a growth stock, use 98% (1.98) expansion factor Can you hold here? 3-Waves Down

GMCR has not achieved PT Tight Closes If market allows GMCR has room to run

FFIV Climax Top +7% above PT

FFIV Short Position