Finding a “Shift” to Determine the Outlook of a Stoc

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Finding a Change in Sentiment

In my book, one of the biggest topics was human behavior and market psychology. In Part 3, I broke down a study showing how investors respond to gains, and how different people assess value. One of the conclusions to the study was that retail investors determine upside based on past performance, yet this way of thinking really doesn’t indicate if a stock is breaking out higher.

A simple look at a one-year or six-month trend doesn’t inform the investor of how much excitement surrounds a stock, as other factors such as market trend must also be considered. For example, more than 80% of all S&P 500 stocks are currently trading above their 50-day moving average. And although I am not a technical trader, I do admit that certain technical indicators can inform investors of a change in sentiment, which is important in determining upside.

The fact that 80% of S&P 500 stocks have broken out above its 50-day moving average is a good sign for the markets. However, this still doesn’t tell us the level of gains for a particular stock. For example, in 2013 Netflix has increased over 100% but is currently trading at just 19.66% over its 50-day moving average. This is mostly because of the rapid shift from pessimistic to optimistic, and the massive downtrend the stock saw. Therefore, by using moving averages in place of YTD, six-month, or one-year stock performances, you are getting a better idea of a stock’s trend and the change in perception among investors.

Three Stocks Seeing the Greatest “Shift”

If using the 50-day moving average as an indicator of outlook and investor optimism, then shares of Best Buy (NYSE: BBY) have by far seen the greatest shift from pessimism to optimism in 2013. Currently, the stock is trading at more than 35% above its 50-day MA, with gains of 95% in 2013. The reason that it’s trading so far above the level is because of both its large downtrend in 2011/2012 and also its sudden rise with an increase in optimism.

 One reason for this shift is due to signs of a stronger economy, lower unemployment, and legislation that could level the playing field between it and Amazon with online sales tax. Regardless of the reasons, this is a stock that is still trading at just 0.15 times sales with a forward P/E ratio of less than 10.0. When you compare these metrics to super company Wal-Mart, and its price/sales of 0.52 and forward P/E ratio of 12.42, you can see that Best Buy could still be a huge bargain.

It’s not surprising that the stocks that have pushed far above its MA are also those that saw long periods of loss. Best Buy is one example, but Hewlett-Packard (NYSE: HPQ) is another, with gains of 63.50% in 2013 and a stock trading 25% above its 50-day MA. Much like Best Buy, Hewlett-Packard is a value play, as the stock trades at just 0.38 times sales. It’s a stock trading with a ratio of just 1/4 on operating cash flow/market capitalization. Furthermore, the company is placing an emphasis on cash flow, which could create even greater interest among institutional investors.

While Hewlett-Packard and Best Buy are both stocks that have seen long periods of loss, there are others such as Safeway (NYSE: SWY) who has seen long periods of minimum movement. In the case of Safeway, it is a stock that has traded in a tight range, but if you look back on its five year trend, it has also traded more towards the downside, versus the upside. However, with strong earnings, a great yield, and improving efficiency within the industry, it has rallied 40% in 2013, 22% above its 50-day MA. Despite these gains, the stock is just as cheap as both Best Buy and Hewlett-Packard, and could continue to trade higher with a sustained shift in outlook.

Conclusion

A large separation in a stock’s price and its MA does not indicate alone that a stock will continue to trade higher. However, these are usually undervalued and oversold stocks that have large upside to reach fair value. Therefore, I suggest incorporating this indicator into your due diligence, because it may help you find stocks with less short-term downside and more short-term upside. 


Brian Nichols is long BBY The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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