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The Avalanche Effect: Using Momentum to Your Advantage

Louis Basenese

Last week, senior analyst Jonathan Rodriguez brought down the curtain on one of the most successful yet misunderstood investment strategies of the last 50 years: momentum.

You’ll recall that the strategy involves buying the stocks trending higher and shorting the market’s weakest-performing stocks.

Like an avalanche, some stocks tend to follow their current trajectories — and often accelerate under the right conditions.

Many “value”-oriented investors are baffled by this technique. Instead, they prefer to buy the weaker names and then sell relatively expensive names.

But this strategy has been lining the pockets of hedge fund managers for years and doesn’t require you to chase pricey stocks, either.

And the strategy works whether you’re an investor trading on fundamentals or someone who trades based on a stock’s price chart.

Today, Jonathan is going to break down this strategy even further with an example…

Ahead of the tape,

Louis Basenese
Chief Investment Strategist, Wall Street Daily

Buy High… and Sell Higher

Jonathan RodriguezAs I mentioned last week, the easiest way to find the market’s hottest stocks is to look at a list of stocks trading at 52-week highs.

Here you can find a list of Nasdaq issues at highs. And here’s a list compiled by The Wall Street Journal on the NYSE.

Before drilling down on that list, I’d like to identify the market’s strongest sectors. These sectors will likely hold the market’s most attractive momentum plays.

In the last year, the top three performers are financials (32%), technology (26%) and industrials (19%).

Now you can focus your research on stocks making new highs in the sectors with the most action.

Here’s an example…

Big Gains With This Tiny Bank

Northeast Bancorp (NBN) is the bank holding company for Northeast Bank, which operates mainly in the six New England states.

In the last year, the stock has gained 97% — outperforming the S&P SmallCap 600 Financials Index (26%) by nearly four times.

In other words, this stock is rocketing up the chart with significant force behind it and leaving its peers in the dust.

Despite the sharp rise in shares, the company sports a market capitalization of less than $200 million, leaving plenty of room to grow.

From a technical perspective, the stock is in an uptrend, well supported by its rising 50-day moving average. In fact, NBN hasn’t closed below its 200-day moving average since last June.

And a quick look at NBN’s fundamentals proves just as promising…

  • Since 2012, the bank boasts an incredible earnings growth rate of 49% — besting the industry (8%) by more than six times.
  • Shares trade at 19 times trailing earnings, well below the Russell 2000 (88) and the bank’s own five-year earnings multiple (44).
  • And on a forward basis, the stock trades at 12 times forward earnings — a discount to the banking services industry average of 26%.
  • The stock could easily rise another 37% from current prices, to $30.08, using Northeast Bancorp’s projected 2018 earnings of $1.88 and the industry’s forward P/E of 16.
  • The stock trades at 3.7 times trailing sales, 12% below the industry average.
  • The company has a debt-to-equity ratio of just 0.4 compared with the industry (0.7).

So the stock is not only charging up the chart with force, but is also backed by solid balance sheet and attractive multiples.

The easiest way to play momentum here: Scoop up NBN shares at market using the earnings-based $30.08 price target and a stop loss at $17.75 — a reward-to-risk ratio of 2:1.

Simple enough, right?

Done correctly, momentum investing is one of easiest ways to accelerate alpha in your portfolio.

On the hunt,

Jonathan Rodriguez
Senior Analyst, Wall Street Daily