New Buy:(SOHU)

It was my intention to spend a couple of weeks (boring you to death) covering my journey from roulette-style penny stock trading to the method I follow today. I had not a single stock on my radar so that seemed like a good possibility. However, things lined up in such a way that I made a new buy today, so I'm going to go into my thought process a bit and talk about my purchase of (SOHU).

I'm torn about how deeply I want to describe the CAN SLIM method here. On the one hand, understanding the system is pivotal to understanding my thought process when considering a stock. On the other hand, there is a book written about it - How to Make Money in Stocks, a website dedicated to it - http://www.investors.com/, and a paper that helps investors with it - Investor's Business Daily. I could hardly cover it fairly in a few blog entries. I think instead I'll cover the basics and let my future posts get into more specific detail as the topics call for it.

CAN SLIM is an acronym. It stands for:
Current Earnings per Share (EPS)
Annual EPS
New - as in New Product, New CEO, New 52 week high in price - some catalyst
Supply and Demand - this honestly is less meaningful now, there is so much money in the market that a stock of almost any size can move well
Leadership - Leading stock in a leading group
Institutional Sponsorship - is the big money supporting the stock?
Market Direction - the most important of all factors

For more on CAN SLIM straight from the fine folks at Investor's Business Daily:

http://www.investors.com/learn/c.asp

I've read some books by folks who paved the way before William J. O'Neil brought us the CAN SLIM system: Jesse Livermore, Gerald Loeb, and Nicolas Darvas so far. William O'Neil took most of the best ideas from these traders and others (Jack Dreyfus, for instance) and put it all together along with probably the most comprehensive market data you can find. IBD includes invaluable proprietary rankings which compare a stock with all other stocks in the market on a variety of factors. O'Neil also did an exhaustive study of past winners and detailed their characteristics to design the fundamental and technical criteria of the CAN SLIM method. It's comprehensive, logical, and based on history rather than opinion.

I plan to cover my growth in trading with this system in the future, so I hope I've covered it enough now and haven't thoroughly confused you. Now, on to today's buy.

For some time now my stock screens have been coming up daily with the same cast of characters - lot's of well extended (beyond a valid buy point) Oil and Gas stocks. I missed the run on these, and don't intend to chase (buy once extended) them. I've instead devoted my time to reading, research, and recently this blog. I've checked my screens daily just in case, but nothing new has come along.

However, last week something caught my eye. Investors.com has a screen running all day called 'Stocks on the Move' which shows high quality stocks that are up that day on big volume. Last week I kept seeing Internet content stocks making this list: (JRJC), (BIDU), (PWRD), (SINA), (GA), and (SOHU). (JRJC) made a HUGE run last September from $15 to $47 in a couple of weeks, so I recognized it, and of course I knew (BIDU). I'd also heard of (SINA).

I went to my Daily Graphs Online (a premium chart and data tool offered by http://www.investors.com/) and pulled up one of the stocks in the group and noticed that (SOHU) had the best Relative Strength rating. A quick glance at the other stocks in the group convinced me that (SOHU) was the leader and therefore the one to focus my study on.

(SOHU) had one glaring defect - it's Industry Group was an abysmal 158 out of 197. This is a group, Internet-Content, that 7 months ago was in the top 20. One of the major changes I made going into 2008 was to limit my focus to stocks in the top 20 industry groups - Jesse Livermore called this 'top down investing.' Find the leading stocks in the leading groups during a healthy market uptrend and you can't go too wrong.

So why was I still looking at (SOHU)? It's a fine question, and I guess the answer is because every other characteristic of this stock was damn near perfect. Earnings growth has been accelerating for 2 quarters from -9% to 36% to 105%. Sales growth has been accelerating for 3 quarters from 9% to 14% to 46% to 90%. Additionally, (SOHU) was forecast to continue accelerating when they released this morning.

(SOHU)'s ROE is 23%, cash flow is $1.50 compared to $1.12 eps last year, no debt, and earnings were forecast to grow 62% in 2008 and 22% in 2009.

Still, studies show that a stock's Industry Group accounts for 40% of it's price movement - so how could I consider a stock in such a weak group?

Again, I took a further look at it. I found there are 36 stocks in the group, and about 10 of them are Chinese. Of the top 10 stocks in the group, 6 are Chinese. I concluded that the group rating is not truly representative of the Chinese stocks in the group, especially when considering the recent action of the Chinese Internet-Content stocks.

I knew (SOHU) was releasing earnings before the open this morning, so I decided to let their earnings be my guide. They knocked the cover off the ball, beating estimates by 70% and continuing their earnings and sales growth acceleration with 256% and 156% respectively. They also increased their Q2 guidance. I decided I would make a buy.

Having looked over the chart I found a deep cup pattern from 12/7/2007 to present with a buy point of 64.93, 10 cents above the high on the left side of the cup. The stock gapped open around $69.60, well above the buy point - but with a gap up open you can buy as high as 10% past the buy point (normally you would not buy a stock more than 5% past the buy point).

I did not buy immediately, though. My trading experience has convinced me that more often than not it's better to sit out the first 15 minutes after the market opens. These first 15 minutes tend to be very volatile and I usually get a better fill (or end up avoiding a stock) if I let them pass and wait for the trading to settle down a bit. In the case of (SOHU) I missed the lows for the day in the $66's but got in at $68.12 - a couple percent lower than the price at the open.

Once the stock got up above 70 and was holding there, I moved my stop loss just below my buy point. If it had sold off after holding up so well I just wanted to get out. It did not sell off though, in fact the stock traded almost 12 million shares, over 10 times it's normal volume, and closed at $70.81 - up 14% and near the highs of the day. It was a picture-perfect breakout, and I'm always happy when I'm up a few percent on the day I purchase a stock. I will probably now adjust my stop to 10 cents below the buy point, giving it some room to correct but not drop below the buy point.

Of course I still have a concern over the group's relative strength. Only time will tell if I was right to take a chance on this stock or if I was 'pressing' and have once again burned myself not being patient enough.

-Geoff