New Buy:(GU)

I made a new buy today, picking up an initial purchase of (GU) Gushan Enviro Energy. This is a Chinese alternative energy company that produces bio-diesel among other things.

The amount of capital I invest with makes it appropriate for me to own about three stocks maximum. I don't need to own that many, and it was my intention to stand pat with (SOL) and (SOHU) rather than expose my capital to risk elsewhere.

However, (GU) came up last night on the same screen that yielded (SOL) and (SOHU) and I had to take a close look at it.

First I'll talk about what I liked. (GU) is in the Energy-Other industry group - the same as (SOL). This group is ranked number one right now, and though (GU) is in a slightly different business than many of it's group mates, it should benefit from the group's strength.

The stock is a recent IPO (12/19/07) and is on a pullback to the 50 day moving average from a first stage base. It only has 31 million shares in the float. After several poor quarters, they just beat estimates and increased earnings 73% over 1st Quarter last year. Sales are accelerating and rang in this quarter at 60%. The forward earnings estimates call for 154% growth in 2008 and 37% growth in 2009. I like to see companies that are doubling earnings year over year.

The accumulation/distribution rating and up/down volume are great, indicating institutions are buying. Despite this, no fund ownership is listed, which means there is plenty of room for (GU) to move as funds build their positions. Volume has been very high as the stock has come off the 50 dma. The moment I saw it, (GU) reminded me a lot of (SOL).

Two key points bother me. First, the chart pattern is a bit wide and loose. Stocks with good institutional sponsorship will tend to trade in tighter ranges. Second - and this one really bothered men - the relative strength line is lagging. For this reason I came very close to passing on this stock. Truth be told, if I hadn't seen what (SOL) did, I probably would've passed on (GU). Perhaps for that reason alone, I should have. It's my impression at this point in my investing career that a leading RS line is a very important indicator to the potential success of a stock.

Why did I buy it anyway then? Maybe I'm flying too close to the sun. Drunk on the success of (SOL), maybe my ego is clouding my decisions. The stocks earnings surprise was just two days ago, and my opinion is that it's not surprising that the RS was lagging since the stock's earnings were too. Now that (hopefully) the company has turned a corner, I believe the relative strength of the stock's price should 'catch up' quickly.

I was also conflicted on where to purchase the stock. You can buy any time a stock comes off the 50 dma in big volume, all the way up to 5% over the recent high. Buying as soon as the stock comes of the moving average in volume gives you a bigger price, but also more risk as the stock has not 'proved' yet that it will clear all of the overhead resistance. Buying after the stock clears the resistance is a more conservative approach, but gets you in at a higher price thereby adding risk as well.

I chose the conservative approach and set my buy stop order at $16.16, ten cents above the recent high. As it turned out, the stock pulled back a bit and close below my purchase price at $15.83. That is a bit nerve wracking, but not all buys will do exactly what I want them to. The group has a tremendous amount of momentum, and hopefully that will translate into a continued move up for (GU).

-Geoff