Highflying stocks with room to rise

By Harry Domash

Editor's note: To view the stock screen mentioned in this column, download the free MSN Money Investment Toolbox.

We're often told to "buy low and sell high." But if you pay attention, you'll find that many successful stock-picking strategies, whether looking for growth, momentum or value picks, take the opposite tack. Following a "let the winners ride" philosophy, they start with a pool of top-performing stocks and, from that list, pick those that meet their fundamental requirements.

Here's a screen based on that premise. It looks for stocks that produced some of the best returns last year and appear to have more room to run.

Finding last year's winners

We'll start by identifying last year's winners. As you might imagine, with the S&P 500 Index ($INX) up only about 3.5% last year, that's not a huge list. In fact, only about 2,600 of the roughly 7,300 U.S.-listed stocks produced positive returns last year, and that's including dividends.

What qualifies as a winning stock? I arbitrarily picked 30% minimum price appreciation over the past 12 months. About 1,200 stocks met that requirement. However, not all of those 1,200 stocks were worth considering.

For instance, a stock that moved from $1 per share to $1.30 technically qualified but wasn't what I had in mind. All too often, cheap stocks trade at those prices because most market players don't think their prospects are very good.

What's too cheap? Some experts won't look at stocks trading below $15 per share; others are willing to consider anything above $5. I took the middle ground and ruled out stocks trading below $10. So my winning stock universe consists of stocks that gained at least 30% in price over the past 12 months and are now changing hands at $10 per share or higher.

Screening parameter: % price change last year >= 30

Screening parameter: last price >= 10

(Note: The "% price change last year" parameter measures the past 12 months' returns, not the past calendar year.)

Only 750 or so stocks met these two requirements. Because I arbitrarily picked both limits, you should feel free to adjust them to suit your investing style.

Next, we'll confirm that passing stocks have sufficient trading volume, or liquidity.

Sufficient liquidity?

If you spend much time reading stock message boards, you know there are many folks out there trying to manipulate share prices by posting messages with phony news -- sometimes good news, sometimes bad, depending on which way they're trying to push the price.

Thinly traded stocks, say those with less than 25,000 or 30,000 shares traded daily, are much more susceptible to such shenanigans than those with higher trading volumes. So I require a 50,000-share average daily trading volume over the past three months. Try reducing that figure to 30,000 or 40,000 shares if you want to see more stocks, but don't go lower than that.

Screening parameter: average daily volume last quarter >= 50,000

Strong all year

I've already stipulated that qualifying stocks must have gained at least 30% over the past 12 months. However, the best candidates will be stocks that registered gains all year rather than those that surged at the beginning and then tapered off. Consequently, I also require at least 20% price appreciation over the past six months, at least 10% appreciation over the past three months and at least 7% over the past month.

Also, to make sure the stock isn't petering out, I also require the year-to-date return to be in positive territory. Try varying these requirements slightly to control the number of stocks turned up by your screen.

Screening parameter: % price change 6 months >= 20

Screening parameter: % price change last quarter >= 10

Screening parameter: % price change month >= 7

Screening parameter: % price change year to date >= 1

Attesting to the choppy market we've experienced lately, only 32 stocks passed all these tests. Next, we'll pinpoint the best prospects out of that group.

Room to run

The biggest risk to a "let the winners ride" strategy is that you might be late to the party. I use valuation and price action to rule out the riskiest bets from that perspective.

The price-earnings ratio, which is the recent share price divided by the past 12 months' per-share earnings, is the most widely used valuation measure. However, the strong stocks turned up by the screen probably got that way based on strong earnings-growth expectations. Valuing strong earnings growers on historical earnings isn't meaningful.

Continued: Flown too high?

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