The rewards of buying high

Stocks at 52-week peaks may not be ready to fall

Your Money

April 22, 2007|By Andrew Countryman | Andrew Countryman,Chicago Tribune

Buy low, sell high.

Naturally. But much easier said than done.

So how about buying high? Simpler, even if it goes against the conventional wisdom. But sometimes, with a little care, it can be profitable.

Some experts see evidence that stocks reaching 52-week highs aren't necessarily primed for a fall, and, in fact, often continue to advance in the following months.

Analysts caution that willy-nilly buying of shares at 52-week highs isn't a smart idea. But with some research into company fundamentals, careful selection of stocks can pay off.

Investor attitudes are at the heart of this phenomenon, research suggests. Experts say investors often are reluctant to buy shares in companies that have run up and maintain a predetermined view of the stock's value, so even positive developments may not be enough to send shares higher, at least at first.

"Traders appear to use the 52-week high as a reference point against which they evaluate the potential impact of news. When good news has pushed a stock's price near or to a new 52-week high, traders are reluctant to bid the price of the stock higher, even if the information warrants it," write professors Thomas George of the University of Houston and Chuan-Yang Hwang of Hong Kong University in a study on the issue published in the Journal of Finance.

"The information eventually prevails, and the price moves up."

A Chicago Tribune study of U.S. companies whose shares recently hit 52-week highs suggests that such stocks frequently do better than the broader market.

Of 256 firms whose common shares hit 52-week highs on the New York Stock Exchange during a week in mid-January, slightly more than half outperformed a mainly flat Standard & Poor's 500 index through the end of the first quarter. The superior performance was driven by mid-cap shares.

Some of the increases during the nine-week period were pronounced: About 10 percent jumped more than 15 percent despite the market volatility during that time.

Buying low, conversely, can be a dicey proposition, the Tribune study found. Of the 20 stocks that hit 52-week lows during the January week, nearly half underperformed the S&P 500 through the end of the quarter.

For investors, selecting the right stocks is the tricky part.

Greg Forsythe, senior vice president of Schwab Equity Ratings at Charles Schwab Corp., said investors need to look for companies that are growing earnings, generating positive free-cash flow and producing earnings above consensus forecasts over recent quarters.

"If I saw that, I wouldn't hesitate to consider the stock, even if it's at its high," he said. "This is a company that's healthy and growing in terms of its basic fundamentals. Fundamental strength is a sustainable driver behind price momentum."

Valuations can be an important component of subsequent stock performance. In the Tribune study, nearly 60 percent of companies with a trailing price-earnings ratio above 30 at the time of their 52-week high underperformed the S&P 500. Conversely, 56 percent of those with P-Es under 15 outperformed the index.

The study found similar results with the 52-week lows: Half of those with P-Es over 15 underperformed the index, while 75 percent of those with P-Es under 15 outperformed the index.

The 52-week lows weren't necessarily screaming bargains. Although more than a third had net losses in the previous 12 months and, therefore, had no P-E ratios, the median P-E of the other stocks was 23, identical to the median P-E of those stocks that hit 52-week highs.

Some analysts are skeptical that broad-based buying of 52-week highs is a good strategy.

If an investor buys shares at 52-week highs, "By definition, you're not buying low. You're buying high," said Dirk van Dijk, director of research at Zacks Investment Research. "It worked like a charm back in the dot-com era, but you saw how that ended up. ... Solely price momentum is a very dangerous way to invest."

Sometimes, he said, shares have risen without solid underlying fundamentals.

"Those things are going to turn around," he said. "They're not good values."

Forsythe said a stock that has risen because of a single positive development is a reason for caution.

"If all I was seeing was one piece of good news, that might not repeat," he said.

Van Dijk looks for companies with sound cash flows, strong balance sheets, good prospects for growth and the ability to ward off competitors, and he watches changes in analysts' earnings estimates.

If the estimates are going up, he said, it is a strongly positive sign.

"An estimate in motion tends to remain in motion," he said.

Such shares may have hit 52-week highs, but reaching that level alone is not a buy signal, van Dijk said.

"The reason to buy is not because it's at a 52-week high, but because the fundamentals are improving," he said.

For many investors, the fear is that buying stocks that have run up means they have missed the boat. But not necessarily, Forsythe said.

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