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[Strategy Week] Buy on the News, Not the Rumor.

A few weeks ago I sat down for a one-on-one interview with Linda McDonough to discuss her “Profit Catalyst” trading strategy. Please enjoy the transcript of that discussion below.

Jim:

Now I’ve been an investment advisor for 30 years, but you’re the first person I’ve come across with an investing model like yours. Can you give us sense for the kind of track record it’s had?

Linda:

I have, and thankfully it works quite well. So basically what often happens is people look for stocks that are a good value, they’re cheap.

And when you buy a stock like that typically the stock isn’t moving that much, it’s been pretty flat or languishing a bit. What I prefer to do instead is actually wait until there’s a fundamental change in a business before buying.

But it’s not just the momentum and trading volume I analyze, I want to make sure these stocks have sound balance sheets; they’re generating significant cash flow. And that they’re valued where the stock will go higher in the future.

When those things all line up, I’ve seen a lot of stocks go on to double or triple.

Jim:

Right, so there’s an old saying on Wall Street “Buy on the rumor, sell on the news.”  When you talk about these “fundamental shifts” I take it’s more sophisticated than just hearing that something is happening and buying?

Linda

It is, in fact I try to wait until any rumors have dissipated and actual news hits. And in doing that sometimes you miss the first 10% or so move in a stock.

But I’m okay with that, because what you do is you also eliminate a lot of the risk because you’ve waited until the news has actually happened – and then you benefit as that fundamental change bears fruit in the future.

Jim:

So in that case, are your strong performance results the fact that investors aren’t appreciating the news that’s being reported?

Linda:

That’s part of it. One part of it is that the investors don’t appreciate it. But the other part is that often when something is brand new, whether it’s a new customer, new product line, or maybe something like geographic expansion, I’ve found that the companies themselves don’t know the full potential of the news. So they actually understate it to the investment community.

So I’m looking for that kind of news. News that will create a change over a longer period, something that will help the business for the foreseeable future.

Jim:

So what’s an example of a company in the last year or two you did pick where things worked out as expected?

Linda:

Sure, for example AbioMed is a company with a heart device and they had a very narrow indication with the FDA. [Editors note: an “indication” refers to the particular ailment a medical treatment is approved for by the FDA]

And they were still selling some products that way and doing okay, but what happened is that they got a much broader indication from the FDA that opened up a massive new market for them. Its market expanded considerably, and the stock has gone on to double and continues to rise.

Jim:

Now, this system isn’t just theoretical, I mean you’ve been testing this and refining it for a long time. You actually have a long track record of doing similar trades like this from earlier in your career, and you’ve tracked the results?

Linda:

Absolutely, and that’s how I came to this more scientific methodology. I was doing this before while working as a hedge fund analyst, but it took some trial and error to really formalize the approach and figure out all of the moving parts.

Jim:

And this isn’t day trading as I understand it, when you buy a stock you stay committed to it for a longer period of time, correct?

Linda:

Definitely not day trading. I’m in these stocks for at least six to twelve months on average. That’s because, when I see the big volume and price spike I use as an initial filter, sometimes a stock will tend to settle down for a while. The future move might not be immediate.  Sometimes it might be a month or so before it starts moving again. But all in all I look for events meaningful enough to drive a stock for multi-year periods.

Jim:

How do you know when to sell a stock?

Linda:

Whenever I look at a stock I have a target based on earnings and growth rates. Every quarter, I go back and reassess that target. If the stock hits my target without any other information to merit a target increase. I sell. Discipline is important if we want to be successful long term.

Editors Note: Yesterday Linda released a watch list of 25 companies passing the initial filter for her “Profit Catalyst” system.  This list contains the one or two companies with a fundamental business change coming that Linda believes will send shares up over 100% in the next six to twelve months. But she still has final vetting to do before she can share their names. Click here to get on the priority notification list and receive Linda’s initial watch list. When you do you’ll also be registered for a special webinar presentation on this system planned for January 5th.

 


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John D. Tran

John D. Tran

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