Beware the “Dead Cat Bounce”

MARKET OVERVIEW

The lexicon of Wall Street is dominated by colorful terms that reflect the somewhat fatalistic nature of the people who populate it, most of which combine a visual image with a grim reality to create a somewhat humorous analogy. One of my favorite expressions is “dead cat bounce”, which describes a situation where the price of a stock has dropped so low that it almost has to bounce back up, based on the premise that if you dropped a dead cat from a high enough window of an office building, it too would bounce before coming back down to earth.

Although the imagery of that analogy may be offensive, the underlying truth is not. In fact, these types of bounces happen all the time, sometimes fooling investors into believing “the coast is clear” and it is okay to resume acquiring shares in the recently devalued company. Unfortunately, a true dead cat bounce is short-lived and is the precursor to another drop, similar to what occurred to Amazon.com (NSDQ: AMZN) over the past couple of months.

chartForSTI (2)

In the case of Amazon its chart pattern could more accurately be likened to dropping a basketball from an office window, bouncing progressively lower each time until it eventually stops bouncing altogether.  So the question then becomes, exactly when (at what price point) does the ball stop bouncing? If you can accurately identify that value then you can make a lot of money investing in tech stocks as that point represents the true “fair value” for a stock at that moment in time.

The good news is that the innogration model that we have developed can be used in a number of ways, including identifying fair value for a stock based on our BiQ/STR proprietary valuation metric. We’ll use Amazon as an example to show you how you can use it to identify price points that are critical in making buy and sell decisions for a stock.

As you hopefully know by now, the Boeckl Innogration Quotient (“BiQ”) is our way of measuring to what extent a company is doing the right things in order to become a long term category winner. It is measured on a scale of 0 – 10, with a score above the midpoint of 5 indicating a likely winner. However, we then convert that score to our Smart Tech Rating (“STR”) to reflect the extent to which its stock is currently mispriced relative to its fair value.

So how do we decide what fair value is for a stock? In our opinion that has to be a relative value, using the STR as the unifying metric to compare one tech stock against all the others. Quite frankly, there is no absolute value for a stock; it is worth whatever you and every other investor think it is worth based on how you vote with your investment dollars.  People often ask me how is it that a stock like Netflix (NSDQ: NFLX) could be worth more than $450 in March and less than $350 one month later? My answer is that given the information in the market at the time, that is how much supply and demand there was for the stock; in other words, a relative measurement based on how investors’ perceived its value compared to everything else.

So, if our STR is accurate in determining relative value for an individual stock, then by extension it should also be helpful in determining how far in either direction a stock price would need to move in order to push it into our ‘buy’ or ‘sell’ zone.  We do that by measuring how far removed the STR for a stock is from the average for its peer group.

For example, currently the average STR for all of the tech stocks we cover is 4.7 (by the way, you can make this calculation yourself any time you like by simply copy and pasting the data from the Smart Tech 50 portfolio to an Excel spreadsheet).  Therefore, a stock such as F5 Systems (NYSE: FFIV), with an STR of exactly 4.7, is fairly valued at the moment.  

Getting back to Amazon, its STR currently stands at a paltry 0.6 suggesting it is still grossly overvalued. In other words, for its STR to equal 4.7 right now its price would have to drop all the way down to $37.64, a far cry from its current value near $300! Do we think Amazon will drop all the way down to $37? No, but we believe that its “STR fair value” will act as a magnet, gradually pulling the stock price lower on each progressive bounce.

Likewise, in order for Apple (NSDQ: AAPL) to reach value its stock price would have to rise more than $600 to $1,206 to generate an STR of 4.7. For that reason Apple’s stock price should experience the opposite phenomenon, bouncing progressively higher after each decline. We realize some of these numbers sound more than a bit fantastic, but in fact that is how the math works out based on our model.

However, the stock market is far from rational so investor perception still dominates the short term trading activity for a company regardless of how far removed from reality its valuation becomes. For that reason we use what we consider to be a fairly conservative approach to identifying buy and sell candidates. Those stocks that are currently valued at more than a 50% premium to the average STR are where we look for buy recommendations, and those priced at more than a 50% discount to the average STR is where we find our short-sell opportunities.

The moral of the story is to look past the sort term bounces, both up and down, that tend to monopolize most investors’ attention, and focus instead on the long term fair value for a company as that is what will ultimately dictate which direction the bounces take you.

NASDAQ Composite Index:

Friday, May 9 = 4,071.87

Year to Date = – 1.7%

Trailing 7 Days = – 1.3%

Trailing 4 Weeks = – 0.6%

PORTFOLIO UPDATE

To follow-up the explanation above about using the STR “fair value” to predict which direction a bouncing stock will ultimately go, below is all fifty stocks in our coverage universe with a column added (“Deviation”) to show the extent to which, and in which direction,  they currently differ from their STR fair value. A stock with a negative value in the far-right column (in red) is overpriced (meaning it has that many more dollars in value to decline before reaching STR fair value), while one with a positive value (in green) is underpriced (meaning its share price can increase that many more dollars in value before achieving STR fair value).

Security

Symbol

Price ($)1

Yield (%)

BIQ

STR

Deviation

3D Systems Corp.

NYSE: DDD

47.64

 

3

1.3

-$34.34

Adobe

NSDQ: ADBE

59.59

 

2.5

2.1

-$32.72

Akami Technologies

NSDQ: AKAM

52.82

 

3.5

2.8

-$21.07

Amazon.com

NSDQ:  AMZN

292.24

 

5.2

0.6

-$254.60

Apple

NSDQ:  AAPL

585.54

2.25

7

9.6

$621.24

ARM Holdings

NSDQ: ARMH

44.85

0.7

7

1.7

-$28.48

Autodesk

NSDQ:  ADSK

46.85

 

3

2.8

-$18.69

Brocade Comm Systems

NSDQ:  BRCD

8.12

 

1.2

1.6

-$5.33

CA Technologies

NSDQ: CA

29.41

3.4

5

10

$33.73

Canon

NYSE: CAJ / Japan: 7751

31.99

3.88

3.8

4

-$4.52

Cisco Systems

NSDQ: CSCO

23.02

3.3

5.7

10.7

$29.86

Citrix Systems, Inc.

NSDQ: CTXS

59.94

 

4.7

6

$17.27

Digimarc Corp.

NSDQ: DMRC

32.5

1.35

2.7

0.7

-$27.62

EMC Corp

NYSE: EMC

25.44

1.81

6.8

6.2

$8.42

Ericsson

NSDQ: ERIC

12.08

2.49

2.3

4

-$1.71

F5 Networks

NYSE: FFIV

102.71

 

3.8

4.7

$0.93

Facebook

NSDQ:  FB

57.24

 

5.2

1.6

-$37.58

Garmin

NSDQ: GRMN

55.83

3.44

3.3

3.5

-$13.88

Google

NSDQ:  GOOG

518.73

 

5.5

5

$38.09

Hewlett-Packard

NYSE: HPQ

32.36

1.98

3.4

4.9

$1.68

Intel Corp

NSDQ:  INTC

26.3

3.42

5.4

8.4

$21.13

Intuit

NSDQ:  INTU

74.92

1.01

3.3

4

-$10.58

Juniper Networks

NSDQ: JNPR

24.6

 

2.9

3.6

-$5.59

Lenovo

OTC: LNVGY / Hong Kong: 992

21.63

1.25

2.9

2.7

-$9.09

LinkedIn Corp.

NYSE: LNKD

148.69

2

5.7

1.6

-$97.62

Micron Technology

NSDQ: MU

26.84

 

1.9

4.1

-$3.22

Microsoft

NSDQ:  MSFT

39.54

2.83

4.5

8

$28.37

Motorola Solutions

NSDQ: MSI

67.26

1.84

3.9

5.7

$15.05

NetApp

NSDQ: NTAP

34.19

1.75

5

3.8

-$6.30

Netflix

NSDQ: NFLX

328.55

1

1.5

0.3

-$307.39

Oracle Corp.

NSDQ: ORCL

41.04

1.17

3.1

8.2

$31.21

Qualcomm

NSDQ:  QCOM

79.5

2.11

7.8

11.1

$109.95

Rackspace

NYSE: RAX

26.28

 

5.5

1.8

-$16.12

Red Hat, Inc.

NYSE: RHT

48.74

 

6

3.7

-$10.02

Ricoh Company

OTC: RICOY

56.16

2.65

8.3

12.4

$93.34

Riverbed Technology

NSDQ: RVBD

19.17

 

3.4

5

$1.41

Salesforce.com

NYSE: CRM

50.28

 

6

0.8

-$41.64

SanDisk Corp.

NSDQ: SNDK

88.84

1.35

5.4

3.8

-$16.36

SAP AG

NSDQ: SAP

75.65

1.31

3.8

5.3

$10.43

Seagate Technology

NSDQ: STX

49.55

3.47

5.2

8.3

$38.74

Siemens Aktiengesellschaft

NYSE: SI

133.44

2.26

3.3

4.5

-$4.53

Symantec

NYSE: SYMC

20.79

2.89

4.1

5.9

$5.54

Tech Data Corp.

NSDQ: TECD

62.91

 

1.4

4.9

$3.27

Twitter, Inc.

NSDQ: TWTR

32.05

 

1.8

0.3

-$29.99

VeriSign, Inc.

NSDQ: VRSN

47.93

 

5.4

5.6

$9.69

Verizon Communications

NYSE:  VZ

48.48

4.37

8

5.4

$7.72

VMware, Inc.

NYSE: VMW

93.25

 

5.3

3.5

-$23.18

Western Digital

NSDQ: WDC

81.95

1.46

5.5

10.1

$95.74

Xerox Corp.

NYSE: XRX

11.84

2.11

3.8

5.8

$2.90

YELP Inc.

NSDQ:  YELP

54.22

2

2.5

0.5

-$48.40

 

 

 

 

Avg STR:

4.658