Many of last year’s hot stocks were speculative to say the least. The best stock in the S&P 500 for 2013 was Best Buy (BBY), which surprised everyone, and certainly didn’t continue into 2014. A move into momentum stocks with uncertain futures happens when investors are more fearful of missing out on the big profits than they are afraid of the risks of companies in trouble. There are signs that this bias is shifting in 2014.
The market is moving more toward something investors call “structurally fair.” We would characterize this as a market dominated by investors who are more interested in companies that are both growing and profitable. These characteristics come in and out of favor depending on market conditions, but with valuations at a fairly high levels, investors want to hedge their risk by not becoming over-exposed to unprofitable or turnaround firms.
One of the qualities that is attractive and make for hot stocks in a market like this is a company that is not only growing but is doing so at a faster rate than it peers. Qualcomm (QCOM) is a company like this with positive top and bottom line trends. Qualcomm makes the microchips that manage wireless communication in mobile devices. These Mobile Station Modem (MSM) chips are finding their way into most electronic devices and the competition is intense.
QCOM reports earnings on Jan. 29after the market closes. Expectations for bottom line earnings have been on the rise recently at $1.21 per share. This would put the company’s profits above the same quarter last year and significantly above the average over the trailing 12 months. The company currently has a P/E ratio of 19.25, which would come down slightly if the company meets or exceeds those estimates. That is still a little rich, until you make a comparison to QCOM’s peers.
To make a fair comparison, we have to also consider the performance of the companies with more ‘attractive’ valuation multiples. For example, Intel (INTC) has a P/E ratio of 13.75, which seems like a better deal until you realize that they are losing market share with fundamentals that are in decline. By contrast Broadcom (BRCM), another competitor, has a P/E ratio of 33.
Valuation multiples can only take us so far. It seems safe to assume that the underlying fundamentals are priced into the stocks within this group. They are widely watched and opinions are fairly uniform on the growth potential next year. However, in a sector like this where information has been very efficiently distributed, technical analysis can still provide a little bit of an edge to help find hot stocks.
Technical analysts examine how the price of a stock changes over time. These changes can tell us a lot about investor sentiment and future expectations without having to make a guess about QCOM’s 2014 fundamental performance. These price changes and patterns tend to repeat themselves and we see a potential opportunity in QCOM, however, we recommend that traders wait for a ‘retest’ before pulling the trigger.
As you can see in the chart below, QCOM just broke above resistance at $74 per share. The rally was assisted by INTC’s terrible report recently. However, these breakouts in hot stocks are often a little fragile. We recommend looking for the same kind of confirmation we got in November after a similar breakout. At the time, many traders waited until the breakout’s support level ($71 per share) was retested on Nov. 20 and 21 with what we call a “piercing line” bullish technical pattern.
We recommend traders prepare to enter a long position on QCOM before earnings if the stock returns to the recent breakout point ($74 per share) and presents a bullish price pattern. It is possible that QCOM won’t return to support at $74 but we think the potential opportunity cost is worth the added confidence of confirmation. Because the entry point will likely be close to QCOM’s earnings report, option traders may also consider adding a married put to the trade like we suggested in recent analysis on UnitedHealth Group (UNH).
InvestorPlace advisors John Jagerson and S. Wade Hansen are co-founders of LearningMarkets.com, as well as the co-editors of SlingShot Trader, a trading service designed to help you make options profits by trading the news. Get in on the next trade and get 1 free month today by clicking here.