Indicator Signals This Momentum Stock Will Continue to Outperform
Newton’s First Law of Motion states, “An object at rest stays at rest, and an object in motion stays in motion with the same speed and in the same direction unless acted upon by an unbalanced force.”
This, of course, applies to physical objects, but there is a similar principle in the markets known as relative strength.
Relative strength, or RS, is a way to rank a stock’s performance relative to all other stocks in the market. Specifically, it assigns a numerical score from 0 to 100 to a stock based on its performance over a certain period of time, typically six months.
RS is one of the few indicators that have been proven to predict the future direction of a stock’s price. Research uncovered that stocks that are outperforming — thereby commanding a high RS rank — are more likely to continue outperforming than those that are underperforming.
In other words, a stock in upward motion is likely to stay in upward motion. It’s a simple concept — and a profitable one.
One stock sporting a high RS rank that caught my eye is computer network services firm Level 3 Communications (NASDAQ: LVLT).
In August, billionaire fund manager George Soros revealed he had taken a big position in the company. According to 13F filings from his Quantum Group of Funds, Soros initiated a $78 million, 1.79 million share position in LVLT during the second quarter.
This undoubtedly helped boost shares; however, the company has a lot more going for it than just the backing of a famous investor.
In the past four quarters, the company beat Zacks’ consensus earnings estimate by an average of 30%.
On Nov. 5, Level 3 reported adjusted earnings per share (EPS) of $0.37 for the third quarter versus the $0.31 estimated by Zacks. GAAP net income of $85 million, or $0.35 per share, compared with a loss of $21 million, or $0.09 per share, a year ago.
Revenue for the quarter climbed 3.8% year over year to $1.63 billion, which was in line with estimates.
Since the earnings release, shares have gone on to make multiple successive 14-year highs, hitting a fresh one on Tuesday at $49.51.
As you can see on the chart, LVLT rebounded strongly off last month’s lows following the market-wide correction in the beginning of October. It is now 32% above those lows compared with just 13% for the S&P 500.
Over the past six months, shares are up 13%, and that performance earned the stock a relative strength rank of 74. That tells us that its price action has outperformed 74% of all publicly traded stocks on its way to those multiyear highs. It also gives us confidence that the share price is likely to continue to outperform based on this momentum.
But there’s one more reason I am bullish on LVLT. The stock earned a 154 out of a possible 200 on a powerful indicator called the Alpha Score.
This little-known tool combines a stock’s RS rank with a fundamental ranking to locate some of the market’s biggest winners.
In fact, so far in 2014, the Alpha Score identified the 7th, 9th, 11th and 16th best-performing stocks — and generated an average gain of 109% on those positions. It also pegged 29 stocks right before they made double-digit percentage jumps within a month.
LVLT’s high Alpha Score gives me confidence that it will continue outperforming. I think shares could move 15% higher over the next three months.
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