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We've all heard the trading adage, "Sell in May and go away."
This annual warning tells investors to pull all of their money out of stocks on May 1 and keep it out until Nov. 1.
"Sell in May" isn't a cliche or an old traders' tale; it's supported by data. According to the Stock Trader's Almanac:
After decades of historical research, we discovered that most market gains occur during the months November through April. Investing in the Dow Jones Industrial Average between November 1st and April 30th each year and then switching into fixed income for the other six months has produced reliable returns with reduced risk since 1950.
That being said, I know many traders, myself included, aren't content to sit on the sidelines for half the year. So, to make money in these trickier summer months, they need an edge.
I have uncovered just such an edge that can help you land big winners year round, and I plan to share it with you.
But first, I promised to alert you to four big-name stocks you most definitely should sell before May 1, and I'm going to get right down to business.
Other than all being generally well known, on the surface, these companies couldn't be more different. They span a number of market sectors, from agriculture to pharmaceuticals, and they range from small to mega cap.
But upon closer inspection, they all have two more very important things in common.
First, each of these stocks has low relative strength (RS).
Relative strength compares the price performance of a stock against every other stock in the market over the past six months. A stock's RS can range from 0 to 100. The lower a stock's score, the worse its performance relative to its peers. More importantly, it has been proven that stocks with high RS are more likely to continue to outperform the market, while stocks with low RS underperform.
AQR Capital Management performed a study looking at U.S. stocks going all the way back to 1927. They found that, at any given time, the stocks that were outperforming 80% of the market continued to outperform for at least the next 12 months. And the bottom 20% of performers continued to underperform over the same period.
The second similarity between these laggards is their poor cash flow relative strength (CFRS), which also ranges from 0 to 100.
Cash flow is one of the most important measures of a company's health and also one of the most reliable numbers in finance. While companies can manage earnings to meet analysts' expectations or inflate balance sheet assets using misleading reserve allowances, this metric is much harder to fake.
A low CFRS score means a company could struggle to reinvest in its business, pay dividends or pay down debt.
Based on these two metrics, we have developed an indicator called the Alpha Score, which ranks every stock on the market, giving it a score between 0 and 200.
The higher a stock's Alpha Score, the more likely it is to break out. In just the past 12 months, for example, we've closed positions for 61%, 71%, 82% and 90% profits by buying stocks with scores between 140 and 200.
The lower the score, the more likely the stock is to lag the market -- or worse -- over the coming weeks and months. And the big-name stocks below are flashing some of the lowest Alpha Scores I've ever seen.
Swiss drug manufacturer Novartis (NYSE: NVS) has been mired in a steep decline for the past nine months. Earnings have taken a hit thanks in part to its poorly performing eye-care business and a strong U.S. dollar eating into its Swiss franc-based profits. Additionally, Novartis recently paid $25 million to settle bribery allegations from U.S. regulators. In the past month, two major investment banks downgraded the stock, but the biggest reason I'm staying away is its Alpha Score of 62.
The bear market in commodities, rising U.S. dollar and slowing global growth have taken a big toll on Archer-Daniels-Midland (NYSE: ADM), which processes agricultural commodities like oilseeds, corn, wheat and cocoa. Analysts have been slashing their quarterly and full-year estimates, and while the stock has been rallying with commodities since mid-January, its Alpha Score of 51 tells me this is no time to jump on board.
Jamba (NASDAQ: JMBA), operator of food and juice bar chain Jamba Juice, has been dead money for the past six months. The company has missed estimates by a huge margin in each of the past four quarters, and we could see more of the same when Jamba reports in early May. Rising labor costs are hurting profits, with many states raising their minimum wage amid a tightening labor market. JMBA's Alpha Score of 50 suggests we're not going to see any life in this stock in the near future.
Despite plunging almost 20% in the past six months, online real estate marketplace Zillow (NASDAQ: Z) still looks overvalued with a forward price-to-earnings (P/E) ratio of 59, three times that of the S&P 500. To add insult to injury, the firm is being sued for $1.77 billion in damages by a rival who claims Zillow illegally used its proprietary trade secrets. The stock's miniscule Alpha Score of 21 screams, "Sell!"
Based on their Alpha Scores, these four stocks are in the bottom 20th percentile of the 5,962 stocks I track. Personally, I only recommend stocks with a score above 140.
For example, back in November, the Alpha Score triggered a "buy" in Volaris (NYSE: VLRS), a low-cost Central American airline you likely haven't heard of. At the time, VLRS was flashing a score of 188.
Since then, VLRS is up 27%, while the S&P 500 has a less than 1% gain to show during that time. What's more, its score is actually slightly higher now, at 189 out of a possible 200. This tells us its outperformance is likely to continue and that the stock could deliver much bigger gains in the months ahead.
I've also recommended a virtually unknown coal company with a score of 158 that delivered a 134% return in 10 months, and a little-known pharmaceutical company with a score of 198 that soared 115% in seven months.
I'm confident the Alpha Score will lead us to more winners like these, even as we head into the "worst" six months of the year.
If you want to learn how you can use it to gain an edge as well, I've compiled a free report that explains how I use it to spot stocks before they make huge runs in a matter of weeks or months. Click here to access it.
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