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Gas in the Tank!The concept of Gas in the Tank is a simple approach for judging how far a stock might advance when it has paused to refresh for a quarter or more after a recent positive move up in price. Gas refers to increasing earnings coming into a stock while it is basing (moving sideways), i.e., the P-E is coming down with increasing earnings to create value. A projected target price can be established by using the difference in the current and next quarters earnings from that of a year ago, multiplied by a P-E range. This difference is the amount of "new gas", while the P-E is analogous to the miles per gallon. The backdrop for the scenario is as follows:
"Gas in the Tank" enables HGS Investors to evaluate the expected price reward after a stock has based and is "ripe" to move up on its next leg. It is a way of assessing the potential reward via checks and balances between the Fundamentals and the Technicals of the stock OVER THE SHORT TERM of several weeks, essentially to the next EPS Report due date. Briefly, it has its value when a successful HGS has had a decent run and then bases, analogous to taking a trip on the freeway and coming off it for a "filler-up". The stock pauses to refresh for a minimum of 1 qtr and IDEALLY, two. Since the stock is essentially basing, the new gas it gets for those qtrs. is the fuel for it to use on its way to the next stop as it breaks out from its base. So if a stock has based for two qtrs with an EPS of 15c and 20c (say) vs a year ago of 5c & 10c, respectively, the new gas is (20c-10c) & (15c-5c) or 20c worth of total gas, for the two qtrs. that it has been basing.
If the P-E range during that period is 30 to 40 (say), then the value of that new gas is $6 to $8 - which would be the expected price advance when it breaks out. As the stock gets back on the freeway, refreshed for the next leg, the 50-Day MA is the ideal spot to evaluate how far the new gas can take it for the NEXT LEG of the journey. Since the stock has moved sideways, its price will be very close to the 50 Day MA line which will be "flattish", implying that Bulls and Bears are in agreement on the fair market value of the stock. This is called the Benchmark Price. This provides a baseline for the fundamental assessment as shown above, as well as the technical assessment via Black Spot Disease (BSD) and Rust to see if the computations for price advance generally agree with each other. Note that I didn't say the entire journey; I said the next leg, hence my emphasis on the NEAR TERM! That's the gist of the concept.
The Underlying Background and Strategy:There are 10 points to understand with regard to the concept and strategy: 1. The assumption is that the stock has had a successful run just previously, i.e., it had an increase in price of at least 25 to 30% (say), before it peaked and based by moving sideways. 2. It reached a high, ran out of steam, and now has based for AT LEAST one qtr., and preferably two qtrs, when it is identified as a potential candidate for the next stage breakout. 3. The earnings for the last qtr came out just AFTER the stock peaked, and are still positive. However, the earnings for the current quarter are not yet out. 4. The stock has produced a tight base and at this point is resting close to "Free Parking", its 50-Day MA, NOW. This implies that Bulls and Bears are in agreement that we are now at the fair market value. This price is usually lower than the old high, but since we established it "produced a tight base" it cannot by definition be any lower than 15% below its old high, and probably closer to <10%. The stock is therefore "ripe" for its next move upwards. 5. The whole purpose of waiting for a base to form is that the stock needs long enough time for the Moving Averages to "catch up" and provide underpinning support. In addition, the anticipation of the coming qtrs. earnings was probably expended in the stock running up to a peak in the first place. So the longer base of a qtr's. worth, rather than just 6 to 8 weeks, is essential for the stock to get over that indigestion of being extended at a high P-E. The base of at least one qtr., gives one a refill of the gas it probably used to reach that old high. 6. Look for the price and the 50-Day MA to be as close as possible after the stock has based. The 50-day MA should be flattish at this point. That means that Bulls and Bears are in agreement. The price at the 50 Day MA, and by definition the stock (since it is at one and the same spot) is the Benchmark Price. Divide that price by the 12-month trailing earnings at that date and you get the Benchmark P-E. The reason for doing this is to give you a fall back price, as well as a better P-E than the Low P-E to use in the forward target calculations. 7. From a fundamental standpoint, basing sideways means that the P-E is going down from its peak value at its old high! The P-E should therefore be lower now than it was at the peak price. Since it is now sitting at its 50 Day MA which should be flattish to just pointing up, (but not pointing down), it is the price at the 50 Day MA that is used as the BASELINE for establishing a Benchmark P-E as described in "6" above. The rule is that one is buying the stock NOW, so your baseline is the 50 Day MA now, and not sometime in the past. 8. This is a basic assumption and is the appeal of the concept, since it brings the "Fundamental" analysis in unison with the "Technical" analysis. We use the SAME baseline for comparing reward via Earnings and P-E for the Fundamentals, and by Black Spot Disease for the Technicals, respectively, to estimate the expected rise. This is WHY it is important to insist on a full qtrs. worth of basing in doing Gas in the Tank analyses, to ensure that the 50-day MA is "flattish". The longer the base, the more likely it is that the 4, 9, 17, and 50 Day MA will converge. The 4 & 9 should already be above the 17 Day MA, and the 17 should be just coming through the 50 Day MA for the safest entry point, with the odds in one's favor that the momentum is ABOUT to pick up again, i.e., the stock is "RIPE" to move upwards. 9. The longer the base, the safer it is to use last qtrs earnings
report and the following qtr in your calculation for the move upwards.
The shorter the base, forget last qtr. and just look ahead to next
qtrs expected "differential" in gas from a year ago.
Thus, "Gas in the Tank" relates to the next qtr, but not necessarily with the next qtrs. earnings, alone. It does apply to the short-term expectations in price growth, but not exclusively for trading. It is used to assess the immediate next step potential rewards. It uses both Fundamental and Technical Analysis, where given a basing period of a quarter or more, the 50 Day MA is the benchmark P-E for assessing fair market value - Bulls and Bears are in agreement. While we do use the PEG (Peter Lynch) method for assessing the under/over value for the longer haul, that uses Fundamental analysis only. Now let's try a hypothetical example using the basics established above: Assumptions:1. Suppose that a good High Growth Stock started its climb at $20, broke out nicely according to all the rules we know, and has advanced in price to $30 say and now pauses to refresh. 2. Let us also assume that AFTER it started to base (move sideways), an earnings report came out. This also implies that it reached its new high of $30 before the earnings were out. One now has the dilemma of whether the stock has already discounted all of the anticipated earnings in its very climb to that new high of $30. Now let's suppose the earnings was 30c vs 15c a year ago. 3. Furthermore, assume that the P-E range of the stock was 30 to 40 during the course of the past two or three qtrs (say). Now let us suppose that the stock bases conveniently for 1 qtr. and you notice that it produces a nice tight flat base or a cup and handle and it is now obviously getting ripe to buy. 4. Also, so that we make it easy, let us presume that it is only 35% from its 200 Day MA and it is currently sitting right at is 50 Day MA, at a price of $27.75. The reason for this statement is to exclude the worry about the stock already being too far extended and is not suffering from Black Spot Disease (BSD). 5. Finally, assume that the next earnings report is due in 6 weeks time and the forecast is for earnings of 35c vs a year ago of 17c. The P-E right now is 35. How can we estimate the Gas in the Tank? Gas In the Tank Assessment:1. The concept is that the stock, like your car, gets replenished with new gas at each EPS Due date, and that replenishment of new gas is the DIFFERENCE between this year's quarterly earnings vs. a year ago. So we have (30c - 15c) = 15c of new gas. That new gas has a value that will fluctuate between the most recent P-E range. So with 15c of new gas x the P-E range of 30 to 40, suggests that the new gas has a value of 15 x 30 = $4.50 or 15 x 40 = $6.00, so we have a potential of $4.50 to $6.00 as a result of the "fill up" the stock had when the last EPS Due report came out. 2. In addition, next qtrs ANTICIPATED New Gas is (35c - 17c) x 30 to 40 for a range of 18c x 30 = $5.40 to 18c x 40 = $7.20. 3. So we have a potential of two qtrs. worth of gas of $4.50 + $5.40 = $9.90 as the low of the range, and $6.00 + $7.20 = $13.20 for the high of the range and a most likely average of $11.05, especially as the current P-E is conveniently right in the middle of that range at 35 P-E. 4. The next task is to estimate how much of the gas was already used up the previous month. The question is whether it used up all of the anticipated earnings as it drove up to its high of $30? Since the stock's price of $27.75 is now $2.25 less than its previous recent high of $30, it would seem reasonable that although it might have used it all up in driving to $30, the fact that it has based for a quarter, and has currently given back at least half of the $4.50 to $6.00 it had previously used, the minimum in reserve due to the basing process for the past qtr. is $2.25. It might be as much as $6.00 if none of it was used up. So we now modify the range on the low side to $9.90 - $4.50 + $2.25 = $6.75 for half used, and a range of $9.90 to $13.20 for none used. 5. Now we are ready to estimate the expected price as a result of the stock breaking out in anticipation of next qtrs. earnings due in 6 weeks time. The 50-Day MA is currently at $27.25, the same place as the price of the stock. Since the stock has based sideways for a whole qtr. it is very likely that the 50-Day MA is the fair market value at this instant in the life of the stock. It is used as the base price from which the stock launches on the next leg of its journey. 6. So $27.25 + $6.75 = $34.00 on the low side, $27.25 +$9.90 = $37.15 for an Intermediate Estimate, and $27.25 + $13.20 = $40.45 on the high side. 7. The potential reward is 24.8%, 36.3% and 48.4%, for the low, intermediate and high estimates, respectively. The market, the degree of interest in the Industry Group and the degree of support coming into the stock determine how far it will get. 8. The Technical Analysis suggests that the stock will have Black Spot Disease at $27.25 x 1.30 = $35.43 and Rust at $27.25 x 1.50 = $40.875, since these would be 30% and 50% up from the 50 Day MA, respectively. This provides a check against the Fundamental Analysis. In Summary, we have: Not all evaluations are as easy as the above. Some stocks are easier to evaluate, especially if their Stability Factor of Earnings is low; in other words, if the P-E range over its history is small (tight) and fairly easily predictable. However, with the types of HGS Stocks that are true rockets, many of them have very High P-E's, and so the caution is not to be overly optimistic in using a very high current P-E. As such one finds that the Industry P-E is usually a better yardstick or the Forward P-E if it brings it into line with Industry P-E. It comes down to a process of trial and error to see which provides the best fit, but one can apply tests of reasonableness based on the actual readings off the chart at the end of each qtr for past qtrs. and compare them to the theoretical values obtained. This enables one to read the street's recent evaluation of P-E for the stock. The concept of Gas in the Tank overcomes the problem that HGS Investors have of judging the correct P-E to use when it is inordinately high for estimating future potential gains. I trust this clarifies the basics for using "Gas in the Tank" analyses. It has appeal since: 1. It brings together both the Fundamental and Technical Analysis in establishing the extent of the Potential Reward prior to buying the stock. 2. It essentially uses the difference in earnings between last qtrs earnings and this qtrs earnings from a year ago. This small number times the Current, Forward or Industry P-E, gives one three measures of an expected target for the Reward. 3. The test of reasonableness is to apply 30% and 50% to the 50 Day MA to establish the Black Spot Disease and Rust yardsticks. 4. Now one is ready to make a judgment as to the extent of the next move up and whether it is worth the risk.
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