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The 10 Highest-Rated Stocks

The stock market wields a powerful influence on all stocks, and when the major indexes
stumble, it can make life difficult even for the best-rated stocks.

That was the case in recent days, when many of the top-performing stocks sold off amid a
broad breakdown in the market. So, investors must make sure performance ratings match
up with the reality of how the stock is acting.

The market's October struggles showed that in some cases, ratings take time to catch up
with stocks' recent -- and sometimes drastic -- price declines. When researching stocks,
investors should take as comprehensive a view as possible of stocks, looking at
financials, industry performance, price action, current news -- and of course how the
market is behaving.

To find the best-rated stocks, Investor's Business Daily started by looking for those with
the highest Composite Rating, a comprehensive score that combines the five IBD
performance ratings plus the stock's relationship to its 52-week high. Second, the stocks
were sorted by Earnings Per Share Rating, which is IBD's measurement of short- and
long-term earnings growth. Thirdly, the companies were separated by Relative Price
Strength Rating, a 12-month stock-price performance gauge.

The companies were selected using Custom Screen Wizard, a stock screening tool at
investors.com. Results are from last Wednesday's market.

1. Natural Gas Services (NGS) - IBD Stock Checkup


The provider of equipment and services to the natural gas and oil industry soared
since July, but sold off sharply early this month. More.

2. Ultra Petroleum (UPL) - IBD Stock Checkup


A new CEO in 1999 helped turn the drilling company around. Today, its main
operations are in Wyoming and China. More.

3. Tenaris (TS) - IBD Stock Checkup


The maker of seamless and welded steel pipes appears to be in good shape to benefit
from rising global energy demand, especially in developing countries. More.

4. Google (GOOG) - IBD Stock Checkup


The online search leader has big ambitions in areas like wireless Internet access, a
software link-up with Sun Microsystems and a possible stake in AOL. More.

5. Fording Canadian Coal (FDG) - IBD Stock Checkup


The mining company specializes in a type of coal used in steel furnaces. Demand is
strongest in the Asia-Pacific region, including fast-growing China. More.
6. Quality Systems (QSII) - IBD Stock Checkup
Medical practices are moving their patient records from those familiar manila folders
to electronic systems, such as those made by this company. More.

7. GFI Group (GFIG) - IBD Stock Checkup


It acts as a middleman between market makers and dealers who want to buy or sell in
the wholesale markets anonymously. Its main customers are major commercial and
investment banks. More.

8. Superior Well Services (SWSI) - IBD Stock Checkup


The oil-field service provider saw sales jump 75% in the last quarter, thanks to more
drilling in its existing locations and activity in its new service centers. More.

9. Chicago Mercantile Exchange (CME) - IBD Stock Checkup


Record trading in options and futures is boosting the exchange, which has been an
innovator in its industry. More.

10. Neoware Systems (NWRE) - IBD Stock Checkup


The maker of "thin client" computing systems that connect to servers rather than
PCs' hard drives saw a rebound in recent quarters, helped in part by several
acquisitions. More.

To Reap The Biggest Stock Gains, Pick The Leader In


A Top Group

BY JONAH KERI
INVESTOR'S BUSINESS DAILY
Adapted from article published May 3, 2004
Buying a stock in a leading industry greatly increases your odds of investing success. Buying the
best stock in a leading group gives you an even better chance at big gains.

Personal computers exploded in popularity in the 1980s and 1990s. If you noticed the trend and
simply threw darts at PC-related stocks during that time, you'd have had a good shot at making
money.

If you'd bought industry leader Dell Computer during that time instead, you could have made
even more, measuring your gains in thousands of percentage points.

The same goes for standard-issue software firms vs. Microsoft, run-of-the-mill retailers vs. Wal-
Mart Stores, or average aviation stocks vs. Boeing a generation ago.

To find the No. 1 company in a given industry or field, stroll through IBD's SmartSelect Ratings,
found in the paper's stock tables. From left to right, you'll find the following:

Composite Rating, a catch-all number from 1 to 99 that covers fundamental and technical traits;
Earnings Per Share Rating, which looks at annual and quarterly earnings power; and Relative
Price Strength Rating, which measures the relative strength of a stock compared to the broader
market.

The tables also list the Industry Group RS, which shows the strength of the stock's group relative
to all others; SMR, which examines Sales growth, profit Margins and Return on equity; and
Accumulation/Distribution Rating, which gauges the amount of buying vs. selling of the stock by
institutions.

The Stock Checkup at investors.com includes all those individual ratings. It also stacks up stocks
relative to the other members of its industry group. Thus you can quickly eyeball not only how
your stock measures up against the market, but also against its peers.

More than headlines and hype, these objective measures can help you find the best of the bunch
before such stocks take off on their huge price runs.

ScanSource formed a long base starting in late 2002. The distributor of bar code scanners and
other point-of-sale products formed a downward-sloping handle in light trade for seven weeks at
the end of its base, a good sign. It then broke out in brisk trade.

A look at ScanSource's ratings at the time of its breakout showed the mark of a leader. The stock
sported a 93 Composite Rating, 83 EPS, 75 RS, A+ Industry Group RS, B SMR and B- A/D.

The stock broke out anew last week, in massive volume 3. Its individual ratings had all improved
since its last breakout, except for its Industry Group RS.

But a true market leader can even overcome some weakness among its peers. In Stock
Checkup, ScanSource earned the top spot in its 27-member Retail/Wholesale-Computer/Cellular
group for Overall, Fundamental, Technical and Attractiveness Ranks.

What is CAN SLIM™?


CAN SLIM is IBD's checklist for the seven common characteristics all great performing stocks
have before they make their biggest gains. You can significantly reduce your risk and increase
returns by using the CAN SLIM Investment Research Tool as a fact-based performance checklist
to evaluate a stock before you buy.
C= Current earnings per share should be up 25% or more and in many cases accelerating in
recent quarters. Quarterly sales should also be up 25% or more or accelerating over prior
quarters. Learn more...
A= Annual earnings should be up 25% or more in each of the last three years. Annual return on
equity should be 17% or more. Learn more...
N= A company should have a new product or service that's fueling earnings growth. The stock
should be emerging from a proper chart pattern and about to make a new high in price. Learn
more...
S= Supply and demand. Shares outstanding can be large or small, but trading volume should be
big as the stock price increases. Learn more...
L= Leader or laggard? Buy the leading stock in a leading industry. A stock's Relative Price
Strength Rating should be 80 or higher. Learn more...
I= Institutional sponsorship should be increasing. Invest in stocks showing increasing
ownership by mutual funds in recent quarters. IBD's Accumulation/Distribution Rating gauges
mutual fund activity in a stock. Learn more...
M= The market indexes, the Dow, S&P 500 and Nasdaq, should be in a confirmed up trend
since three out of four stocks follow the market's overall trend. Learn more...

: Current Earnings Growth


Research shows that earnings growth is the single most important indicator of a stock's potential
to make a big price move. The stocks you select should show a major percentage increase in
current quarterly earnings per share (the most recently reported quarter) when compared to the
prior year's same quarter.
Winning Characteristics

• Large increases in current quarterly earnings per share. Look for these increases to be at
least 25%. (Three out of four of the best-performing stocks in our research showed
earnings increases of 70% or more in the quarter right before they started to make their
huge price moves!)
• Preferably, look for accelerating earnings in at least the three most recent quarters.
• Check earnings consensus estimates to make sure the company is projected to be on a
positive track.

Investing Tip: The best stocks often have high - some would say ridiculous - P/E ratios when
they start their big climbs. If you weren't willing to pay the higher P/Es, you eliminated most of the
best stocks of all time.
How to Identify Companies with Superior Earnings Growth
Investor's Business Daily and investors.com make it easy to identify companies with superior
earnings growth:

• An Earnings Per Share (EPS) Rating is provided for all stocks in our database. This
proprietary rating measures a company's earnings performance by looking at its: 1) latest
two quarters' earnings per share growth, 2) 3-year annual earnings growth rate, and 3)
stability of annual earnings growth. These factors are then weighted and compared to the
same measures for all other public companies.
• EPS Ratings are on a 1-99 scale, with 99 being highest. An 80 EPS Rating, for example,
indicates that a stock is outperforming 80% of all other companies based on earnings
performance. In other words, a stock with an EPS Rating of 80 is in the top 20% of all
companies in terms of recent quarterly and annual earnings growth. Research shows that
the stocks that make the most powerful gains usually have an EPS Rating of 80 to 85 or
higher.

Where Can I Find Earnings Per Share (EPS) Ratings? EPS Ratings can be found in
IBD's main stock tables and the IBD Stock Checkup® and IBD Charts on investors.com.

• Domestic companies generally report their earnings four times a year. Investor's
Business Daily's "Earnings News" section provides comprehensive earnings reports. To
make finding earnings leaders easier, IBD separates these reports between companies
posting earnings gains and those reporting lower results. The list is arranged by order of
highest percentage gains in earnings to save you time. IBD also provides a "Best Ups"
section to help you zoom in on the absolute best earnings reports. The number of
companies in each of these categories gives you an overall idea of whether corporate
earnings are healthy or not.

Where Can I Find Earnings Reports? Quarterly earnings reports are provided in the
"Earnings News" section of Investor's Business Daily. Earnings information is also
available in IBD Stock Checkup®.

• Another source for identifying companies with superior earnings is IBD's "Your Weekly
Review," produced each Friday. This feature lists stocks that rank in the top 15% of all
companies in earnings performance. In addition, these stocks must pass rigid
performance criteria in order to make the list (85 in both EPS and RS Ratings) and must
be within 15% of their 12-month price high. Make sure you view this prospect list for
potential new investment ideas.
• Black-bar highlighted stocks in IBD's main stock tables identify stocks you may want to
research further. In addition to having strong earnings, these companies possess top
growth fundamentals, including sound profit margins and ROE figures.

A: Annual Earnings Growth


As we've seen, strong current quarterly earnings are critical to picking the market's biggest
winners. However, three out of four of the biggest winners in our research also showed at least
some positive annual growth rate over the five years preceding the stock's big run-up. We'll also
look at other key fundamentals you'll want to consider.
Winning Characteristics

• The annual earnings per share should show consistent growth over the past three to five
years. Look for average annual EPS growth of at least 20% to 25%.
• Between 1980 and 2000, the median annual growth rate of all outstanding stocks in IBD's
study of the greatest stock market winners, prior to big price moves, was 36%.
• Look for stocks where each of the last three years shows an increase in annual earnings,
with no one single-year being down.
• It is also helpful to see either the annual pre-tax profit margin and/or the annual return on
equity expanding.
• Return on Equity (ROE) should be 17% or higher.
• The last three quarters' sales should either show acceleration in the rate of increase
and/or the latest quarter should be up at least 25%.
Investing Tip: In a few cases you may accept one down year in the last five as long as the
following year's earnings quickly recover and move back to new high ground.
How to Identify Companies with Superior Annual Earnings Growth and Other Strong
Fundamentals
Investor's Business Daily and investors.com make it easy to identify companies with superior
earnings growth and strong fundamentals.

• An Earnings Per Share (EPS) Rating is provided for all stocks. This proprietary rating
measures a company's earnings performance by looking at its: 1) latest two quarters'
earnings per share growth, 2) 3-year annual earnings growth rate, and 3) stability of
annual earnings growth. These factors are then weighted and compared to the same
measures for all other public companies. EPS Ratings are on a 1-99 scale, with 99 being
highest. An 80 EPS Rating, for example, indicates that a stock is outperforming 80% of all
other companies based on earnings performance. Seen another way, a stock with an
EPS Rating of 80 is in the top 20% of all companies in terms of recent quarterly and
annual earnings growth. Research shows that the stocks that make the most powerful
gains usually have an EPS Rating of 80 to 85 or higher.
• The Annual Earnings Growth Rate is provided for every stock in our database in the Vital
Statistics section of IBD Stock Checkup®.
• "Stocks In The News" charts in Investor's Business Daily profile stocks showing current
strength - either making new price highs, near new highs, or showing price strength on
unusually high trading volume. Annual earnings growth can be found on these charts
also.
• Another source for identifying companies with superior earnings is IBD's "Your Weekly
Review," produced each Friday. This feature lists stocks that rank in the top 15% of all
companies in earnings performance. In addition, these stocks must have strong price
performance in order to make the list. Make sure you view this prospect list for potential
new investment ideas.
• Black-bar highlighted stocks in IBD's main stock tables identify companies you may want
to research further. These are top fundamental stocks.
• An SMR Rating™ (Sales + Profit Margins+ Return on Equity) is provided for every stock
listed in Investor's Business Daily. This rating combines four fundamental factors that
research shows can influence a stock's price: sales growth rate over the last three
quarters, pre-and after-tax margins,and return on equity (ROE). The SMR Rating™ uses
a simple A to E scale:
A = Top 20% (Outperforming 80% of all other stocks in these key fundamentals)
B = Next 20%
C = Next 20%
D = Next 20%
E = Bottom 20% (Under performing 80% of all other stocks in these key fundamentals).

Where Can I Find the SMR Rating™? The SMR Rating™ can be found in IBD's main
stock tables and the IBD Stock Checkup®.

• The Fundamental Rating found on the IBD Stock Checkup®, provides a single
assessment of a company's earnings and key fundamentals. This rating measures
annual and quarterly sales and earnings growth, sales and earnings acceleration,
earnings stability, and profit margins and return on equity. Like other IBD ratings, the
Fundamental Rating uses a simple 1-99 scale, with 99 being highest.
N: New Products, New Services, New Management, New Price Highs
Explosive stock growth doesn't happen in a vacuum. Usually, new products, new services, new
management or new industry conditions propel stocks to new heights. In its study of the greatest
stock market winners, IBD discovered that more than 95% of the successes in American industry
met at least one of the above criteria. And, contrary to the beliefs of many investors, stocks that
make the biggest price advances start their moves when they are already at or near new price
highs. By following the old adage, "buy low, sell high" investors would have missed out on most of
the biggest stock successes in market history.
Winning Characteristics

• A stock that makes big gains often results from new products or services. But be wary of
unproven products, especially if the company management doesn't have a solid track
record.
• Superior management is essential to a company's success. That's why often a shakeup
at the top pushes a stock's price higher.
• Quality stocks making new price highs just as they emerge from sound chart bases on
higher volume are often likely to continue climbing, while stocks making new lows are
probably headed even lower. Therefore, focus on the new price highs list for the best
potential opportunities.
• You can think of a stock's price as a measure of its quality and, consequently, its
potential. Typically, stocks higher in price reflect higher quality.
• Always be on the lookout for new products, new services, new management, or major
improvements in industry condition.

Investing Tip: An IBD survey indicated that 98% of investors do not buy stocks making a new
high price. An analysis was made of the IBD's new-high and new-low stock lists during several
good, as well as poor, market periods. The findings were clear: stocks on the new-highs list
tended to head higher, and those on the new-lows list often continued lower.
How to Identify Companies with Positive New Conditions

• "The New America," found daily in IBD, features companies with enterprising products or
services and good fundamentals, often before they are widely known. These are
companies that exhibit the characteristics found among the market's biggest leaders of
the past.
• IBD publishes a daily list of stocks making 52-Week Highs. These new highs are
categorized by sector to more easily identify potential market leadership.
• IBD's main stock tables show each stock's 52-week high. And stocks making new highs
or up at least $1 for the day are boldfaced to help quickly identify strength.
• The "Internet & Technology" pages in IBD regularly profile high-tech companies
developing innovative products. A team of Investor's Business Daily reporters and editors
in the heart of Silicon Valley covers this field. The section includes interviews with top
executives of leading technology companies.
• IBD's Industry Groups page features Groups With Highest % Of Stocks Making New
Highs to help identify market leadership, as represented by new highs.
• A good way to keep up with changes in corporate boardrooms is Investor's Business
Daily's "To The Point" section. This is a one-page news summary, packed with dozens of
developments at U.S. companies, including reports on leadership changes at major
businesses.

S: Supply and Demand


Our study of the greatest stock market winners validates what most investors understand.when
demand for a stock outpaces supply, the price usually heads north. The best way to measure a
stock's supply and demand is by watching its daily trading volume. When a stock rallies up in
price, you want to see volume rise at the same time, which may represent institutional buying that
can really power a stock's move. When a stock pulls back in price, you want to see volume dry up
indicating no significant selling pressure.
Winning Characteristics

• Watch the demand for shares by looking at the Volume % Change for each of your
stocks. It will show you immediately how much a stock traded vs. its average daily
volume over the last 50 trading days. For example, a stock that trades 100,000 shares on
average will have a 50% Volume % Change if it trades 150,000 shares on the day.
• Stocks closing at their highs for the day or gapping up in price can indicate strong
demand.
• Companies buying back their stock in the open market and companies showing stock
ownership by management can be positive indications.
• When a stock breaks out of a price consolidation area, trading volume should be at least
50% above its average daily volume, indicating strong demand.
• In many cases, a strong stock breakout will see volume up 100% or more for the day,
indicating solid buying and the possibility for further price increases.

Investing Tip: A stock moving up in price on lower than normal volume could be a sign of
weakness. Look for strong demand supporting price increases.
How to Track Demand for a Stock

• Volume % Change is computed for all stocks in IBD's main stock tables. This helps you
easily identify stocks with higher than average demand.
• In the quotes area on investors.com, Volume % Change is updated continuously
throughout the day, looking at volume at that point in the trading session.
• Investor's Business Daily can help you track the level of supply and demand among large
institutional investors. The Accumulation/Distribution Rating (ACC/DIS Rating™) ,
provided for every stock in our database, analyzes price and volume changes over the
past 13 weeks. An A or B Rating is bullish, because it indicates big investors are, on net,
loading up on the stock. Such accumulation is one sign that the stock could turn out to be
a winner.

Where Can I find the Accumulation/Distribution Rating (ACC/DIS Rating™)? This


key rating can be found in IBD's main stock tables as well as on IBD Stock Checkup® at
investors.com.

• "Stocks On The Move" lists higher quality stocks that are moving up in price on unusually
high demand. Investors.com provides a continuously updated version of the Stocks On
The Move list as well.
• For a broader look at the moves of institutional investors, there are two key charts to
check out on IBD's Industry Groups page. One is "Big-Cap Growth Funds Vs. Small-Cap
Growth Funds". When the line on this chart is moving up, it tells you big-cap stocks are
outperforming small-cap stocks. This indicates there are probably more investment
opportunities in large-cap stocks than in small-cap stocks, based on current institutional
demand. "Value Funds vs.Growth Funds" is the other screen that can help you zoom in
on where current demand is focused.
L: Leader or Laggard
Our studies show that, on average, 37% of a stock's move is directly tied to the performance of
the industry the stock is in, and another 12% is due to strength in its overall sector. That's why it's
so important to track the performance of both industry and sector groups. Leadership also refers
to an individual stock's performance in the market. Once you've identified the most powerful
industry groups, the next step is to identify the strongest stocks in those industries.
Winning Characteristics

• Look closely at the top 20% of industry groups (Investor's Business Daily tracks 197). Our
study of the greatest stock market winners show the best stocks generally come from the
top 22% of industry groups. Also, you want to avoid the bottom 20% of groups. Historical
analysis also shows stocks within the top half of all industry groups greatly outperform
those in the bottom.
• The best-performing stocks are generally No. 1 in their industry based on key
fundamentals, including return on equity, annual earnings growth, pretax and after-tax
profit margins and its relative price strength.
• Look for confirmation of strength from at least one other company in the same industry
group.
• Look for leading stocks: Our study of the greatest stock market winners found that all-star
stocks had, on average, outperformed 87% of the market before they began their most
dramatic price advances. In a manner of speaking, if you want to find next year's winning
stocks, look at the better-performing stocks today.
• Once a general-market decline is definitely over, the first stocks to bounce back to new
price highs are almost always your authentic leaders.

Investing Tip: Stay away from "sympathy plays," meaning a stock in the same industry group as
a leading company bought in hopes that the leader's luster will rub off on to it. The performance of
such sympathy plays usually pale in comparison to the true leaders. Eventually they will try to
move up "in sympathy" but they rarely, if ever, do as well.
How to Find the Leaders

• IBD's "Your Weekly Review," found in Friday's edition, lists earnings and performance
leaders sorted by industry group strength. This is a great starting point for potential
investment ideas.
• Each day, Investor's Business Daily's Industry Rankings table, found on the Industry
Groups page, ranks 197 different industry groups by the price performance of all stocks in
that group over the latest six months.
• An Industry Group Relative Strength Rating is provided for all stocks. The proprietary
rating describes how well the industry to which the stock belongs is performing. Industry
groups are rated on a scale of A+ to E, with A+ being best. B-rated stocks may also have
potential. It's also significant when the industry group has been moving up in ranking in
the industry rankings table.

Where Can I Find The Industry Group Relative Strength (RS) Rating? This gauge of
industry strength can be found in IBD's main stock tables and IBD Stock Checkup® on
investors.com.
• The table of 52-Week Highs, which IBD sorts by sector, can also provide good insights to
which industries are drawing interest among professional investors.
• Look for stocks with a Relative Price Strength (RS) Rating of 80 or higher. This rating is
on a scale of 1 to 99, with 99 being highest. An 80 rating indicates the stock is
outperforming at least 80% of all other companies based on its price performance over
the last 12 months.

Where Can I Find The Relative Price Strength Rating? RS Ratings, indicating the
price strength of a stock relative to all other stocks, can be found in IBD's main stock
tables and IBD Stock Checkup® on investors.com.

• The Relative Strength line, included in IBD Charts on investors.com, helps confirm a
stock's upward price movement. You also want to see the RS line moving in a strong up-
trend.
• IBD Stock Checkup® on investors.com provides a list of the top five stocks in each
industry, based on the most relevant fundamental and technical factors.

I: Institutional Sponsorship
Mutual funds and other professional investors represent the vast majority of trading activity in the
market. As such, they wield tremendous influence over stock prices, capable of sending their
favored stocks up significantly. Here, you'll learn how to spot stocks benefiting from "institutional
sponsorship."
Winning Characteristics

• A stock should show an increasing number of institutional sponsors in recent quarters


(accelerating sponsorship).
• A stock should have at least several institutional owners. If there is no institutional
sponsorship, it is likely the performance will be more run of the mill.
• You want stocks owned by the most successful money managers, the ones who have a
proven record for consistently selecting top-performing stocks at the right time.
• Consider giving greater weight to those stocks being bought by top-performing mutual
funds, either as new positions or add-on purchases.

Investing Tip: Many institutional investors avoid buying stocks selling for less than $15 a share.
How to Track Institutional Demand for a Stock

• One of the most useful ways to spot current institutional trading is to study Volume %
Change figures, that is the percentage up or down in trading volume of a stock compared
to its average daily volume over the past 50 days. This is often the first sign that
institutions are moving in or out of a stock in a major way.
• Volume % Change is listed in the stock quotes at investors.com and provides an updated
projection of the day's volume as an early indication of any unusual trading activity.
Investor's Business Daily's stock tables also include Volume % Change.
• "Stocks On The Move," provided on the home page of investors.com, is a continuously
updated screen of stocks making notable price moves with the most unusual buying and
selling activity. Such activity may be an early indicator of stocks heavily traded by
institutions.
• "Stocks On The Move," also offered in the pages of Investor's Business Daily, provides
stocks making notable price movement and showing unusual trading activity the previous
day compared to their average. A different list is provided for the NYSE, Nasdaq and
American Stock Exchange.
• "Your Weekly Review" shows positions taken by the best-performing mutual funds in the
top-quality stocks chosen for their high EPS and RS Ratings. This powerful list identifies
high-quality stocks that may be in high demand by institutional investors.
• The Accumulation/Distribution Rating weighs the amount of buying volume vs. selling
volume in a stock over a 13-week period. (The calculation uses a moving average of
price and volume data.) The result is represented by IBD on a scale of A to E and
enhanced by "+" and "-" symbols to show institutional buying and selling activity in finer
detail. You should consider stocks with A or B ratings. C stocks are neutral and may be
O.K. to buy. The Accumulation/Distribution Rating is a proprietary rating included in the
IBD SmartSelect® Corporate Ratings.

Where Can I Find the Accumulation/Distribution (ACC/DIS) Rating™? This key rating
can be found in IBD's main stock tables as well as the IBD Stock Checkup® at
investors.com.

• IBD's Sponsorship Rating (SPON Rating™), which can be found Tuesdays in the main
NYSE and Nasdaq tables, is designed to spot stocks being bought by funds, especially
those with good performance records. The Sponsorship Rating is boosted for stocks
owned by more funds each quarter. A higher rating is also placed on stocks more heavily
owned by the top-performing mutual funds. Sponsorship is shown on a scale of A to E,
with A representing the highest rating. Because it relies on reports from fund companies,
this rating is best used to evaluate longer-term sponsorship trends.
• In IBD's mutual fund charts, check the "Top New Buys/Sells and Top 10 Holdings" for
information on which stocks have been bought and sold by leading funds. A stock should
show an increasing number of sponsors in recent quarters.
• You can tell if the market is shifting to small- or big-cap stocks by watching the chart titled
"Big-Cap Growth Funds Vs. Small-Cap Growth Funds," found in IBD's Mutual Funds
pages.

M: Market
Market direction is the most critical characteristic to consider when investing. Almost all the best
stocks over the past five decades have made their upward moves when the overall market was
strong. And historically, three out of four stocks have followed the general market trend - up as
well as down. So it's critical to understand exactly what the market is doing by watching it every
day. Accurately gauging the market is not a matter of luck or "Monday morning quarterbacking."
There are clear telltale indicators that can help you identify market tops and bottoms.
Winning Characteristics

• Bear markets are normal and necessary and serve to clean up prior excesses. They also
allow the market to create a whole new set of chart bases and leaders for the next bull
market. It's important to not get discouraged or lose confidence; otherwise, you'll miss the
next bull market.
• Bear markets create fear, uncertainty and a loss of confidence. When stocks hit bottom
and turn up to begin the next bull market - loaded with opportunities - most investors
simply don't believe it.
• New big winners emerge during the first 10 to 15 weeks of a new bull market. It's
important to identify market turns early to capitalize on these great opportunities.
• The market indexes signal a market bottom. Look for the first attempt at a rally. If the rally
follows through anywhere from fourth to tenth day of a rally (preferably by the seventh
day), it is an indication of a new uptrend. For a valid follow through to occur, look for an
increase in total market volume from the previous trading day and substantial price
advances for the day - at least 2% in either the Dow. S&P 500 or Nasdaq Composite.
• At major market turns, you may see market indexes moving in different directions. The
Dow, for instance, may be making new highs while the S&P 500 does not. It's also
important to note if an index is advancing or declining at a much greater rate than
another. For example, if the Dow rises 3% one day as the S&P 500 (the broader index)
rises only 1%, it indicates the rally is not as broad or strong as it may appear. This is why
it's helpful to study market indexes in tandem, to more easily spot confirmations or
divergences at key turning points.
• Historically, market tops occur after the major market averages move into new high
ground and show several days of large and increased volume with either poor price
progress or actual declines in the averages.
• Few market predictions ever materialize. That's why you shouldn't listen to any personal
opinions about the market. Instead study the day-to-day price and volume changes in the
leading indices. The goal is not to predict the market into the distant future but rather
understand its exact condition at the time. Is it in a confirmed uptrend or downtrend, and
is it acting in a normal or abnormal manner?
• It's of no value to make a worthwhile gain during several years of a bull (up) cycle and
then give it all back during the following bear (down) cycle. It's better to get out of the
elevator on one of the floors on the way up than to ride it all the way back down.

Investing Tip: Many of the biggest investing opportunities can be found right as the market
begins a confirmed change in direction.
How to Determine the General Market Direction

• The Big Picture provides a clear analysis of what the market is doing. Just as important,
you'll learn what the market isn't doing. This daily column includes the "Market Pulse," a
table summarizing the major action in the indexes and leading stocks. IBD's Big Picture
pointed out distress signals in March 2000 when distribution heralded the end of a great
bull phase.
• IBD's General Market & Sectors page should be checked every day to evaluate the
market's health. The three key indices (S&P 500, S&P 600 and Nasdaq Composite) are
stacked, one on top of the other, to help you spot confirmation or divergences in action at
key turning points. A brief column next to the charts analyzes significant action, using
numbered bullets to help readers understand what the charts are showing.
• The Markets, accessible from the homepage of investors.com, updates index prices and
charts throughout the day.
• During attempted rallies in a bear market, the advance/decline line (produced by taking
all NYSE stocks that rise in price for the day and subtracting those that fall) can be
telltale, particularly when this line shows no ability to rebound when the indices try to rally.
• The General Market & Sectors page also shows several valuable psychological market
indicators. The percentage of investment advisers who are bullish or bearish and the ratio
of put volume to call volume have historically been solid indicators. These contrarian
indicators can be valuable when examined in conjunction with the major market indexes.

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If all of IBD's 20 rules are carefully followed (not just the ones you like), your
investment results should materially improve:

1. Consider buying stocks with each of the last three years' earnings up 25%+, return on
equity of 17%+ and recent earnings and sales accelerating.
2. Recent quarterly earnings and sales should be up 25% or more.
3. Avoid cheap stocks. Buy higher quality stocks selling $15 a share and higher.
4. Learn how to use charts to spot sound buy points. Confine your buys to these points as
stocks breakout on big volume increases.
5. Cut every loss when it’s 8% below your cost. Make no exceptions so you can always
avoid huge, damaging losses. Never average down in price.
6. Have selling rules on when to sell and take a profit on the way up. Review "When to Sell
and Take a Profit" in How to Make Money in Stocks.
7. Buy when market indexes are in an uptrend. Reduce investments and raise cash when
general market indexes show five or more days of volume distribution.
8. Read IBD’s "Investor’s Corner" and "The Big Picture" columns to learn how to recognize
important tops and bottoms in the market indexes.
9. Buy stocks with a Relative Price Strength Rating of 85 or higher in the IBD SmartSelect®
Corporate Ratings.
10. Pick companies with management ownership of stock.
11. Buy mostly in the top six broad industry sectors in IBD’s New High List.
12. Select stocks with increasing institutional sponsorship in recent quarters.
13. Current quarterly after-tax profit margins should be improving and near their peak
margins.
14. Don’t buy because of dividends or P-E ratios. Buy the #1 company in an industry in
earnings and sales growth, R.O.E., profit margins and product quality.
15. Pick companies with a new product or service.
16. Invest mainly in entrepreneurial New America companies. Pay close attention to those
with an IPO in the past 8 years.
17. Check into companies buying back 5% to 10% of their stock and those with new
management (what is management’s background?).
18. Don’t try to bottom guess or buy on the way down. Never argue with the market. Forget
your pride and ego.
19. Find out if the market is currently favoring big cap or small cap stocks.
20. Do a post-analysis of all your buys and sells. Post on charts where you bought and sold
each stock. Evaluate and develop rules to correct your major past mistakes.

1. American Oriental Bioengineering (AOB) - IBD Stock Checkup


It's a leading Chinese biotechnology company. It came up with a more efficient way
to produce soybean protein peptide for the making of medicines and nutritional
supplements. More.

2. Home Solutions of America (HOM) - IBD Stock Checkup


It provides water-damage restoration, cabinet and countertop installation and other
niche services for homeowners. More.

3. Channell Commercial (CHNL) - IBD Stock Checkup


A designer and manufacturer of equipment for phone and cable TV operators. The
Temecula, Calif.-based company also has operations in Toronto, London and Sydney,
Australia. More.

4. GeoResources (GEOI) - IBD Stock Checkup


An oil and gas exploration, production and drilling company whose principal
operations are in the Williston Basin area of North Dakota, where activity is
accelerating. More.

5. ENGlobal (ENG) - IBD Stock Checkup


A provider of engineering services and systems to the oil industry. Refine operations
account for much of its current order backlog. More.

6. Fieldpoint Petroleum (FPP) - IBD Stock Checkup


The oil and natural gas exploration and production company went public Sept. 20 at
$4.50 a share. It's been trading at about double that price. More.

7. Bolt Technology (BTJ) - IBD Stock Checkup


The company invented a device that has become a widely used piece of seismic
equipment for undersea energy exploration. More.

8. Mesa Air Group (MESA) - IBD Stock Checkup


The regional airline, which serves as a feeder for United, US Airways and other large
carriers, plans to launch an airline serving Hawaii next year. More.

9. New Dragon Asia (NWD) - IBD Stock Checkup


It mills, sells and distributes flour and related products, including instant noodles,
throughout China. More.

10. U.S. Global Investors (GROW) - IBD Stock Checkup


The firm manages 13 no-load mutual funds with more than $2 billion in assets.
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