Will Momentum Stock NeuStar (NSR) Lay Another 221% Golden Profit?

Dr. Scott Brown

 

By Dr. Scott Brown

The birth of NeuStar in June of 2006 was promising.  Shares opened $2 higher than the IPO offering price of $22.  The stock was seen as a “low risk” VoIP play. That’s Skype-ish kind of stuff.  The offering was well received because NeuStar enjoyed a monopoly until 2011 on the North American phone numbering plan. The initial offering was for 27.5 million shares. Private equity investors Warburg Pincus, acquired NueStar’s technology from Lockheed Martin (LMT) in 1999.  They retained control over 80% of the shares outstanding. NeuStar is a clearinghouse for phone number porting. This is how customers keep phone numbers when switching between Verizon (VZ), AT&T (T), Nextel (NXTL), or cable companies offering calling services such as Comcast (CMCSA) or Time Warner (TWX). NeuStar also distributes new new phone numbers. NeuStar (NSR) gets a buck a transaction. Investors greatest fears were calmed when the Federal Communications Commission (FCC) renewed the company contract through June of 2015. 

See press release HERE.

NeuStar stock has traded as low as $12.61 in January of 2009.  And up to annual highs of $40.57 today. This is an astounding 221% holding period return already on this momentum play!

The Fundamental Numbers

Doc Brown’s Trading University Trade of The Week
Stock Neustar Inc
Symbol NSR
Sector Telecom
Exchange NYSE
IPO Date 6/29/2005
IPO Price  $25.00
IPO Offering Price  $22.00
IPO Shares Outstanding (millions) 27.0
Sales Growth (3-Year) 14%
Earnings Growth (3-Year) 21%
Earnings Acceleration (Qtr. To Qtr.) 47%
Date 9/28/2012 7/19/2012
Shares outstanding (millions) 66.4 66.9
Composite Rating 99 89
EPS Rating 96 91
RS Rating 84 62
Group RS Rating C+ D
SMR Rating A A
Acc/Dis Rating A+ A
Dr. Brown uses Investors Business Daily for fundamental data.

Shares outstanding has increased from 27.5 million shares to 66.4 post-IPO.  I prefer stocks that with between 5 and 30 million shares outstanding. 

66.4 million is double my upper sweet spot. 

Neustar fit this criteria perfectly when it went public.  But its performance languished in the crash from 2007 to 2009.  This was simply bad luck for the firm. 

Many good firms were hammered in 2009 such that (at least for me) it would have been impossible to spot the opportunity in NeuStar (NSR) shares at that time. 

Imagine the size of an institutional purchase it would take to move or support a lunker like PetroBras (PBR) with 13,044.5 million shares outstanding?! 🙁   No small wonder that the relative strength of PBR is 54 as compared to 84 for NeuStar (NSR).

NeuStar (NSR) has a relative strength 30 points higher than a monster cap like the Brazilian national oil company PetroBras (PBR). 

However today Neustar has double digit sales growth, earnings growth, and earnings acceleration.  The IBD Composite Ranking is a healthy 99 which is a 10 point upgrade from the date of NSR recommendation by a major investment newsletter. 

Earnings improved from last quarter to this quarter such that analyst’s estimates were broken by more than ten percent. 

In MBA finance terms we say that the last quarter earnings surprise was 10.3%.  Make sure you check this number each new quarter.  You want to see ongoing earnings surprises.  This helps sustain the upward momentum of NeuStar (NSR) share prices. 

This is a telecom industry momentum play.  The group (industry) leader is NeuStar (NSR) in terms of share price performance. 

The firm’s fundamentals have improved over the last quarter.  There has been a marked improvement in the relative strength of this stock from 62 to 84.  This tells you that the share price has responded upward faster than before. 

NeuStar (NSR) at this time is a very healthy firm that acts as if share prices are building into a strong rise on momentum. 

The Technical Picture

Never use technical analysis to forecast the market.  That may be confusing until you stop to think about price charts.  Such graphs are based on past information — prior data. There is no reason that a stock should rise or fall if markets were truly efficient.  If so prices would be random.  You wouldn’t have any better chance of winning on any particular stock than a coin flip.

This roulette wheel is flawed!

Close your eyes for a second and imagine the stock market as a vast roulette wheel the size of the circumference of the city limits of Las Vegas.  There are over fifteen thousand numbers representing all of the stock (mostly junk) that trades across United States stock exchanges. You put part of your life savings down on a particular number each time you trade a stock or stock option.  You wait for the wheel to spin.  You wait patiently for the outcome.  Then you break-even, make, or lose money. Most little guy Main street (retail) stock and stock option traders operate at a serious disadvantage.  They fail to understand a secret the best professional money managers understand intimately through intense study. This roulette wheel is flawed.  The bearings are severely worn with flat spots. The rusty shaft of the wheel bowl is ever so slightly bent.  This gives the roulette ball a a slight wobble as it is thrown into the groove in the opposite direction of the spin of the mahogany rim of the rotor. The wheel frets are worn and uneven.  The metal (diamonds) pins are chipped and irregular. Once smoothly lacquered number pocket veneers have unglued into raised slightly warped leafs that sometimes bounce the ball to an unintended number. The croupier is a tall, jaundiced, straggly grey haired, ancient man with shifty eyes.  An alcoholic in final stages of cirrhosis he is also a convicted pedophile who shakes and nervously scans the crowd for cops. With clumsy half-hazard carelessness he drops the ball into play. But you are catching on to the game.  You’ve learned the wheel’s quirks through meticulous study.  You now make money because you know when probability is in your favor.

WAKE UP!

This is the end of the guided meditation part of this post.  Open your eyes now or you won’t be able to read the rest of this…  ROFL! 🙂

The stock market is a gargantuan wheel of (mis)fortune that (curses) blesses some people in the public with (poverty) riches.  It is based on probabilities. Odds aren’t even on this stock market wheel of (mis) fortune. The quirks in the stock market that put your odds in favor are (1) high momentum, (2) small size, and (3) high book to market ratios.   In this lesson you have learned how to employ high momentum (stocks breaking into annual highs) and small firm size (shares outstanding) to your advantage. Don’t put all your faith into even the most diligent analysis that flags a stock as a momentum stock. There is still no guarantee that it will go up immediately, in the mid-term, or ever at all!  You only perform analysis to increase the probability of success from investing in any given stock.  You can never guarantee any outcome. It is socially irresponsible to be an unloving parent. But this is a prudent mindset in the stock market.  Be careful to never love any of your stocks. Be cold, calculated, and demanding with your shares of stock.  Enslave them patiently as long as they make money. Be very quick to fire them when they lose. When conditions change and probability turns negative you’ll have to give that “favorite” stock a quick death.  And like the farmer with his favorite old dog riddled with cancer seeking to save on the vet bill. He takes his beloved pet out to the bone yard.  He puts a bullet in its head.  He saves hundreds of dollars.  Learn from the farmer with the cancer ridden old favorite family dog…

 BE UNMERCILOUS WITH YOUR POSITIONS!

Sell off stocks and stock options that go against you as quick as you can.  You will do this with technical analysis.  This allows you to directly monitor market conditions.  Technical analysis allows you to be nimble in your stock and stock option trading.

IMPORTANT LESSON:

Never forecast.  Focus on enhancing your probability of success! another reason I wanted to feature this stock is to show you that even the best IPOs will be buffeted by strong general market forces.  This once promising NeuStar IPO was issued at an inopportune time! Take a look at the monthly chart and you will understand why.

The Opportunity

NeuStar initiated it’s recent run on June 18th of 2012.  It did not formally become a momentum stock until it broke the 12 month resistance level of $36.02 on September 4th of 2012. Share prices rose quickly for 4 days following penetration of this major resistance level. The stock price has consolidated now for just over two weeks.  A natural buy point will be at the resistance line over the last week of 40.53. In technical terms this stock is just starting a momentum run (if share prices continue upward).

The Danger

The danger with any momentum stock is that large shareholders might sell out at any time.  The largest shareholders are institutional funds. You can track this by tracking the ACC/DIS ranking at Investors.com. ACC/DIS today is A+.  Check once a week and watch to see if it drops.  A drop from A to B is a major shift. You can set up a weekly Google calendar alert to check the ACC/DIS ranking.  Watch it like a hawk for downgrades.

Money Management

Don’t risk over 5% (or a more conservative 1% )of your portfolio on NeuStar.  Always save a fifth of your after-tax annual income for investing toward your retirement. At $39.90 NeuStar (NSR) stock requires an investment of $3,990 for 100 shares disregarding the commission you pay.  A deep in the money option such as the 35 Jan call has a theoretical value of $5.60 per share with a delta of 82%. Stock options control 100 shares.  So this call has a speculative cost of 100 x $5.60 = $560.  That is $3,990 ÷ $560 = 14% of the cost of owning the shares outright. With a January expiration the option trader has just over 3 months for the market to continue to work upward.  Options traders have to be (1) quicker to exit than stock investors and (2) have to use mental stops due to the less liquid nature of options.

Stops and Mental Stops

Look at the daily chart for NeuStar.  Notice that the prior consolidation base has support (the lower level of the consolidation channel) at $37.11.  With the market trading at $39.90 that is a ($39.90 – $37.11 ÷ $37.11) = 7.5% initial risk (stop). This is a good stop level for outright owners of this stock.  This stop is based on the fact that a strong momentum stock should not fall below the support of the preceding consolidation base. A logical mental stop for NeuStar (NSR) options is the upper resistance of the prior consolidation base at $37.74. This is a ($39.9 – $37.74) x 0.82 delta = 2.16 x x 0.82 delta = $1.77 initial risk per option. Gains can be calculated as multiples of this initial risk.  If the option premium appreciates to $5.60 + $1.77 = $7.37 the stock option trader has enjoyed a 1R gain.  If the price advances to $9.14 the trader has garnered a 2R gain and so on. Note:  I am fixing delta as a constant rather than the non-linear continuous function that is.  The error from this assumption is minimal.  It dramatically eases calculations of initial risk (R). This translates into a $1.77 ÷ $5.60 = 31.61% initial risk of option margin. Notice that the leverage of an option is a two edge sword.  A stock option enhances your return by reducing your initial investment. But that simultaneously multiplies the loss of any mental stop as compared to an outright stock position with a mechanical stop at the same price level. If NeuStar rises into a new higher consolidation base move your stops to $39.25.  This is the support of the current consolidation base.

-Dr. Scott Brown

P.S. If you don’t play you can’t win.  If you lose everything you can’t play.  🙂

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