RealMoney Silver - How to Play a Market That Isn't Going Your Way

How to Play a Market That Isn't Going Your Way
By Bill Trent
RealMoney.com Contributor
6/10/2008 10:02 AM EDT

I think the recent run-up in stocks was a bear market rally, in part because the screens and models I use to generate stock ideas aren't giving me much. I usually want a stock to score highly in four out of five categories before giving it much consideration: earnings momentum, earnings quality, price momentum, free cash flow and return potential.

This week, only three stocks went four for five, and I've talked about them all before: W&T Offshore (WTI) , Pitney Bowes (PBI) and Rent-a-Center (RCII) . As I look for new investment ideas, I'm left with three options, each of which has significant drawbacks.

Go short
Change strategy
Stay on the sidelines

I seldom short stocks, but I'll probably try to scratch out some extra gains by writing covered calls on stocks like Ansys (ANSS) that I like long-term, but that look a little stretched in the near term. I also will likely leave a little cash standing by to put to work when conditions are more favorable.

But like many investors, I generally plan to stay long and close to fully invested. In markets like this one, that means shifting gears a little bit.

Let Your Winners Ride

There's always a bull market somewhere, and all it takes to participate is to buy what is working. This can mean averaging up into existing holdings or checking the momentum leaders for new ideas. If they don't quite fit into my strategy, sometimes they don't miss by much. It can be worthwhile to loosen the criteria a bit to get some new names.

W&T Offshore is up 19.5% since I wrote about it barely a month ago. The super spike in oil suggests this could continue. Since WTI still fits my primary strategy, this isn't exactly a change in process, but it requires sucking it up and paying more if necessary.

Go Deep

My next plan would be to go deep. Value, that is. If I can't have a stock I am confident will rise, I want to have some degree of confidence that it won't fall too much. In my case, I usually look at the free cash-flow yield.

NutriSystem (NTRI) , Tempur-Pedic (TPX) and Pitney Bowes are all yielding north of 10% free cash flow to market cap. They all have lots of hair, but also seem to be holding on to their current values. I'm not a technical analyst by trade, but when a stock holds on to values near its low for an extended period, it looks like a bottom to me.

Speculate

The last thing I do is look to sources like StockPickr's stocks with unusual option volume to find a few speculative ideas to consider just for a short-term trade.

ADC Telecommunications (ADCT) is trading at $17.50, yet the January 2009 25's are trading high volume. Is a deal in the cards? Cognizant (CTSH) options sent a similar signal last week. I'm afraid of Cognizant, but ADC has at least been experiencing positive earnings momentum. It may be worth a look.

Obviously these ideas aren't for everyone, but sometimes staying in the game means going outside your comfort zone. They key is then to get comfortable with the risks associated with the new plan ... and watching your holdings like a hawk.