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Speculating With The 10-Bagger

02/12/08 01:03:37 PM PST
by Thomas Maskell

Neither fundamentals nor technicals quite did the job with the 10-bagger. Will speculation do the trick?

The fundamental approach to 10-baggers failed to anticipate their launch. Technical analysis identified the launch but could not distinguish it from a false start without a confirmation regimen that significantly eroded trading profits. This leaves us with just one remaining approach for 10-baggers -- speculation. Given that 10-baggers tend to move six to 12 months prior to a change in their fundamentals, it is reasonable to assume these movements are caused by speculators. But who are these speculators and what can we learn from them?

There are three kinds of speculators: extrapolators, visionaries, and gamblers. Extrapolation is the act of projecting history into the future; therefore, the extrapolator must be a student of history. In that respect, they are similar to growth investors except they make their extrapolations without the benefit of historical growth. They act on historical events that they believe will lead to growth. For instance, they buy gold stocks during a recession because, historically, gold stocks rise during a recession regardless of the actual revenue growth in the gold industry.

Visionaries make their decision without the benefit of history. They go where no man has gone before. They are innovators or at least able to recognize innovation when they see it. They may not create the invention, but they realize its potential and are willing to bet on its success. They are the buyers behind the bubble, the false start and, in some cases, the early stages of the 10-bagger.

The gambler plays the odds. They know they shouldn't buy the tip, chase the fad, or trust the boiler room, but they do. To the extent that they play this fool's game, they know that the only real fool is the last fool. Their goal is to be first and not last. The gambler and the trader share many traits, but technical analysis is not one of them. The true gambler lacks a system. Figure 1 illustrates the relationship between speculators, investors, and traders.

FIGURE 1: STOCK MARKET PLAYERS. There are three kinds of players: extrapolators, visionaries, and gamblers. Here you see the relationship between all three.

There are only three types of stocks in the market: trackers, laggards, and leaders. In a truly rational stock market, all stocks would be trackers. Unfortunately, the market isn't that rational. In fact, it is rather irrational, which creates gaps between the value of a company and the price of its stock. When the price outpaces the value, it is called a leader. When the value outpaces the price, it is a laggard. Figure 2 graphically illustrates these stock types.

FIGURE 2: TYPES OF STOCKS. There are three types of stocks in the markets: trackers, laggards, and leaders.

In our search for the 10-bagger, we discovered that most 10-baggers begin as leaders. This precluded fundamental analysis as a predictive tool. Had 10-baggers been laggards, fundamental analysis would have identified them as stocks ready to take off. There would be cause (an undervaluation) and effect (a price correction). In fundamentalist terms, they would be value plays. But in our study, we discovered that most 10-baggers are growth plays, not value plays, because the high growth rate of the company (after their initial price move) turns them from leaders, which are not attractive to fundamentalists, into trackers. Figure 3 illustrates the transitional nature of the 10-bagger.

FIGURE 3: THE TRANSITIONAL NATURE OF THE 10-BAGGER. Most 10-baggers begin as leaders, but transition into trackers.

But how did they become leaders? The answer is speculation. (It certainly isn't trading, since traders are inherent trackers.) Speculators buy stocks based on their gut-feel, insider information, strategic clues, tips, or extrapolations. Which of these reasons fit our 10-baggers? That is difficult to determine with any statistical accuracy without historical data mining. But we can show some anecdotal evidence that suggests that strategic clues play an important role in the speculators' decision to buy a 10-bagger.

Strategic clues are actions that the company takes or events that occur in its environment that point to an upside potential. The actions might be the issuance of a patent, the entrance into a new market, or the launch of a new product. The environmental events could be the increase in demand for the company's products caused by war, nature, or demographics. What makes these clues strategic is that they are reported prior to the stock's launch. If they are unreported, they are insider information. If they are unsupported by post-launch fundamentals, they are simple tips or gut-feel. Since insider trading is illegal and gut-feel indefinable, I will restrict my discussion to those strategic clues that were reported and ultimately affected the company's fundamentals and its stock price.

A good example of an action-driven speculative play is Ampex (AMPX). Ampex is basically a patent holder. They hold hundreds of patents relating to digital photography. They produce nothing -- no chips, no cameras, no video equipment. The key to their success is getting producers to pay up. That often requires a trip to the courtroom.

FIGURE 4: STOCK CHART FOR AMPEX (AMPX). Here you see what happened to the stock after a significant press release. Note the breakouts that took place coincidental with the releases.

Figure 4 illustrates the stock chart for AMPX along with a series of press releases and their dates. The content of the releases are summarized:

1 June 2003: Announces video agreement. Reverse stock split 1:20
2 November 2003: Delisted from AMEX
3 May 2004: License hard disk video; sues Sanyo over still-camera patent
4 July 2004: Sues Sony
5 October 2004: Licenses Sanyo and Canon; sues Kodak
6 November 2004: Settles with Sony
7 December 2004: Announces early debt retirement.

At the same time these press releases were occurring, the stock experienced several breakouts. The most notable breakouts occurred on May 2003, June 2004, and October 2004. Let's compare these to the press releases.

The May 2003 breakout occurred just prior to the June 2003 reverse stock split and the announcement of a video agreement. Since the split was probably known prior to its occurrence, the May breakout was probably in response. The announced video agreement was icing on the cake.

However, these two occurrences point out two important characteristics of Ampex. First, the video agreement suggests that there are valid and potentially profitable patents in their portfolio. Second, the reverse split illustrates a willingness of the company to defend its stock price. This second characteristic should not be underestimated, since many companies don't care about their stock price. In this regard, the reverse split is very instructive.

A reverse split has two sides to it. It first allows the company to meet the price requirements of a prestigious exchange listing. Unfortunately for Ampex, their split failed in that regard (see the press release of November 2003). Second, it makes the stock more tradable. Just prior to the split, AMPX was trading at $0.05 a share, too low of a price to bring traders to the post. Without traders, the stock would be very sluggish and sporadic.

The rest of the press releases and breakouts are fairly self-explanatory. As Ampex continued to sue and settle with other camera makers (Sanyo, Sony, Canon, and Kodak), it became clear that their patents were valid. Any time between May 2004 and October 2004 would have been a good speculative buy point. By then it was clear that Ampex was winning its court cases, and there would be an increased royalty stream in their future as more camera makers fell in line.

On the environmental side is Force Protection (FRPT). At the end of 2005, the stock was selling at $1.40 a share (see Figure 5), and a visit to their website revealed a company that made armored bomb-disposal vehicles. Given the threat of terrorism at home and the nature of the Iraq war, the demand for bomb disposal vehicles should rise. At the same time, Force Protection was responding to military requests for a bomb defense vehicle.

FIGURE 5: FORCE PROTECTION. A speculator buying the stock at the end of 2005 would have bought into an 18-month 20-bagger. Certainly the market environment was there, but what was not known was whether FRPT would be profitable. But the unknown is the speculator's forte.

This points out another aspect of speculation -- being in the right place at the right time with the right contacts. The military saw a need for bomb-resistant vehicles, and FRPT was making bomb-disposal vehicles for them. The company was a logical source to retrofit old vehicles as well as design an entirely new vehicle. The environment, the contacts, and the experience combined to create explosive growth (no pun intended) in both the company and its stock.

While the big stock move occurred after a significant fundamental confirmation in sales growth, the speculative nature of the stock is still apparent. Even though the company was growing sales at a brisk pace, prior to the move, they demonstrated no ability to translate those sales into profits. In fact, gross margins went negative in 2004 and barely turned positive in 2005. They didn't achieve an annual net profit until February 2007. By then the stock had already achieved 10-bag status. This does not preclude quarterly hints of profitability, but it does illustrate, even with those quarterly premonitions, that speculation requires a leap of faith, and that takes a special kind of player.

A speculator buying the stock at the end of 2005, before the fourth quarter and year-end financials were reported, would have bought into a 18-month 20-bagger. Certainly the market environment was there. The big unknown was whether FRPT could translate that opportunity into profits and a rising stock price. But the big unknown is the speculator's forte.

Speculation is not a function of the stock charts or the financial reports. It's all about the market place, the trends, the positioning of companies, and the vision of the players. Many of these elements can be found in company news releases, media articles, and management statements to interviewers. But much of it is in the speculator. They need to be in tune with the times, the trends, and the markets. If they don't see it, it doesn't matter that it is there.

Over the past several articles we have looked at 10-baggers from three different perspectives: investing, trading, and speculation. No one perspective clearly predicts the 10-bagger with a high degree of effectiveness and efficiency. However, before we allow these shortcomings to dampen our enthusiasm for the quest, let's combine some elements of all three approaches in order to create a comprehensive selection strategy.

Of course, we can't do that now. It will have to wait until next time.

Maskell, Thomas [2006]. "The Search For The 10-Bagger Begins,", March 23.
_____ [2006]. "The Anatomy Of The 10-Bagger,", September 5.
_____ [2007]. "Search For The 10-Bagger Fundamentals,", July 3.
_____ [2007]. "Trading The 10-Bagger,", December 4.

Thomas Maskell

Thomas Maskell is a frequent S&C contributor whose recent book, The Complete Guide to Investing During Retirement, provides an excellent primer on investing, trading and speculation in the stock market. It is available nationwide. To comment on this article or his book, contact him at or visit his blog at

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