Late-Stage Bases

Investor's Corner, Monday, November 27, 2000

Late-Stage Bases Carry Higher Risk Of Failure

By David Saito-Chung, Investor's Business Daily

You can get a good idea how far your car can go just by glancing at the fuel-level gauge. Do the same with a winning stock by looking at its chart.

Before hopping in, check how many bases a stock has formed. If a great stock has logged one or two bases, it may have lots of mileage left for gains.

But a stock with three or four bases could be running on empty. A larger number of bases raises the risk of serious failure.

Few stocks have the specs to build four bases during a bull market. Many Internet service provider and software stocks that took off in 1999 and early 2000 went up so fast they flamed out in huge climax runs after only their first or second base.

Counting bases can be tricky. Don't count a 15%-20% decline as a base if it lasts six weeks or less. It could be a normal pullback or part of a larger structure, such as a base on top of a base.

You can reset the base count after a great stock has gone through a deep correction. America Online rose from 9 to 71 during an 18-month rally from November 1994, then got pounded back 68% to a low of 22 3/8. The company digested those losses and started a massive new rally as profit regained its footing.

The best stocks tend to launch rallies with little fanfare. They form a firm first base in a bear market while most stocks are getting clawed. Then they break out to new highs right when the market turns higher but most investors are still nursing their wounds or aren't willing to go back in.

By the time a top dog has carved its third or fourth base, the company's name pops up on cable TV, at the gym and on magazine covers. That's a bad sign. If every investor has picked up shares, the stock lacks new buyers to drive its price higher. Instead of rising further, it begins a steep fall.

Yahoo rose more than 10,000% from its April 1996 IPO to its peak in March. While the Web portal built its first base, 66 magazine articles containing the words "Yahoo," "stock" and "leader" were published during the 12 months following its debut, according to Nexis.com. That number ballooned to 454 articles in the 12 months from April 1999 to March 2000, during which period the stock worked on its fifth base. Newspaper articles citing Yahoo numbered in the thousands. Yahoo never finished its fifth base in March, and has since collapsed.

Late-stage breakouts tend to reveal weaker price and volume action. Buyers hoisted Nortel Networks out of a three-month base in mid-June, its fifth major base since 1995. The stock gained 39% by July, but ran out of gas. On Oct. 25, Nortel tumbled 29% after the firm reported slower-than-expected sales of optical networking gear.

On its breakout, volume in the week ended June 16 grew sharply from the previous week (Point 1 in accompanying image.) But it paled vs. that of other weeks inside the base (Point 2.) That suggests institutions were unloading shares.
Institutions acted more bullish in late 1995, when Nortel broke out of its first base. Volume exploded in the week ended Dec. 1 as the stock closed at its highest level in 2 1/2 years (Point 3.)

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