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A trade like this one comes along too infrequently. The chart shows Conseco (CNO) on the monthly, logarithmic, scale. In some of my charts, when I discuss the target price, I have highlighted overhead resistance like the red line on this chart. The flat base makes for a tempting price target.

In this case, the relatively horizontal price structure has lasted for years, from 2003 to 2007, before price broke down. To me, that suggests the fair value of the stock should be at or above that line, or somewhere in the range of 17 to 25.

Reversion to the Mean

All of this implies that price will rise back up to that level. It is a concept I call reversion to the mean and it is borrowed from the math department. The idea behind reversion (or regression) to the mean is that prices way out of normal will eventually return to the pack. They will revert back to their average value. My recent buying is using that concept to find price targets for long term (2-3 years) ownership. During that hold time, I expect all of the stocks I buy to double or triple. If a stock shows less than a potential triple, I often throw it back into the market pond.

So, that is how I got my price target. I also know that the year after a bear market, price tends to recover dramatically (based on research using fundamental analysis). In the first year after the 2000 to 2003 bear market ended, price climbed 25% in the stocks I studied. A year after that, price continued moving up, but at a much slower rate. I am not saying that price will climb 25% this year. I am saying that the year after a bear market ends is when you will see a strong move up, just like we are seeing now.

Why Buy Now?

Why buy the stock and why this one? On my fishing expedition, I first noticed the overhead price target well above where the stock was trading, so I decided to take a closer look at the company. The research reports said the news was not good. S&P wrote in a report dated April 3, Our risk assessment for Conseco reflects the potential for the company to file for bankruptcy protection. In addition, our assessment takes into account CNO's weak capital position, the potential for further investment losses, and volatility in earnings. We also see risk associated with ongoing litigation and restrictive covenants. Scary stuff, all.

On the plus side was the insider buying. On April 2 and 3, insiders bought stock 14 times with additional buying stretching back into 2008. None were selling until as far back as October 10, 2008 when one insider sold 1,466 shares. Even as price dropped, insiders were buying and the heavy buys (200k, 25k, 20, 14.3k and 10k shares) happened in April 2009. That tells me the risk of bankruptcy is possible but overblown.

From a fundamental analysis perspective, the ratios were right were you want them to be: at the lower end of the 3 year channel for price to earnings, price to cash flow, price to book value and price to sales. On a value basis, assuming the fundamentals were still valid, the company was cheap. Of course, the fundamentals use historical data and anything can change in the back office kitchen, depending on how they cook the books.

I started looking at the stock on April 5 and noted that earnings would come out on May 4 according to yahoo!finance. That was outside the 3 week zone in which I will not buy a stock for fear of price tumbling.

Here is the criteria I used to find this stock.

  • Price shows a flat ceiling for years
  • Long-term price target ($17 - $25) is well above the current price ($1.64)
  • Fundamentals at or near low end of 3 to 5 year range (price to earnings, cash flow, book value, and sales)
  • Quarterly earnings announcement is more than 3 weeks away
  • Headline search and research reports turn up nothing scary about the company
  • Insiders are buying large amounts with little or no sales
  • The stock is cheap and represents good value

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The Buy

When price climbed out of a congestion zone, I bought and received a fill at $1.64. I forgot about the earnings report. My intent was to hold the stock for the long term, to see it climb from 1.64 to 17 or even 25.

Each day price seemed to climb but I did not focus on it. If the stock market did well (which I expect), then the stock would also. Why? Because insurance companies take their outrageous premiums they charge you and me and invest it in the stock market. If their investments rise, the worth of the company rises and the stock should follow.

When I looked at CNO this morning (Monday). It did not dawn on me that the stock had gapped up 45% (from yesterday's close of 2.69 to a high so far of 3.90). Then I went searching for the reason for the gap. Earnings. The company announced earnings this morning, something that I forgot about. Fortunately, they were better than the market expected.

The Sale

Knowing that I bought the stock at $1.64 and it was now at 3.50 and dropping, I decided to pocket my winnings. I sold it and received a fill at $3.47.

What happens to the stock in the coming days is anyone's guess. I think it will make a higher high tomorrow (Tuesday) and perhaps coast higher before rounding down. I consider this an inverted dead cat bounce.

I will say that I am not pleased with this trade. I gave up too much money (from the 3.90 high). I was worried about another trade that went bad, and that still colors my perception of this one. I also missed the earnings announcement, meaning that I bought just a few days before the announcement, despite having a checklist to prevent such mistakes. Of course, if I had followed my checklist, I would not have bought the stock.

Here are my reasons for the sale.

  • The likelihood of price dropping exceeds the upside short-term potential
  • I doubled my money in 6 days! Yippee!

I made about 110% on the stock in 6 days. Annualized, that is a return of almost 6,800%. That highlights the fallacy of annualizing returns, but wouldn't it be nice to see that kind of return every week?

-- Thomas Bulkowski