Why Late Stage Bases Are Danger Signs

12/19/2012 6:00 am EST

Focus: STOCKS

William O’Neil said that as a stock runs up, it is likely to form successive bases, but in the fourth or later stages, stocks start to run out of gas, so avoid those stocks, writes Ken Shreve.

The bull market that started in March 2009 has yielded several big winners. Be careful, though, because many growth names are forming late-stage bases after massive price gains. Names like Mastercard (MA) and Ulta Beauty (ULTA) come to mind.

Why are late-stage bases riskier than early-stage bases? After a stock breaks out from a series of bases, or consolidation areas, its growth story is already known. In many cases, it’s too late to buy. Late-stage bases should generally be avoided because in most cases, the big money has already been made. Apple (AAPL) tried to break out from a late-stage base in August and didn’t get far. Institutional investors have been dumping the stock since early October.

Some growth names currently might look like late-stage bases, but they’re not because they reset their base counts. What does a base reset look like? It’s not hard to recognize. It happens when sellers come into a stock in spades. The stock pulls back sharply, and the ultimate low of the pullback undercuts the low of a prior base. The thinking is that when enough sellers get shaken out of a stock, it paves the way for a new uptrend.

Since the start of the bull market, shares of Netsuite (N) have gained nearly 500%, but it reset its base count in October 2011. Shares hit an intraday low of $25.32, undercutting the low of a prior base that formed earlier in the year. The new base that formed yielded a fresh, first-stage breakout in December. A second-stage breakout followed earlier this year in July.

chart
Click to Enlarge

The stock is currently working on the right side of a third-stage base. Headed into today, it had climbed to within 4% of a 52-week high. Last week was bullish accumulation week for the stock. Shares popped 8.2% on volume of 3.4 million shares. In a normal week, Netsuite trades about 2.3 million shares. It’s always good to see institutional buying when a stock starts to re-test a prior high. Netsuite showed it last week.

The company is a provider of on-demand customer relationship management (CRM) and enterprise resource planning (ERP) software. It shows consistent bottom-line and top-line growth in recent quarters and strong growth is expected to continue as demand remains strong for the company’s products and services. Full-year profit is seen rising 60% this year to $0.24 a share and 33% in 2013 to $0.32 a share.

By Ken Shreve, Contributor, ExplosiveOptions.net

Related Articles on STOCKS