The Sexy Secret Behind Run-Up in Frederick’s Stock
Take it from Frederick’s of Hollywood: Don’t fight the tape!
Shares of the Los Angeles-based lingerie retailer started the year at $11. By mid-March, the price was $17.
Now, you’ll pay $25.25 a share to become an owner of Frederick’s. That’s a rise of 130% in a little over three months--more than 10 times the gain of the average stock in the Dow Jones industrial index.
All of this for a stock that doesn’t enjoy the serious attention of more than one Wall Street analyst--and even he doesn’t write reports on the company.
Frederick’s is a great example of a “momentum” stock. Many of the people buying the shares are doing so not because they love the retailer’s garters, negligees and teddies, but because something else is far sexier to them: The rocket-like direction of the stock on a chart.
To momentum market players, when a stock is going up with the force of Frederick’s, you simply get on board; revenue, earnings, dividends and other fundamental measures of value take a back seat, at least temporarily.
When the momentum players are in control, expectations of higher prices can become a self-fulfilling prophecy. That’s part of what makes a bull market. If you’re a long-term investor in a stock that has suddenly turned into a momentum issue, the smartest thing you can do is just go along for the ride and avoid selling too early.
Momentum players aren’t a new feature on Wall Street. They come and go with broad market trends. But their strategy of locating stocks that are in the early stages of big moves has become more accessible to more traders in recent years, given the advances in instant computerized stock-charting programs and the general expansion of financial media.
Relying on a stock’s price chart and its trading volume to signal a buying opportunity is, after all, less difficult than poring over balance sheets and income statements. “It’s just easier to be a chartist than a fundamental analyst,” notes Chris Pedersen, head of trading at Twenty-First Securities Corp. in New York.
Who are the momentum players? For the most part, “They’re not market-makers (brokerages) or the ‘Joe Doakes’ retail customer,” says Larry Rice, head of over-the-counter stock trading at Wedbush Morgan Securities in Los Angeles. Some are major institutional investors. But many are likely to be smaller traders, often “people who used to be in the brokerage business,” Rice says.
Now off on their own in boutique investment firms, or just managing their own money from a home computer, these players are in for the quick buck. They watch for stocks that are breaking out of extended dull trading patterns. And they learn to quickly assess the potential in surprise announcements--for example, a better-than-expected earnings report.
Indeed, though momentum stocks take on a life of their own once they are ascending rapidly, their initial moves often are based on some fundamental good news, or the expectation of good news.
In Frederick’s case, no Wall Street brokerage has published earnings expectations for the company. But when the stock was trading for $11 early in the year, that price was just 15 times the 75 cents a share Frederick’s earned in fiscal 1990--even though earnings have risen more than 35% annually each year since 1987. An astute trader could figure the stock deserved better.
On March 4, Frederick’s stock moved to the New York Stock Exchange from the much-smaller American Stock Exchange, drawing broader attention. And on March 27, the firm announced a 3-for-2 stock split. That seemingly innocuous announcement sent the price up $4.125 for the day, to $24.875. No longer was there any doubt that Frederick’s had become a momentum play.
Other stocks are moving just as dramatically with far less to support them than Frederick’s has. Carpinteria, Calif.-based Digital Sound Corp., a voice mail equipment maker whose sales plummeted last year, has seen its stock rocket to $2.50 now from $1 on March 26. Why? Digital says it doesn’t know. It appears that some traders believe that the firm’s first quarter will show a turnaround. But that’s just a rumor at this point.
To the momentum players, however, Digital is rising almost nonstop, and that’s all they need to know.
Twenty-First Securities’ Pedersen notes that the credo of the momentum players has been enunciated by famed trader George Soros: “I will follow the trend, even though I feel that the trend is wrong, until the falsehood is recognized.” Put another way, momentum trading is just the Greater Fool Theory--stay the course as long as there’s always someone else willing to pay more.
What halts momentum stocks? Ultimately, says Pedersen, the momentum players exit when trading volume begins to taper off, or a bad earnings surprise hits, or the stock chart simply shows signs of topping out. For a stock caught in the game, momentum can last a few days, a few weeks, or much longer--even years.
Long-term investors needn’t be flustered by the momentum players. They may quickly take your stock way up, and then way down, for little apparent reason. But if the fundamentals of the business are strong, your investment is likely to produce the same good return over the long haul with or without momentum players.
Hot for Frederick’s Frederick’s of Hollywood, the lingerie retailer , illustrtes what happens when “momentum” traders get hold of a stock: it runs straight up. Weekly close, except latest: Tues., close: $25.25 Stock now traders on NYSE.
