Stock Selection: Institutional Quality vs. Speculative Stocks
“Never confuse brains with a bull market.”
Roughly 75% of all stocks follow the general direction of the major market indices such as the Nasdaq 100 ETF (QQQ) or the S&P 500 Index ETF (SPY). As such, more stocks rise in a bull market, especially a robust one like the one investors enjoy currently. However, a bull market results in excesses and can cause laziness among investors. Stocks that generally wouldn’t perform well can spike rapidly on rumors or gossip.
This phenomenon occurs to different degrees; however, the internet bubble is the poster child for this type of market. In the heat of the internet boom, it was not uncommon for profitless, pre-revenue companies to double or triple in a few days, just because they had a “.com” in their name.
Because these speculative retail stocks cause the most pain on the way down and are less sustainable, you want to limit yourself to investments in institutional quality, and true market leading stocks and speculate or trade everything else. Below, I will unveil five ways to tell the difference between quality stocks and speculative stocks:
Key Differences
Liquidity and Institutional Sponsorship
Liquidity and institutional sponsorship are the easiest ways to parse the difference between quality and non-quality stocks. Quality stocks have deep liquidity and have investors such as Stan Druckenmiller or Fidelity within their ranks. I prefer to look for stocks that trade a minimum of one million shares per day (assuming the stock is $20, the stock trades a minimum of $20 million in dollar value per day.) You can also scan 13F reports or institutional data to ensure some big names have an interest in the stock. Below are legendary investor Paul Tudor Jones’s holdings as an example:
Image Source: Zacks Investment Research
Institutional investors are important because their research teams conduct extensive due diligence, are the main drivers of stocks due to their deep pockets, and support stocks when bad news hits.
Conversely, speculative names can fall fast due to a lack of liquidity and sponsorship.
Profitability EPS Growth vs No Profit
Underlying fundamentals and strong earnings growth drive stocks in the long term. It is likely a speculative name if your stock is unprofitable and lacks growth. Chip-leader Nvidia’s (NVDA) growth history is a perfect example of what you want to see in an institutional quality stock.
Image Source: Zacks Investment Research
Low Beta vs High Beta
The best investors trade in a “boring” fashion. Instead of looking for volatile, news-driven stocks, savvy investors focus on limiting risk and riding long-term trends. Beta can help you find smooth trading, low volatility stocks such as IBM (IBM). A beta of 1 means the stock trades in line with the S&P 500 Index. Institutional quality stocks tend have low beta (beta close to 1), which means they are less volatile and thus, are easier to hold, all else equal.
Image Source: Zacks Investment Research
Relative Strength: First Movers in a Bull Market Junk floats to the top
As the name implies, “true market leaders” tend to lead. Super Micro Computer (SMCI) is a great example. In late 2022, the stock exhibited standout relative strength by hitting new all-time highs while the S&P 500 Index was printing lows.
Image Source: Zacks Investment Research
Meanwhile, lower-quality stocks, or what I call “junk off the bottom,” tend to appear when the bull market is already mature.
Bottom Line
Sticking to institutional quality stocks keeps savvy investors out of trouble. In bull markets, investors must understand the difference between speculative stocks and quality stocks.
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International Business Machines Corporation (IBM) : Free Stock Analysis Report
NVIDIA Corporation (NVDA) : Free Stock Analysis Report
Invesco QQQ (QQQ): ETF Research Reports
SPDR S&P 500 ETF (SPY): ETF Research Reports
Super Micro Computer, Inc. (SMCI) : Free Stock Analysis Report
