Top Picks from a Coolcat Strategy

Using a market timing and momentum strategy, Kevin Kennedy has earned the newsletter industry's second best performance record over the past 15 years; here, the editor of Coolcat Explosive Small Cap Growth Stock Report explains his strategy and highlights a number of recent additions to his portfolios.

Steve Halpern: Joining us today is Kevin Kennedy, editor of the Coolcat Explosive Small Cap Growth Stock Report. How are you doing, Kevin?

Kevin Kennedy: I'm doing fine, Steve.

Steve Halpern: Well, thank you for joining us. According to the rankings from the Hulbert Financial Digest, your model portfolio was the Number Two Best Performer over the past 15 years, with an overall gain of 557%. To generate those returns, you follow a strategy that you call the Three Ms. If you don't mind, let's walk through those—and the first M is market timing. Could you explain?

Kevin Kennedy: Sure, well, you know, most stocks obviously are going to attract the market. As a matter of fact, research shows that about half the gain of a stock is more or less attributed to the market action.

So, you don't really see stocks making a lot of progress unless the market's going up and so, basically, you want to look at some of the leading indexes. I follow the Nasdaq very closely and that's been very strong in the last year and that's why there's a lot of stocks that have been doing well in the last year.

Now, when, obviously, you see a period like 2001, 2002, 2008 and 09, stocks are going the other way, so you can't really emphasize how important it is to be in tune with the market.

Steve Halpern: Now the second M in your strategy is momentum. Could you expand on that?

Kevin Kennedy: Sure, and, as I indicated, you need a strong market. In a strong market, typically, the strongest stocks are going to rise about twice as fast as their weaker brethren.

Basically, what you're looking for is stocks that go up and they have something new in the stock—there's some earnings news or analysts are jumping on board—they've got some new products.

But bottom line, you're seeing price gains, you're seeing their relative price strength, over the last six months, rise.

And typically, what I like to find is stocks that have been heading downwards and then righted the ship a little bit and, all of a sudden, are seeing some big volume coming into the stock, some new highs. Obviously, a trend going upward.

Steve Halpern: Your third M stands for money management. Could you explain how that's involved?

Kevin Kennedy: Sure, so, you want to be in sync with the market, then you want to identify the right type of stocks, so then, the remaining piece of the puzzle is when do you buy them and when do you sell them.

So, I, basically, use some approaches. I, typically, am trying to buy these stocks as they're just breaking out to new highs or when they make that first pullback.

Technically, when a stock's going up you're going to see the 50-day moving average cross over the 200-day average and, typically, what you see in a lot of these stocks is they'll make a nice move forward, and then they've got to pull back a little bit, kind of re-gather their strength, so to speak.

So they'll, typically, pull back below that 50-day moving average. They'll typically be down for a month, or so, and they'll look kind of like a bad stock, so to speak, in that they've lost their momentum.

But as long as they're pulling back on reasonably lighter volume than the high volume that made them break out in the first place, then that's a natural thing.

If you look at the 20 winners—the 20 or 50 best stocks—over the last year, and you look at their charts, you're going to see a lot of these type of pullbacks and they turned out be really good buying opportunities.

In any case, no matter what kind of stock criteria you pick, you're going to have some losing stocks—so you've got to use stops and you've got to take some gains along the way.

You don't want to be too picky. If a stock doubles, we like to take a little bit off the table. Let's sell as that stock continues to advance, particularly when it's kind of showing some signs of peaking. And raise trailing stops behind your winners.

Again, some of those stocks aren't going to work out so you've got to have a plan. You've got to have some stops on the downside, you've got to take some losses while they're still small.

Steve Halpern: Let's look at this three-step approach in terms of some specific stocks. One new position in your portfolio is Fuel Tech (FTEK). What's the attraction there?

Kevin Kennedy: Well, Fuel Tech is an air pollution control provider. They develop tech for that and they really showed a big jump, particularly in November and December, right after they reported revenues.

This is a profitable company; in their third-quarter report, their earnings tripled to 15 cents a share and they had a 35% jump in revenues, so it really spiked the stock.

It doubled in a little bit more than a month. It peaked a little bit above $9.50 in December, but has since pulled back about 34%, so that's, again, kind of a spot I try to find new stocks.

They're going to report on March 10, so it looks like their earnings are basically improving in that story. Every stock has, basically, some story that's driving it for the investors to jump in.

Steve Halpern: You've also recommended a company called Crossroads Systems (CRDS). Has that shown the same pattern of moving up and then showing a pullback?

Kevin Kennedy: Yes, Crossroads has been one that, if you look back two or three years, it's been in a persistent downtrend. It was over $6.00 and then actually hit bottom at 69 cents in October, but since then, it's been on a big uptrend.

And, basically, that's coincided with—there's a former Soros Hedge Fund manager who's a director of the company, Jeff Eberwein, and since, between October and December, he bought more than 900,000 shares of this company.

This is a stock that has a trading flow of about eight million shares—it's a smaller company, with $13 million dollars in sales.

They do data archive solutions and they're not profitable, but they've got a lot of lawsuits out there against the likes of Cisco, and Dell, and Oracle. Patent infringement lawsuits; so it kind of gives them another wild card, along with, obviously, Eberwein's interest.

Again, this is a stock that raced up from, as I said, 69 cents, up to $3.45 in mid-January, but since, pulled back below $2.50, so, again, and below a 50-day moving average on trailing volume. So it looks like a good set-up.

Steve Halpern: Now, before you go, is there a third name that you might want to suggest for our listeners to look at?

Kevin Kennedy: Actually, I do publish three other newsletters that focus on other areas, such as ETFs, so I got a few names that I'll just, kind of, throw out here a la carte, so to speak.

In the ETF space, iPath-Coffee (JO) made a big move recently; but, again, it's coming off of a fairly long-term downtrend.

But, in the last couple months, it's just started to breakout. There's a lot of concern there about the drought in Brazil and coffee prices going through the roof. I don't see rain coming right away to solve that problem.

In the tech area, F5 Networks (FFIV) is a Nasdaq 100 company. Earnings are expected to rise 71% next year.

And then another beaten down sector—there's a small-cap and a large-cap play—is shipping. The small-cap play is Frontline (FRO). They're still losing money like a lot of these shipping firms. They're more of a tanker firm but they're, again, starting to show signs of strength, but they've pulled back here, recently.

The second shipping name is a little bit more of a large-cap name or, at least, a mid-cap name. It's DryShips (DRYS). Again, another stock that, in its heyday, was trading over $100, now it's like in the $3.50 range, but it's coming off its lows.

It's probably about double its low and they're, actually, supposed to be profitable next year, earning 64 cents a share, so it's an interesting situation.

Steve Halpern: Well, we really appreciate you taking the time and sharing your insights today. Thanks for joining us.

Kevin Kennedy: Thank you, Steve.

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