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The One Simple Measure to Identify Outperformers

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“Life is really simple, but men insist on making it complicated.” – Confucius

If you want to beat the market, you have to own stocks that are outperforming the market. It really is that simple, but many investors insist on complicating the process. There are hundreds of indicators available to help pick stocks. But in my experience, the more complicated a strategy is, the less likely it will work in the future.

A strategy that is easy to learn and has a history of profitability is much more likely to work in actual investing than an overly complicated approach. The more complex an indicator is, the more difficult it is to use and the higher the probability that an error will occur. My motto in investing, as well as in life, is simple is better.

One of the most useful measures to help investors identify leading stocks and funds in any market environment is relative strength. This technical analysis tool assists us in gauging how an investment has performed relative to the market or another relevant benchmark. For example, we could use relative strength to detect stocks that have outperformed the Nasdaq so far this year.

This convenient measure is not to be confused with the relative strength index (RSI), which technical analysts use to generate overbought and oversold conditions. Investors using relative strength tend to assume that the trend of outperformance will continue into the future. Let’s take a look at an example of how we can use this simple indicator to identify a stock that is widely outperforming the market.

Richardson Electronics, Ltd. (RELL - Free Report)

Richardson Electronics is an electronic component provider of power and microwave technologies and customized display solutions. RELL is a global powerhouse whose products are used to control, switch, or amplify electrical power signals, as well as to display devices used in alternative energy, medical, aviation, military, and semiconductor markets. The company also manufactures and distributes products for the healthcare sector such as imaging replacement parts for CT and MRI systems. Richardson Electronics was founded in 1947 and is based in LaFox, IL.

Take a look at RELL’s relative performance versus the Nasdaq year-to-date. We can see that the stock has been steadily outperforming other technology companies and has been making a series of higher highs:

StockCharts
Image Source: StockCharts

The stock has returned investors north of 95% over the past year, while the Nasdaq has fallen over 20%:

StockCharts
Image Source: StockCharts

It’s easy to see the power behind using relative strength to identify leading stocks. Adding to the bullish case is the fact that RELL is a component of the Zacks Electronics – Parts Distribution industry, which currently ranks in the top 2% out of approximately 250 industries.

Quantitative research studies suggest that approximately half of a stock’s price appreciation is due to its industry group. By focusing on stocks that are showing relative strength in leading industries, we can dramatically improve our odds of success. Also note the favorable characteristics for this industry below:

Zacks Investment Research
Image Source: Zacks Investment Research

RELL is set to report fiscal Q4 earnings on July 20th. Analysts are expecting continued momentum, with the Zacks Consensus Estimate standing at $0.21 per share – a 50% growth rate relative to the same quarter in the prior year.

Make sure to include relative strength in your process to help uncover leading stocks like RELL.


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