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The Importance of the Fed
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We on TV are often accused of spending too much time trying to guess and anticipate the Federal Reserve. Lots of the criticism of the press is on the mark, but the "too-much-Fed-watching" rap sure isn't. Under all the methods I care about—the GDP method, the sector earnings cycle method—the Fed can play a role, either to screw it all up or make it work.

You need to know when the Fed is going to act and which way it is going to move not only because it directly affects what the big boys are going to do, but also because interest rates can be just as important as earnings streams in trying to predict the next big gob of points on a stock.

Interest rates matter intensely when you are trying to anticipate big moves in stocks. They also matter as competition to stocks. When interest rates are high, people prefer bonds to stocks. When the cash rate, or the amount that you get to keep your money in a bank account, skyrockets because the Federal Reserve is tightening rates severely, that can kill even the best stocks. Think about what happened in 2001, when cash gave you a 6.5 percent return. That interest rate helped cause the great turn-of-the-century bear market. Rates matter as a cost of buying stocks; the lower the rates, the more speculative people tend to be because you can borrow money cheaply to buy stocks. Margin buying, using cheap money, fueled the destructive 1999 rally that led to the bear market. I can't stress how important "easy money" from the Fed was in creating the bubble that has since been pricked by none other than much higher Fed rates.

Interest rates are also a major component of what we will pay for future earnings, for the "growth of the enterprise we are investing in. Remember the process we use to find out what a stock should sell for in the future, as opposed to what it sells for now? First we figure out what a company can earn. That's the estimate portion of the price. Then we need to figure out what we will pay for those estimates—the price-to-earnings multiple. To calculate the multiple we take into account all sorts of considerations for the management, the earnings cycle, the macro economy, any political or economic risk. But what often tends to matter more than anything else is calculating the "dis­count" rate that we will pay for those earnings, something that is entirely dependent upon prevailing longer-term interest rates. I don't want to bore you with difficult nonarithmetic concerns here, but after we arrive at what we think the earnings will be in the future, and after we consider all the sector, macro, and micro issues that could affect those earnings, we then have to figure out what they are worth in the present to figure out what the price of the equity should be now. It is not enough to know what's in the future, we need to know how to relate that to a current value. We need to know what is called the "pres­ent value" of those earnings.

Present value analysis mystifies most people. They don't understand the discount mechanism of rates, and how rates help set the current value of assets. Yet we accept the discount premise intrinsically when it comes to our bank account. Let's use that example to drive home how interest rates help set the prices now for what we will pay in the future. If you are going to put $1 in the bank at a 2 percent rate per annum, you are going to get $ 1.02 a year later. That $ 1.02 a year later is worth only $1.00 now. That's another way of saying that the present value of $1.02 a year from now is $1.00. Same with earnings. Let's say we think Maytag could earn $5 in 2010. What's that worth now? How do we discount it back to the present? By using the same prevailing rate we would use for a bond. Stocks are considered "long-dated as­sets," meaning they are discounting the long-term earnings power of the companies underneath them. Just as we calculate how much $1.02 in the bank is worth today by using 2 percent per annum as a rate, we would look at comparable longer-term bond yields to assess what to pay now for those future earnings.

Normally, in a stable environment where there is low inflation, we would tend to want to pay a lot for those earnings. But at times when inflation is raging and bond prices are going down—yields going higher—we want to pay much less; we want to discount those future earnings at a higher rate. Again, consider how much you would pay for Maytag this year if it were going to earn $5 a share next year, versus how much you would pay for Maytag this year if it weren't going to earn that $5 until 2010. This is the market's equivalent of a bird in the hand being worth two in the bush!

I don't want to get too technical. I don't want to slide into "Genuine Wall Street Gibberish," as I say on my radio show. For the purposes of trying to catch big moves off of changes in earnings estimates, what you need to know is that when interest rates are moving higher, the multiple you will pay for earnings shrinks. When rates are moving lower, the multiple you pay for earnings expands. Or expressed another way, when rates are going higher we will pay less for the future earnings and when rates are going lower we will pay more for future earnings. The economy ultimately determines the long-term interest rates, but the Fed controls the short rates and can help control inflation. When inflation runs unchecked, rates go higher, and we pay less for those earnings; we "discount" them more. When inflation runs lower, we pay more for the earnings because the discount rate will be lower.

So because of that present value factor we need to assess any signal that gives us the direction of future interest rates. How does this play out in the real market? When interest rates spiked dramatically in 2004, 1994, and 1990, the price-to-earnings multiple shrank for all stocks because that discount rate went up. When interest rates fell in 2003 we paid more for the earnings than we were willing to pay in 2004. We won't pay a lot for future earnings in a high-rate/high- inflation environment, no matter how good those near-term earnings are. In the beginning of 2004 the story was the incredible shrinking M, because the E didn't go down, but the prices did (M = PIE). People new to the game, people who didn't understand the relationship be­tween stocks and interest rates, misinterpreted the price decline of stocks to mean that perhaps a recession was coming and that the E in the equation, the earnings estimates, wouldn't be made. That was nonsense. It was just the discounting mechanism bringing down prices and chiseling away at the multiple. I call such a contraction in the multiple the silent stock killer because so many people can't see the cause of it—higher rates—until it is too late and stock prices are obliterated. The vast majority of individuals I speak to each week on my radio show pay no attention to rates; the homicidal effect rates can have on prices continually surprises neophytes and even relatively seasoned investors. You have to focus on interest rates if you are going to buy stocks. Or, to put it another way, rates are like the oil in a car. You don't want to bother with it, but if you don't, you know the engine goes bad. If you don't focus on interest rates as the lubricant to your portfolio, your portfolio will most surely go bad, too.

Remember, I am trying with every fiber and sinew to winnow out the stocks that have the greatest chances of losing a ton of points and focus on the stocks that have the greatest chances of gaining big. Knowing when and how aggressively the Fed will move can often be the key determinant, particularly with cyclical stocks, in assessing which equities will make you the most money in the shortest time (and keep you from losing the most money). I wish I could give you a series of indicators that would tell you when the Fed is going to move. The Fed assesses many things: the real interest rates that the market sets, the CPI (Consumer Price Index), the PPI (Producer Price Index), the price of gold, employment growth, wages. What matters if you are going to be picking stocks is that you recognize when inflation is picking up. I don't like to outthink this process, but when the CPI registers four straight upward moves, I think you should expect that the Fed will have to tighten. Remember, the essence of investing is anticipa­tion. You can't wait until the Fed actually moves. You have to move ahead of the Fed if you are going to capture the maximum points. The reason is that the big mutual funds, which buy and sell stocks fairly emphatically if not recklessly, all know this stuff and own so much of each stock that they have to move well in advance of the actual deed. That's fine. We know it; we adjust accordingly.

Think of the Fed as some sort of bizarre schoolteacher who rewards the most stupid and uncooperative students and punishes those who do the best, or, in the case of the economy, grow the fastest. Most of the time the economy, like students, is average, call it a B or a C. The Fed does nothing when things are average, virtually sits on its hands. When the economy is roaring, an A economy, the Fed gets all furious and starts using its only real instrument to slow things down, its ability to raise short rates. But the Fed rewards a D economy with joyous rate cuts, and if the economy's flunking, as ours was in 2002 after 9111, the Fed takes rates as low as possible to get the economy moving again.

The effect on the companies is obvious. With cheaper credit companies can refinance, paying off high-interest debt, just as you might refinance your mortgage when rates decline. With cheaper debt companies can expand and hire and take down more inventory to sell at cheaper prices because it doesn't cost as much to borrow to hold inventory. That's how business gets going again. Of course, the companies are hurt when rates go higher as it may become too costly to build inventory or expand. So the Fed slows the economy when it's A rated and speeds it up when the economy's failing. But remember we aren't as interested in the specific impact of interest rates on individual com­panies as we are in the effect the Fed's moves have on the methods we use to predict outsized stock price moves. We care more about the perception of rising and falling of rates on future earnings than we care about what occurs to the companies, because the perception dictates the price movements.

I emphasize the Fed's actiohs here because if the economy were always strong, we would need to own only the stocks of the companies that were producing shoot-the-lights-out numbers. But because the Fed gets in the way all the time to slow down the economy or to speed it up when it is lagging, that shoot-the-lights-out method is a dangerous course of action. If you ignored the Fed, for example, you may have stayed fully invested well into 2001, which would have been a disaster for just about every kind of stock, but particularly for those caught in tech spending cycles, even if the textbooks said that you could still make good money in them.

If you want to minimize the Fed as a force—something you do at your own peril—you could lose unfathomable amounts of money in bad times or get blown out of the game entirely. That's why I emphasize both the Fed and these money-making cycles so much. Ignorance—and the buy-and-hold pattern it instills—is not bliss. It is why paying attention to your money makes it grow much faster than when you ignore it, and why you can, with some work, consistently beat the market over time.

A third method of divining big moves, an untraditional one I would like to think I have helped pioneer myself, comes from examining a different, unexploited cohort, which I call the undiscovered stocks of unknown companies. Most of the time individuals and institutions are simply trying to gauge and catch the moves of well-known companies with fully valued stocks—solving for M or solving for E, so to speak, trying to figure out the earnings or the multiple to those earnings that investors will pay—in order to gauge the ultimate objective, the price.

But what if there is no E? What if the companies are so new or so down on their luck that there are no earnings to be found, let alone earnings estimates? What if solving for E or M is impossible because E is too far away in the future? That's the case for many, many compa­nies. Does that mean we have to give up and stay with the tried-and- true where the E and M are predictable and therefore the price somewhat logical if not perfect?,Hardly. In fact, while these moves can be rewarding, as we have demonstrated above, they are dwarfed by the gains that can be had by newer companies without an E to game or an M to solve for. In fact, even after companies become discovered, their stocks can still be undervalued. We can make fabulous wine from these ignored and scorned vineyards, but we must also accept the fact that when we labor in the out-of-the-way fields we must be much more careful. We need both a buy and a sell price; we can't simply buy and forget about them. Many of these unseasoned stocks will poison our portfolios if they stay there too long.

If my unknown company/undervalued stock terminology confuses you, it's because I don't like to use the term that Wall Street usually puts on these stocks: small capitalization stocks. I don't like to focus on small capitalization stocks; I like to focus on stocks that have a small capitalization that shouldn't be small because the companies underneath them have too much potential to be stuck with such an appellation.

My method puts a premium on identifying small capitalization stocks before they begin their journey to mid and large cap. As Willie Sutton said about robbing banks, that's where the money is.

It always amazes me that so many people accept the fact that investing in solid, well-known companies, even with the two ways we described before, produces the greatest return. It's simply counter­intuitive. The well-known companies tend to be companies with billions of dollars in market capitalization, sometimes hundreds of billions. On a percentage basis, the shuffling back and forth of stocks that are already in the S&P 500 can certainly yield rewards. However, the biggest rewards come from identifying stocks of unknown companies at the beginning of their journey, when they might be worth no more than a hundred million dollars and are undiscovered, unknown, unloved, and, most important, uncovered by Wall Street. These situations have the least information, the most ignorance, and the greatest potential.

This method understands and anticipates that the real value of Wall Street is its ability to promote themes and companies that need money once they catch fire. This method tries to anticipate which of the themes and sectors will be the next Game Breakers. Wall Street is fabulous at taking the seemingly mundane and making it exciting and investible. It loves new concepts that need money to grow: teen fashion, arts and crafts, big and tall, low-carb food, Mexican food, Asian food, down-home food, Indian gaming, nanotechnology, video on demand, homeland security devices, alternative energy ideas, you name it. All of these trends took many low-dollar, low-capitalization stocks on the journey from small to mid cap and, in some cases, large cap. Yet, for the most part investment professionals and amateurs alike shun this cohort as too dangerous and too speculative. Again, they consider it akin to wagering. They prefer to dwell in the vineyard of the perfect, the perfect companies with the perfect information and the perfect values. I like to dwell in the unexplored wilderness where much less is known about stocks and the information—and therefore the prices—can be wildly off the mark. They irrationally fear the losses that could come from the single-digit stocks that don't make it; they act as if stocks can go to minus something.

For the longest time, academics claimed that all stocks are priced perfectly, that there is no information edge available. You can't beat stocks, they say, so you might as well join them, perhaps through in­vesting in an S&P 500 index fund. As you can tell, I have developed some ways to game the big moves from the discovered cohort, but I would be remiss if I told you that most investors can consistently beat the professionals within the vineyard of the known. But in the unknown cohort when the information is available, more money can be made here. Other forces, however, including crowd psychology—behavioral finance—rule this cohort. Given that we know that people inherently judge risk incorrectly, that they inherently buy at the top, that they can't restrain themselves from taking risks, particularly when they are losing, we can begin to predict patterns of behavior that can be anticipated to make you money. We know, for instance, that crowds get euphoric over certain concepts. We know that individuals are tragically overconfident when they should be underconfident, that they are swept away in ways that dwarf the efficient market and make it tremendously inefficient to the academic observer, but not to those who understand the patterns and see them over and over again. Put simply, the academics believe that the "market" will exert rational pricing on all securities, but the "market" is rational only for the thousand or so largest stocks. After that, emotions and psychology play a large role, which you can profit from. When he was explaining why short sellers who bet against the irrationalities of the market often get blown up doing so, John Maynard Keynes wrote, "Markets can remain irrational longer than you can remain solvent." I stand that logic on its head and say that irrational markets can last long enough for you to get in and make hefty profits before you have to get out. Of course, my method will seem like gambling to those who think that all stocks are perfect and all behavior is rational. All I am recommending, though, is speculating prudently—meaning taking into account the behavioral tics of other investors and exploiting those tics to your own profit.

This third method of getting in and out before markets grow rational is perhaps the single best way to make huge sums in the shortest time possible. I am confident that the academics who research behavioral finance will one day exert themselves and trump the rationall efficient folks. When that happens my techniques will be the equivalent of "fundamental" investing. In the meantime, though, let's just make the money and forget about being blessed by the Ivory Tower.

I know that I never cared about such constraints at my hedge fund. I was willing at times to put up to 20 percent of my fund into these potentially gigantic rewarders dcspite their lack of long-term fundamentals. I had the freedom to do so because no one was watching over me saying, "You can't make that kind of money in a Viant or a Webvan"—to name two bankrupt dot-coms—"knowing that they will eventually burn out." No one was critiquing me or my buys of stocks that were unlikely to amount to anything in the long term, but that in the interim gave you a superb return as long as you didn't overstay your welcome.

At my hedge fund I called this the search for the "red hots : ' the stocks that were like red-hot potatoes: you could own them for a few days, weeks, or months, but you didn't want to get stuck holding the hot potato unless you had taken your existing capital and a profit out of the situation before letting it ride.

But that doesn't mean we can't anticipate another kind of promo­tion that is just as powerful, in fact, more powerful, than the corrupt Wall Street promoters. We can anticipate what the crowd wants, the chattering classes, those people who can't control themselves because they think that every idea is the next Microsoft or Amgen. We can do it because we have enough empirical data about what they like and what sells for them, what piques their interest and gets them hyping things on the Internet, so that we can be ahead of the crowd and ride the wave that they create.

These kinds of stocks are another variety of "Game Breaker.'' They are like supernovas, stars that shine bright for a short period of time before they explode from their own heat and gas. Game Breakers exist because the most compelling mantra of all investing is "Find the next Home Depot" or "Find the next Genentech or Yahoo!, etc. Given the fantastic returns those famous stocks have produced, the search is logical even if in its suspension of skepticism it seems, at times, to be lacking in rigor. If we graft a buying discipline on what could look like the next big idea, the next Game Breaker, and tack on a selling discipline that cuts out the losers quickly and lets the winners run, we can make consistently good money simply piggybacking on others who are trying to find the next hot stock. We can limit our downside and, on the upside, take out our stake and then play with the house's money.

Since retiring from the hedge fund I have developed a keen sense of what could look like the next Game Breaker; I have honed the characteristics and systematized the otherwise haphazard process of culling the stocks to separate the potential diamonds from the dirt that surrounds them. This Game Breaker search tries to anticipate crowd psychology. To put it in the language of fashion, which is what this method attempts to exploit, we are trying to figure out which fads are going to sweep Wall Street and take companies' stocks up in wild excess of what would normally be expected. It is important to get into these stocks early, before they receive too much scrutiny from Wall Street, because that's when the best moves can be had.

For a new sector to get the attention necessary to be able to go from a small unknown idea to a mid cap idea with some real heft, the sector has to have what Andy Grove called "10X potential" in his excellent book Only the Paranoid Survive. In that book Grove postulates that there are some tremendous ideas out there, like Internet browsers, e-mail, the microprocessor—total game changers. "Tech­nology changes all the time," Grove writes. "Most of this change is gradual: competitors deliver the next improvement, we respond, they respond in turn and so it goes. However, every once in a while, technology changes in a dramatic way. Something can be done that could not be done before, or something can be done 10 x better, faster or cheaper than it would have been done before," These "strategic inflection points" don't have to be limited to technology, Grove says. They can revolutionize everything from the movies (silent to talkies) to phone companies (the creation of competitive phone companies through government deregulation being a classic example). The trick for Grove was to recognize that these changes could come from left field and then learn how to anticipate them. The trick for us is to play in left field and see the ball better and earlier than others.

Of course, there are lots of ideas out there that aspire to be 10X ideas that never get there, but my method builds in those losses and accepts them. My method exploits the crowd's inability to distinguish a 10 X idea from a lot of ideas that just fizzle and gets you in and out before the fizzling starts.

Let's take one of the more current fixations, nanotechnology, a science of manipulating small particles to make new compounds. Of course, the cynical trader in me says that this is simply the science of manipulating stocks so that more can be formed and bigger underwriting profits can be accrued. As is typical with the stocks of an unknown but exciting new sector, almost anything "nano" will get taken up. The trick is to figure out ahead of time what would have the most credibility if it were rewarded with a market capitalization that might be attractive to Wall Street, which ~ypically doesn't want to touch anything smaller than a billion dollars in market cap.

In the initial stages, I examine which companies have a modicum of revenues, decent bloodlines when it comes to managements, and scientific prospects that sound somewhat legitimate. I do that by reading trade journals, newspaper and magazine articles, and academic studies on what might be working and what isn't. Typically there are a host of these kinds of stocks, many selling below $10.I like to place bets on "the field," meaning that I don't know which stocks will ulti­mately gain the most credence. To me this process resembles what venture capitalists do, except with odds slightly better for me because there is a ready public exit market whenever I need it for the losers, while the winners can more than make up for the losers. Venture capitalists ride the bad ones to zero; we can bail out whenever we realize they aren't going to fulfill the 10 x potential.

If the venture capital analogy loses you, try this one: It's like fishing in a school of bluefish; it's impossible not to catch something when you are in the frenzied field. You've got to get that hook, line, and sinker in the water when a group like nanotechnology bites. You must seize it if you want to rack up big percentage gains in a remarkably short period of time, which is always what I am shooting for when I buy stocks.

Using the example of nanotechnology, to get the players for the field bet, I simply do a Google search for the companies involved, then find out which are public and examine their bona fides as described above. If I am early enough—judged by whether any major Wall Street firm yet covers the group—I pounce. If there is a lot of coverage of the group, particularly by the main firms based in New York , not just the regional firms from the hinterlands, I skip it. Major coverage means I am already too late to the party. The idea's been fully exploited.

Typically, if the science is sexy enough, or the demand strong enough, you can easily anticipate the group gaining steam. You see the trading volume of the stocks pick up, you see the chatter on the stock boards pick up, particularly the Yahoo! boards where my assistants trawl for comments, and you start seeing the more inventive Web sites, like TheStreet.com, writing up the ideas.

As soon as the companies in the cohort get some critical mass, the investment bankers at the regional brokers—not the ones in New York; that happens later—prowl the country and the world for companies that look like nanotechnology companies they can take public or write up with the hopes of getting some of their business down the road.

As stupid and as knee-jerk as this sounds, it is important at this moment to own as many nanotechnology stocks as you can because even the currently hobbled and uncorrupted Wall Street promotion machine can still be effective in moving stocks up when there are compelling technologies and big dollars on the line.

I continue to accumulate the stocks until the analysts at the major firms start their promotion and I stay long the group, that is, I hold these stocks, until the group is fished out, producing some of the best gains imaginable. How do you know when the group is fished out, that is, that the big gains have been made, when you can't trust the multiple process to yield any limits given that the group tends to have no E to put an M on? I let the Street's greed—almost as good a yardstick as its myopia in measuring stocks on earnings growth—tell me when to get out. During the expansionlfrenzy process, the merchandise gets created at a fast and furious pace. Underwriting after underwriting occurs as the group goes higher and higher.

I can always tell when the frenzy's about to crash, though, by measuring supply and demand. Right near the absolute top—it's too difficult to call the exact top, and I have done that only once in my life, on March 15, 2000 —the underwritings, all of which were fantastic to participate in, begin to fail. Merchandise that was considered "hot," meaning that it went to a premium almost immediately after it was launched, begins to sag. Deals open up and then slip to or below their deal prices. Secondaries—offerings of stocks already public—begin to pop up like mad as insiders, who can sell on those deals but couldn't sell previously because they were locked up on the initial public offerings—dump their shares. The secondaries don't stop despite the hammering they do to the stocks because the insiders know the pieces of paper are incredibly overvalued and want to get out.

At the exact top of the dot-com bubble, for example, every deal, every piece of merchandise, started failing or dropping below the level at which it was priced. None of the deals was working. That was the signal to get out. Supply had overwhelmed demand.

I have gotten into trouble with the intelligentsia and the pundits of the stock world because I tend to press the envelope of these stocks as aggressively as possible right to the very end of when you can still make money. I do that because that's when the gains are most mighty, as short sellers, who are always too eager to sell overvalued merchandise, short and then cover the stocks higher because the pain of short­ing them is too great.

I take heat because it looks like I am recommending and buying the most overvalued stocks in the world relative to the companies underneath. But as I have stated over and over again, there is a world of difference between the companies and the pieces of paper that trade on behalf of them, and the biggest money is made exploiting those differences at crucial times. In fact, the rate of return of playing this promotion game, particularly if you can catch it before it starts, when you have undervalued stocks of unknown companies, is the single most lucrative game that can be played with the market. The purists hate this and hate to admit that the percentage gains from these levels dwarf any other in the investment process; heck, they think it is pure gambling! Again, I point out that if you are willing to speculate pru­dently, with rules, and obey the sell discipline, you should not care if the companies of the stock you buy ultimately ever amount to a hill of beans. They probably won't. Who cares? You will have made so much money exploiting potentially worthless pieces of paper that what hap­pens to the companies is irrelevant. You simply need to be able to see the world through the eyes of the optimists and recognize what they are willing to embrace without any skepticism. At the same time you must combine that rose-colored~glasses approach with the cunning and rigor that will allow you to anticipate when the jig is up, and many—but not all—of the companies are exposed as frauds or jokes. You can ride the 10 x wave as long as you get out before it crashes, or before it is clear that only a handful of real companies is going to benefit. That's right—some companies actually do turn out to be the next Microsofts and Home Depots, and with my buy-sell discipline de­scribed later, you should still be able to hold on to some stock after taking profits off the table. You could end up with a portfolio of Yahoo!, eBay, and Amazon, as I did at my hedge fund, playing with the house's money while I shorted the junk mercilessly into the single digits.

It is at the moment when these kinds of stocks with no earnings look like they are going to infinity that the merchandise from all of the crummy and ersatz companies bulges from the woodwork and you have to scram as fast as you can. You have to be prepared to love the stocks at one moment and leave them unmercifully the next. You may have to flip on a dime; flexibility is everything when you trade these kinds of names.

How spectacular can the gains be if you initially suspend the skepticism and accept the possibilities out there? How fantastic can the gains be if you find the unknown and undervalued stocks ahead of others, simply because you are willing to accept that there might be a 10 X idea out there? How much money can you make anticipating that something will be adopted by the masses as a potential lOXer? Remember, potential is all you need because with my sell discipline, I promise you will get out ahead of when the cataclysm strikes, or at least be playing with the house's money.

Consider the two charts on pages 141 and 142. The first one shows some spectacular moves I was able to anticipate at my hedge fund and in my writings over the course of the last decade, along with the duration of those moves and the gains that could have been had by the nimble in an amazingly short time. The second chart is the original list of companies I put together at the dawn of the dot-com period simply by reading the prospectuses at the time and trying to figure out who would be regarded as the providers of the picks and axes for the Internet gold rush. In that case, I and a partner, Matt Jacobs, who ran my research department at Cramer, actually created a rotis- serie league—yep, like in baseball or football—where we had a mythical pool of money and had to draft players for the team. While we were drafting, the stocks were going up so fast that we quickly changed it to real dollars and were able to make a fantastic rate of return in an in­credibly short period.

You can see how you would have done in like periods investing in the S&P 500, the perfect proxy for the stocks out there. The S&P doesn't come near these stocks. The gains on these speculative stocks

are so magnificent that you would have to be crazy not to want to try to get some and lock them in. You get in, you get out, and you sit in cash until the next wave appears. Mind you, this is not backdated stuff like so many huge gains that advisers brag to you that you could have had if you had used their service. These are gains that were had! I actually owned and recommended these stocks to others in the electronic pages of RealMoney.com. I simply got out in time, although at the moment I pulled the sell trigger, the move looked incredibly foolish if not actually traitorous to the cause. I took tremendous heat

when I said in March 2000 that the jig is up, you have to sell; the heat from those last gains was just plain scorching. But if you understand my style and recognize that you are being a pig if you overstay those huge gains, you will recognize that the gains are so outsized as to be well worth the risk that some stocks won't appreciate at all.

To those who still insist that it is impossible to identify and isolate the Game Breakers before they happen, consider the stories we highlight on my CNBC show. Anyone who watches knows we frequently vet these small caps before they take off on their trajectory. Take the stock of Taser, which I discovered on national TV when it was less than a $100 million company after I had the company's management on my CNBC show.

After studying the company's fundamentals and its technicals— including the small number of shares outstanding—I said it could easily go to $1 billion in a short time. It was not hard to see that Taser could put on a lot of capitalization. It had a unique product, a good buzz—remember we are anticipating fashion—and, best of all, an ex­tremely limited float (number of shares outstanding), so if some institutions tried to buy it they would have to take the stock up beyond what most thought was possible. Six weeks later the stock became a $1 billion market capitalization stock as the frenzy took over. When it got to $1 billion, I said enough was enough and suggested people take profits, that the frenzy had grown out of control. It peaked shortly thereafter and declined precipitously, as these stocks often do when they reach the $1 billion level and the volume expands, signaling that there is, at last, too much float and the stock has finished its upward trajectory.

Getting in and getting out in time is possible and doable if you fol­low my buy and sell disciplines.

For two years people have been buying Sun Microsystems because it is a nice low-dollar stock. For two years it has been among the most active stocks on the NASDAQ. And for two years it has done nothing. That's because we are late to the game of Sun. It's an old stock, one that has already had its day. Same with Gateway. Or EMC. I am looking for stocks with velocity, stocks that can move, and move quickly, not quagmire stocks that sit and move in small increments. Low price alone does not make a stock a good investment.

What are the ingredients for the recipe of a mass-psychology- driven move upward? What should you be looking for in order to spot these huge gainers ahead of the monster leaps? I break it down like this:

40 percent management. This includes speaking with the company and evaluating management ownership and recent changes in ownership, ability to sell the story, and accessibility of information on the company. The salability of the a story and the credibility of manage­ment are subjectives that can't truly be measured. They provide the springboard for all other work on the topic. I talk to the management of almost every company I can get on the phone; firsthand knowledge is important when you are riding these rockets.

30 percent fundamentals. That means cash-flow growth, earnings growthlpotential, balance sheet, liquidity. The stocks that could turn into Game Breakers tend to have real financials; they are not shell companies. At times they have real profits; they always have revenues and rapid revenue growth. They are not just penny stocks thrust upon the market by the fraudsters in the boiler room.

15 percent technical analysis. This includes stock momentum, support levels, simple chart reading. I am not a chartist, but I am looking for stocks that have been basing for a long time. I want to see stocks that could break out or are about to soar if the crowd lights a match under them. Consider the chart work the search for a bag of Kingsford Match Light charcoal before the match gets struck.

15 percent what I call "TheStreet.com alpha factor." That's a proprietary measure I have created based on the stock's float, low volume relative to the float, how the stock has reacted to strong news in the past, and the short interest ratio. It is a measurement of the potential "short" pressure on the name, meaning whether there is enough stock out there, physically enough stock, to absorb the buyers' demands without it flying through the roof. This factor is a precursor to a stock's velocity, a tell that allows you to approximate how fast a stock can go from zero to sixty, if you will, without gravity or stock supply interrupting. These stocks work only when the size of the stock is "too small" for the concept and has to be supersized quickly by the crowd. That's one of the reasons I like to work off a screen that yields stocks that have a minimum of 100,000 shares, $100 million in market cap, and a price between $1 and $15. That's where most of these stocks live. Supply—merchandise for sale—has to be hard to come by, and when it isn't hard to come by, the move is probably already over. Supply must be so tight that when a buyer of 5,000 shares comes in, the stock is tough to find without moving it up to where sellers are. That's the Match Light scenario in action.

Consider the gauntlet we put Taser through. First, the company had seasoned management that had been in the business of developing stun guns for years but had not been able to crack any major police market. The balance sheet and the cash flow were superb. The stock had been basing for ages and most of it was held by just a few people, including insiders. Given the incredible news backdrop—that police departments all over the country were suddenly united in adopting Tasers because the number of fatal police shootings is a politically charged issue that hurts the overall functioning of the police and the elected officials—once one or two major police departments went to Taser, it wasn't much of a leap of faith to think that there would be many others behind them. The Miami force, known as both progressive and reformist, gave the signal when it picked Taser over the standard handgun for its manslaughter-plagued officers. Given the "tight" float (there were barely 1.5 million shares outstanding) and the demands on that float, it was, in essence, a predictable short squeeze that created instant wealth as the stock galloped from $100 million to $1 billion. It ramped and kept ramping until the market was overwhelmed with supply and the move was over, even though the news background stayed positive. How could we measure when the supply had caught up with demand? The explosion in volume told us that the stock had at last found a level where more wanted out than before; that changed the balance and left the stock hanging too limply. If we had waited until the fundamentals turned (the company would soon begin to lose business because of fears that Taser might be thought of as an instrument of torture and because the stock's capitalization gave it no room to lose any contract in any major metro area) we would have given back much of the easy gain.

What's working right now at this very minute, you ask? Tough question, because this is a moment-to-moment cohort with no room for buying and holding. That doesn't mean, though, that I can't be toiling in this vineyard for you anyway. For those of you who are Web savvy, because you have bought this book I will give you this URL: www.thestreet.com/stocksunderten. It allows you to participate for free in a service that isolates the potential next lOxers before they occur and while they are still under $10. It is called the "Stocksun- der$ lO" electronic newsletter, and while I would love to give you a list right here of what fits, the short time frame for selecting such winners makes it impossible to do anything other than send you to the site with my compliments. What's working is too fluid, changes too often. Try it out. You will see that this type of investing—gambling, if you like—is actually far more predictable and gameable than the Wall Street experts think. The next Game Breakers are out there. Like a good venture capitalist, you can own a bunch of them with this service, and you can get out of the losers before they crash and stay with the winners as they produce ever bigger gains.

As is so often the case, the process seems counterintuitive to many investors, who are often caught at the top when playing these stocks without strict rules regarding losses and without regard to the fundamentals, which, as always, do matter. That's why I have taken to using the metaphor of the Holland Tunnel Diner to explain this kind of investing to the public. After a brutal night in the city where we'd drunk too much, my wife and I used to like to stop at the Holland Tunnel Diner, a grungy place with a red-hot griddle, for a couple of egg sandwiches to sop up the inebriation. I used to marvel at that griddle man because that griddle was so hot it could fry an egg to perfection in what I measured to be nine seconds. But if the egg was left on for a tenth second, the griddle man would burn the bejesus out of it.

When you are playing the crowd promotion game, when you are solving for M without an E, you've got to be that griddle man at the Holland Tunnel Diner. You have to play it until the heat gets so hot that it makes a perfect egg sandwich, but you must bolt from the griddle before you overstay for even one second. Otherwise you could wreck your whole portfolio.

Fortunately, unlike the Holland Tunnel Diner, our griddle emits warnings. For individual Game Breaker stocks we see the volume expand; we see the secondaries get filed; we notice the insiders bailing. For the group moves, we see new underwritings and we see those fail as the IPOs go to a discount to price almost immediately. These pitfalls are obvious to anyone paying attention not to the companies themselves, but to the supply and demand in the marketplace. When the secondaries break down at inception and the primaries, or IPOs, retreat to a discount immediately, those are signs that things have overheated and you have to go elsewhere pronto. Don't worry, it is incredibly easy to spot these warning signs. With sector moves it's the moment when underwritings are coming through the chute like tor­rential rain only to sink in the muddy discount almost immediately. Every single group move of consequence has experienced this pattern, where you still have time to get out before dreadful financial consequences occur. It is usually at this moment that the press discovers the trend and there are dozens of articles everywhere about the "craze" that is no longer a craze but is a solid idea that is going to produce the next Home Depot or Genentech or Microsoft. That's the moment when the skeptics seem silly and the "new era'' folks seem most wise. That's the moment when it looks like money grows on low-hanging branches and you don't need a ladder to pick it off.

When you hear that kind of talk, when you read that kind of gibberish, be prepared to get the hell out of the diner or pay the price for the burned egg sandwich.

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