In their paper, Evidence That Trading Volume Sustains Stock Price Changes, Financial Analysts Journal, 1994, academics Scott E Stickel and Robert E Verrecchia noted that: "Price changes are more likely to reverse following weak volume support than strong volume support, because price changes reflect demand for a stock and higher volume reflects a greater likelihood that the demand originates from informed rather than uninformed trade." The academics proved that, as trading volumes rise, the probability that the price change is information-driven increases, too. The evidence indicated that large price changes on days with weak volume support tend to reverse, at least partially, the next day, since prices are being driven by some transitory effect unrelated to information. However, returns generally do not reverse following days of strong volume support. In fact, large price rises with strong volume support tend to be followed by another price increase the next day.
Interestingly, academics Charles MC Lee and Bhaskaran Swaminathan of Johnson Graduate School of Management, Cornell University, showed in their 2000 study, Price Momentum and Trading Volume, Journal of Finance, that past trading volume provides an important link between 'momentum' and 'value' investment strategies and concluded that, as companies move through periods of relative glamour and neglect, then trading volume can play a useful role in identifying where a stock is in this cycle. The key point here is that if we use trading volumes to identify when investor interest is on the rise and screen for companies with strong fundamentals about to signal chart breakouts, then we have the holy grail of stockpicking. And this is precisely what is on offer from IQE (IQE), a global supplier of advanced wafer products to the semiconductor industry.
High volume gains
What really caught my attention was the surge in IQE's trading volumes last week. On 17 October, when the share price rose 5 per cent to 30p, almost 13m shares changed hands, more than 5.5 times the average daily turnover in the past year. And, in the past 16 trading days, the average daily turnover has been 3.5m shares, more than 50 per cent more than the 12-month average. During this time, IQE's share price has moved up from 26.25p to 30p, but importantly has been backed by high volumes - a positive sign and one that is backed up by the performance of the business. That's because IQE is on the verge of a massive step up in profitability - and one that is yet to be fully reflected in the current valuation.
Compelling valuation
In fact, analysts at Canaccord Genuity expect cash profits to more than treble from £4m in the first half of 2012 to £12.9m in the second half. Chief executive Dr Drew Nelson is confident of meeting these expectations - and with good reason as his company is clearly benefiting from the rapid adoption of smartphones and tablet devices.
Industry analysts predict that total handset shipments will be flat at around 1.7bn units this year, but smartphones will account for 35 per cent of the total, up from 26 per cent in 2011. And these growth rates are expected to be maintained as analysts at Gartner and iSuppli forecast that smartphone sales will grow at 28 per cent a year on average over the next three years, surpassing 1bn annual sales by 2015. The popularity of tablet PCs is proving a boon for wafer makers, too, as annual sales of mobile broadband devices are forecast to exceed 350m units by 2015. And as wireless operators roll out 4G networks and devices this will underpin demand for 4G LTE handsets: around 28m are expected to be shipped this year.
All of this is very good news for IQE, which uses advanced crystal growth technology to make and supply bespoke semiconductor wafers to major chip manufacturers, which then use them to make the chips that form the key components of virtually all high-technology systems. The company also manufactures advanced optoelectronic and photonic components such as semiconductor lasers and optical sensors for a range of applications, including: DVD and Blu-ray storage; thermal imaging; ultra-high-brightness LEDs; and high-efficiency concentrator photovoltaic (CPV) solar cells. And it is the CPV that is really taking off. In fact, IQE has received its first major order, estimated to be worth $90m (£56m) to the company, through its venture with Solar Junction, a leading CPV developer and manufacturer.
So, assuming IQE delivers on Canaccord's cash profit forecasts, this implies adjusted EPS will rise from 1.6p in 2012 to 2.2p in 2013. Broker Peel Hunt is even more bullish, pencilling in EPS of 2.7p in 2013, based on an increase in revenues from £92m this year to £119m. On this basis, the shares, at 30p, are modestly priced between 11 and 14 times next year's EPS estimates. That compares rather favourably with industry giant Arm Holdings (ARM), which is rated on a 2013 prospective PE ratio of 37.
Chart breakout looms
Interestingly, the recent upmove in IQE's share price has taken it close to the 32p resistance level which stalled previous share price rallies in March and July. In my view, any close above 32p would be a major buy signal ahead of a sharp move higher to a prior level of support between 38p and 40p. I think this will be third time lucky for IQE and, in advance of the chart breakout, I advise buying the shares at 31.5p, targeting a rise to 38p-40p on a three-month basis.
