This is where a company's share price breaks through a resistance level at the third time of asking. It can be the prelude to a strong upmove, especially if the price is not hugely over-bought on its relative strength index (RSI). The RSI was developed by J Welles Wilder in the 1970s and is a momentum oscillator, measuring the velocity and magnitude of directional price movements. Momentum is the rate of the rise or fall in price. The RSI computes momentum as the ratio of higher closes to lower closes: shares which have had more, or stronger positive changes have a higher RSI than those which have had more or stronger negative changes. Generally speaking, a share is in overbought territory when the RSI is above 70 and oversold when it is below 30.
Clearly, shares can trend higher despite being slightly overbought and this can go on for lengthy periods before buyer exhaustion sets in and a correction takes place. So, by targeting shares that are on the verge of, or have just completed major break-outs, it is possible to capture the large part of a fresh upmove where there is positive share price momentum.
This is very relevant right now because a company I have been following for the past 16 months has just signalled a triple top buyout signal on its point of figure chart and a swing buy signal, too.
A major break-out
The company is marketing services provider Communisis (CMS: 55.5p) and one that should be familiar to regular readers of Investors Chronicle because I have recommended buying the shares several times since I initiated coverage when the price was 28.5p ('Small-cap trading buy', 13 Feb 2012).
I subsequently reiterated that advice in the autumn of last year when the price was 40p ('Communisis shares to fly', 19 Oct 2012) and also at 36p ('Happy Capital returns', 17 Dec 2012). In fact, I was so convinced that the company's full-year results would not disappoint in March that I recommended buying again twice in January this year ('Jumping the gun', 14 Jan 2013 and ('Bumper trading gains', 23 January 2013). And when Communisis raised £20m through a placing and open offer the following month ('A fund-raising well worth backing', 18 February 2013), I had no hesitation recommending readers take up their allocations of new shares at 40p. The price at the time was 45p and my target price was 55p, a price that is very significant.
That's because the 55p level acted as a major support to the share price in August 2006 and April 2007, before finally giving way in the stock market crash in the autumn of 2008. It has taken four and a half years for Communisis shares to recover back to that level. It is no coincidence either that the share price hit resistance at 55p twice in March this year. But it was third time lucky last week when the share price broke through this resistance, both on an intra-day and closing basis.
True, the RSI is above 70, but it is not at extreme overbought levels. This gives me confidence that the break-out has clear potential to run higher. Moreover, the shares have also given a buy signal on the MACD chart, a technical analysis indicator created by Gerald Appel in the late 1970s. This is used to spot changes in the strength, direction, momentum, and duration of a trend in a share price.
Strong fundamentals
It's worth noting that the fundamental case for investing remains strong, too. In fact, when Communisis released full-year results in early March, the company announced a three-year contract with Yorkshire Building Society and a two-year extension on an existing contract with Thames Water. The contract wins follow major agreements with BT and Nationwide Building Society in the preceding months. This also highlights the point that with the benefit of a debt-free balance sheet post the fund-raising, the business is not being constrained in tendering for new business by a lack of funding.
It also means that Communisis can be selective and focus on higher-margin contracts as it strives towards its 10 per cent medium-term margin target. Indeed, analyst Johnathan Barrett at broker N+1 Singer has substantially increased his margin expectations, given the company's strategy and the equity financing that has been secured. Mr Barrett has raised his net operating margin estimate from 7.5 per cent to 7.8 per cent for 2013; from 7.6 per cent to 8.4 per cent for 2014; and expects the company to achieve margins of 9.5 per cent in 2015.
Operational gearing
So, as Communisis replaces lower-margin legacy contracts with much more profitable new contract wins, small changes in revenue will have quite a dramatic impact on profits. For instance, N+1 Singer's revenue estimate of £237m this year is forecast to produce pre-tax profits of £12.2m, but revenues of £245m in 2014 are expected to generate profits of £13.9m. And if margins do hit 9.5 per cent in 2015, and Communisis meets N+1 Singer's revenue target of £256m, expect profits to rise even further to £16.1m. On this basis, the EPS figures for the following three financial years are 5p, 5.5p and 6.3p.
Furthermore, there is scope for more of the company's operating cash flow to be recycled back to shareholders. Mr Barrett expects the dividend per share to be raised from 1.7p to 1.8p this year, rising to 2p in 2014 and 2.2p in 2015. On this basis, the prospective dividend yield is 3.2 per cent, 3.6 per cent and 3.9 per cent, respectively.
For good measure, Communisis shares are also attractively priced 26 per cent below pro forma book value of 76p, adjusted for above the share issue.
Target price
In my view, a run up in the company's share price to around 70p now looks firmly on the cards. Even then the shares would only be trading on 12.5 times 2014 earnings estimates, falling to 11 times in 2015, and the dividend yield would still be healthy.
We may not have long to wait either, as Communisis is scheduled to give a first-quarter trading update at its annual general meeting on Thursday, 9 May. I would advise buying the shares, on a bid-offer spread of 55p to 55.5p, ahead of that update. My three-month target price is 70p.
MORE FROM SIMON THOMPSON ONLINE...
I have written seven other articles in the past week, all of which are on my homepage and include the following companies or sector trades:
Housebuilders ('Seasonal stock picking strategies', 30 Apr 2013)
Daejan Holdings, Mountview Estates ('Hot property', 1 May 2013)
Aurora Russia, Thalassa ('Small-cap stock picks', 1 May 2013)
Town Centre Securities, Terrace Hill ('Hot property: take two', 2 May 2013)
Netplay TV ('A golden nugget', 2 May 2013)
Polo Resources, Heritage Oil, IQE ('Bargain shares update', 3 May 2013)
KBC Advanced Techonolgies ('Fuelled for growth', 6 May 2013)
