Forest Labs: Boring But Good Technicals

01/18/08 08:44:30 AM

by Mike Carr, CMT

Forest Labs combines solid fundamentals in a defensive industry with technical reasons to buy.

Security: FRX
Position: Buy

Forest Laboratories (FRX) sells branded and generic forms of ethical drug products as well as nonprescription pharmaceutical products. Its products include drugs to treat major depression, generalized anxiety disorder, moderate to severe Alzheimer's disease, hypertension, alcoholism, diaper rash, infant colic, eczema, and psoriasis. Even if the US economy plunges into recession, these products are likely to continue selling.

Fundamental analysts agree that earnings are likely to be steady over the next few years. The company earned $2.88 per share last year, is forecast to earn $3.24 this year, and $3.50 the next. It trades at levels near 12 times reliable earnings. Fundamentally, it's a solid company trading at below-market valuations.

Technically, the chart indicates that a buy may be a good idea (Figure 1). The stock has just broken through resistance near 39. This consolidation pattern can be thought of as a rectangle, or a W. Either way, it is bullish and projects a price target just above 43. Stochastics, the relative strength index (RSI), and other oscillators confirmed the breakout and are now near overbought levels. A trendline break occurred earlier this month. The weight of the technical evidence is clearly bullish.

FIGURE 1: FRX, DAILY. Prices have through a trendline and pushed through resistance. The measured price objective offers a 10% return.

Graphic provided by: Trade Navigator.

An additional factor in FRX's favor is the short interest in the stock. Buyins.net tracks short interest in stocks and calculates the average prices on those shorts, providing a squeeze trigger price. At the squeeze trigger, shorts can be squeezed and stock prices can shoot higher as shorts scramble to cover their losing positions. The current squeeze trigger in FRX is $43.87, close to the price objective attained from the daily chart. This potential demand increase adds to the confidence level of taking a long position in FRX at, or near, the current price.

Mike Carr, CMT

Mike Carr, CMT, is a member of the Market Technicians Association, and editor of the MTA's newsletter, Technically Speaking. He is also the author of "Smarter Investing in Any Economy: The Definitive Guide to Relative Strength Investing," and "Conquering the Divide: How to Use Economic Indicators to Catch Stock Market Trends."