Don't be too quick to brush off a stock that's built a very deep base.
Yes, a 40% or 50% correction is a serious flaw. But if the stock shows great potential, look for an excuse to get in. A great stock will give you one.
This is not to say you should ignore the rules. A deep base is a problem, and a from a problem can easily be a problem.
But realize, too, that stock-market history is full of great stocks that, at one point or another, build a base that runs far deeper than the 30% to 33% maximum decline you'd ideally like to see.
So is this a contradiction? Not at all, and Lumber Liquidators (LL), one of the star stocks of 2012, shows how both are true at the same time.
After a big run-up in 2009, the operator of retail flooring stores fell 49% from July through early September 2011. (1) The selloff includes a 29% loss in the week ended July 8. That proved to be the first — and worst — week of a seven-week losing streak.
It would have been easy to believe in Lumber Liquidators this year.
"We like the stock a lot," said Piper Jaffray analyst Peter Keith in a May 18 New America article. "It has the one-two punch of an improving industry backdrop and improving company fundamentals.
By the time the base's right side was taking shape, (2) Lumber Liquidators in January had posted quarterly EPS gains of 73% (Q3) and 43% (Q4). Those nice numbers ended a rough patch of four profit-shrinking quarters.
The stock eventually built a right side and broke out from a deep cup-with-handle in the week ended March 9, 2012. (3) If you had captured this breakout, you'd have paid 22.95 — and done very well.
The stock doubled from that price as recently as late October. You'd have done well, but consider what could have gone wrong. By the time it broke out, Lumber had already doubled from its September low.
Scrutiny of the daily chart showed signs of aggressive institutional buying as Lumber formed the base's right side.
The stock gapped down 11% and sliced below its 50-day line Feb. 22 in monster , the reaction to a disappointing earnings result. But it opened the next day above the line and kept rising. Lumber ended the week at 21.07, not far from the weekly high of 22.16. The market's strong hands were there.