A Buy Strategy for Chegg

 | Feb 05, 2014 | 9:00 AM EST
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Chegg (CHGG) has been widely touted as one of "the failed initial public offerings of 2013." It's true. Chegg did get off to a rough start three months ago.

Shares of Chegg made their debut on the New York Stock Exchange on Nov. 11 at $11 apiece. The stock hit an all-time low of $6.32 on Monday. I believe, however, that 2014 will be a comeback year for the company.

Chegg services a niche segment of our society, but a rather expansive niche: college students. It has branded itself as a "student-first, connected learning platform that empowers students to take control of their education to save time, save money and get smarter."

While it has made a name by selling and renting print textbooks, which are inarguably on the demise, Chegg was founded in 2005 and has been forward-thinking from the start. Through the platform the Student Hub, Chegg also provides eTextbooks, supplemental materials, homework help, courses, college admissions and scholarship assistance.

The Student Hub also provides Chegg with a steady stream of advertising revenue from companies hoping to reach Chegg's growing user base, which now spans to more than seven million students.

The consensus among analysts is for a 12-month price target of $11 to $14 a share. Nevertheless, Chegg has continued to fall into this week. Why does this company suddenly catch my eye at these levels? Because the technicals now suggest that something is afoot.

I love trading stocks that have recently IPO'd. They often see highly predictable sets of price action that come in the initial months after the opening offer. One of those patterns you can simply think of as "sets of two." When a recent IPO initially sells off, that move tends to come in two waves. The continuation of that selloff also tends to have price action that contains two waves within each trend move. First, the initial selling phase will have two sets of downside, often with only a brief pause between those legs. Two corrective waves then follow.

Usually the second corrective wave off the lows is more gradual than the first, and this leads to another break to the downside. Unlike the first set of downside action, however, the second set tends to be less extreme. This second set will typically also have two legs of downside. At that point a strong reversal then becomes likely.

Twitter (TWTR) had similar price action following its own IPO around the same time -- although it played out this series of waves on a 120-to-240-minute time frame, as opposed to the daily time frame. This was why I waited until the end of November to take an interest in Twitter, although it was not until early December that I initiated a position.

This is where Chegg and Twitter differ: Chegg has shifted momentum into the lows coming off its second major wave of downside, whereas Twitter did not. I've included both the daily chart of Chegg above and the 120-minute chart of Twitter below to show you the comparison.

Facebook (FB) also experienced this same type of pattern development in its first four months. As with Twitter, it paid to be patient with Facebook. Now that a similar type of price action has played out in Chegg, I believe that the current level is ideal to finally initiate a position in this recent IPO as well.

In this type of pattern development, the breakdown zone from the slower, second upside move (shown in green) will then become initial resistance on a rebound. In Twitter this was around $41, which took several weeks to break. In Facebook it was $28 to $30, a level that the stock failed to break until last July. In Chegg that area is $8.25 to $8.50. While the longer-term outlook on Chegg may easily be that $11-to-$14 zone, one should still be prepared to deal with nearer-term resistance that could easily hold this one back for several months.

Two things to note: first, Chegg's earnings announcement is scheduled for Thursday, Feb. 13. The second is that despite its revenue growth, the company has yet to show profitability.

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