Wednesday, August 30, 2006

buy low or buy high?

[1/28/07] A stock trading near its 52-week high may not seem like much of a bargain. But research suggests it may still add plenty of value to your portfolio.

That's because stocks near their highs tend to climb still higher over the next six to 12 months. (The reverse is also true: Stocks near their 52-week lows tend to slide lower.)

The main reason for this phenomenon: The market usually underreacts to good news when a stock is near its 52-week high. That's because investors who are taught to "buy low and sell high" get skittish as stocks near their recent peaks and - in the short run - they hesitate to bid up prices furthers. But the reluctance doesn't last forever.

"Eventually the impact of the news wins out and the stock's price trends up," says Thomas George, a finance professor at the University of Houston's Bauer College of Business. Dr. George and colleague Chuan-Yang Hwang pioneered research about the 52-week high as a predictor of future performance.

Greg Forsythe, senior vice president of equity ratings at Charles Schwab, says his clients are just as reluctant as many professional traders to buy stocks near their recent peaks. His response, in some cases: The stock price may be higher than it was a few months ago, "but it's low relative to where it should be."

Mr. Forsythe urged clients to consider selected stocks near their highs in a November 2005 newsletter. He picked eight stocks that had Schwab's highest rating for potential outperformance - based on factors including earnings quality and valuation - and that were close to their recent peaks. Over the following twelve months, the group of stocks gained 22%, compared with the Dow Jones Industrial Average's 13% advance for the same period.

The accompanying table lists five stocks that last week held Schwab's top rating and were near their 52-week highs.
Cigna (CI)                           $130
Hasbro (HAS) $28
Hewlett-Packard (HPQ) $42
International Business Machines IBM) $97
Prudential Financial (PRU) $88
The case for buying stocks near their highs may seem counterintuitive, especially since investors are usually counseled not to chase performance when it comes to individual mutual funds and fund categories - high-yield bonds, for example, or technology stocks. But the research shows individual stocks that are near their highs can sustain that momentum through the next 12 months.

There are some "momentum" investors - on the lookout for companies with recent outsidezed stock returns - who do use 52-week highs to spot possible targets. And, to be sure, some stocks near their 52-week highs may be unattractive and overpriced relative to the companies' earnings and prospects. For instance, stocks near their 52-week highs that have Schwab's lowest ratings include Las-Vegas-based station Casinos (STN) and auto-parts company Amerigon (ARGN).

Proximity to the high is perhaps best used as a tiebreaker that helps investors choose among a handful of stocks with good potential. If you have three equally attractive stocks, the one closest to its high is likely to be a "better performer and to perform more quickly" than the others, says Schwab's Mr. Forsythe.


[8/30/06] What goes down tends to go down some more.

This has been shown in several studies that are sliced, diced, and summarized by noted NYU finance professor Aswath Damodaran in Chapter 8 of his book Investment Fables.

In these studies, when you measure time in terms of months, stocks that have gone up tend to keep going up. In other words, winners keep winning. And vice-versa. So when people advise you not to try to "catch a falling knife," they're not being silly -- they're playing the smart odds.

However, when time is measured in terms of years, the contrarian strategy begins to pay off. Oft-referenced work by Fama and French found that the contrarian strategy is far more successful for five-year returns than for one-year returns. Moreover, it works better for smaller companies than large ones.

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[8/25/06] Barry Ritholtz at The Big Picture had a recent comment about never buying a 52 week low. As you might expect, such absolutes simply don’t exist in trading.

Here’s fellow RealMoney.com columnist James “quant-jock” Altucher’s take:

I took all Nasdaq 100 stocks since 1996, including stocks that have been deleted from the index (to avoid survivorship bias). What happens if you buy stocks hitting 52-week lows that are trading for greater than $5 (avoiding penny stocks) and sell them one quarter later?

The results actually demonstrate that, over this period, the odds were on your side to outperform the market if you bought stocks at 52-week lows. The average return per trade was 7.34% (over 662 trades), including wins and losses. This far outperforms the average return per quarter of the Nasdaq during this period of 2.6%.

Some 60% of the trades turned out favorably and 40% were failures.

This would seem to run counter to O'Shaughnessy's What Works On Wall Street which found that buying stocks with the worst 1-year price performance turned out to be the worst strategy in the whole book.

The difference could be the universe of stocks looked at. Altucher looked at the Nasdaq 100 while O'Shaughnessy used the CompuState database which had about 3500 stocks on average. It could well be that the smaller companies chosen had a higher percentage of companies headed for bankruptcy. The "Large Stocks" did decidedly better that the All Stocks universe, but still underperformed the Large Stock universe.

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What Works on Wall Street (Chapter 15) looked at stocks with the best and worst 1-year price changes.

The stocks with the best 1-year price appreciation outperformed the All Stock universe by 2-to-1.

The stocks with the worst 1-year price appreciation widely underperformed the All Stock universe beating it only 11 of the 43 years reviewed and only once on 39 5-year periods.

Conclusion: buy the stocks with the best 1-year relative strength.

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However another study found that the momentum strategy is a relatively short effect, the biggest gains were over the next year. Momentum doesn't seem to affect the stock after a year.

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Tweedy Browne's study What Has Worked In Investing (page 43) cites a study which the 35 worse and 35 best performing stocks over the last five years. The worst performing stocks over the preceding five-year period produced average cumulative returns of 18% in excess of the market index 17 months after portfolio formation, a compound annual return in excess of the market index of 12.2%. The best performing stocks over the preceding five years produced average cumulative returns of about 6% less than the market index after 17 months, a compounded annual negative return of 4.3% versus the market index.

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In summary, the above studies indicate that buy high works in the short term (about a 1 year period), while buy low works in the longer term.

-- written up after the Tweedy Browne study was uploaded at magicformulainvesting

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[5/28/06] In the June 2006 SmartMoney, Jaack Hough cites a study by George and Hwang which looked at stocks within 5 percent of their 52-week highs and lows (rather than the top six month gainers and losers that the Jagadeesh and Titman study looked at). This would for example exclude stocks that was up 60% for six months though it has backed off 15% from the high. Again, these stock beat the overall market but "strong returns kept rolling in for at least five years".

I'd say this strategy would have worked quite well in 1998 and 1999, but pretty poorly in 2000. So value would have to figure in somewhere.

Hough looked at stocks with PEG <= 1 and trading within 5% of their 52-week highs. The screen came out with the following stocks. ABK (79.70), ACO (28.28), PLCE (56.22), DFG (51.00), EBF (19.38), GS (158.12), KAI (22.37), LEH (144.82), NE (81.44).

The Future for Investors

A book review of Jeremy J. Siegel's book The Future for Investors: Why the Tried and the True Triumph over the Bold and the New.

The Inside Value Approach (an advertisement)

[3/23/07] Conviction is perhaps the most important factor in investing

[11/15/06] Virtually all of the greatest investors -- Warren Buffett, Benjamin Graham, Charles Munger, John Neff, Walter Schloss -- earned their fortunes by following value principles. They've done so well not because value stocks have grown faster than so-called growth stocks. Instead, they've triumphed because stocks are priced largely based on their expected growth rates. More often than not, those expectations are wrong.

[10/30/06] David Meier looks for falling prices and rising returns

[9/5/06] methods of valuing companies

[8/30/06] The only two things that matter in investing

[7/20/06] Growth or value: which is the best way?

[7/14/06] Richard Gibbons tells value investors to buy growth stocks

[5/14/06] David Meier says that turnarounds are better path to multibagers

[5/2/06] It may take time to beat the market with value investing

[4/17/06] Richard Gibbons follows three important rules

[4/11/06] Nathan Parmalee on the P/E ratio

[4/10/06] David Meier's triple double

[4/5/06] Seth Jayson hunts for value

[3/14/06] David Meier points out examples of bad growth, good growth, and great growth.

[2/24/06] Richard Gibbons warns value investors that temporary bad news is sometimes not so temporary

[2/9/06] Richard Gibbons presents Three Simple Rules

[2/3/06] Buy ugly, but not too ugly

[1/24/06] Two paths to profits: Rule Breakers vs. Inside Value

[1/13/06] The Inside Value team looks for relentless growers.

[1/6/06] Durrell says turnarounds are right under your nose.

[12/23/05] There's a good reason why many wealthy folks could credibly be described as "cheap".

[12/21/05] How to beat Inside Value

[12/18/05] Seth Jayson says wiggles give you opportunities for profits.

[12/9/05] Jim Gillies gives his definition of "value" investing.

[12/3/05] Jim Gillies discusses Stern Stewart's trademarked concept of Economic Value Added. Or EVA = [ROIC – WACC] * IC.

[11/3/05] Richard Gibbons says to buy strong companies when blood is in the streets

[10/29/05] Richard Gibbons talks about buying companies in crisis.

[10/28/05] Seth Jayson talks about Buffett's Stealth Values which are strong companies that are neither dirt-cheap or expensive.

[11/24/05] Tim Beyers learns four lessons from the bubble

[9/15/05] Chuck Saletta again

[8/29/05] The evolution of Richard Gibbons

[8/29/05] Invest like you shop (Chuck Saletta's turn to write the ad)

[8/18/05] In this article/advertisement, Richard Gibbons explains the Inside Value newsletter approach to selecting stocks. Here's my summary: find a great company, then buy it cheap.

[5/6/05] A Patient Investor's Guide to Profit

Monday, August 28, 2006

Remember the bubble

[8/25/06] A review of Roger Lowenstein's book 'Origins of the Crash'

[12/19/05] Jeremy Grantham studied 28 financial bubbles, ALL of which eventually
reverted to the mean. (from chucks_angels)

[12/17/05] Tulips should serve as a reminder to us investors of the dangers of speculation.

[3/14/05] Looking back at the bursting of the bubble

Finding your 'latte factor'

You may have heard of the "latte factor," which states that by skipping the daily stop for a $3 coffee, you can save hundreds, even thousands of dollars, a year. But if don’t drink that much coffee anyway and are still short on savings, what do you do?

Since many Americans are higher in credit card debt than they are in bank account balances, figuring out one’s own latte factor is crucial to keeping spending under control. That means paring down the shopping list and accepting the fact that your "wants" are far more numerous than your "needs."

Tuesday, August 22, 2006

The Hot Product

We analyze all kinds of companies to find opportunities for the long-term investor. One category that can be a challenge sometimes is the firm with a hot product on its hands. The product is usually something new that is generating a lot of hype and excitement. Soon enough all the "cool" people have the item and the sky's the limit on the new opportunity.

With excitement comes risk, however, as stock prices shoot up and attract investors at the peak of expectations. Then the realities of the marketplace hit. Some investors get caught at the top, unaware of the white-knuckle ride back down that will soon commence.

Sunday, August 20, 2006

How Bad Can It Get?

investors who bought the Dow at the peak of the market in 1929 had lost roughly 89% of their investment only three years later. They broke even, in real terms, in 1954 -- 25 years later. If you include dividends in the mix, it's a bit better. In that case, the breakeven year was 1945.

Let's look at a more recent example -- the market's fall from its highs in 2000. From peak to trough, the Nasdaq fell 79%. Investors who bought at the peak broke even in ... well, actually, they're not at breakeven yet. The S&P 500 fared better, with investors losing "only" 50%.

Friday, August 11, 2006

The Congressional Fund

Weekdays in August are a good time to own stocks. The end of October isn't bad either. Christmas can be fine for equities as well.

What these dates have in common is that they are times when Congress isn't in session. Back in 1991, a Wall Streeter named Eric Singer noticed that equities that year tended to do better when lawmakers weren't in Washington. He published an op-ed in Barron's proposing that the correlation was no coincidence.

Later, he looked at a wider timeframe and went around the squash courts of New York telling people he might write a book about his thesis. Now Singer is going one step further. He has created a hedge fund, Singer Congressional Fund. Its goals include making money from the Congressional calendar.

How the Fed Affects You

By now, you have probably heard that the Federal Reserve chose on Tuesday to leave the federal funds interest rate unchanged after having made 17 consecutive increases over the past two years.

Perhaps the most confusing thing about Fed announcements is why they really matter. The Federal Reserve isn't a bank that has individual customers, so the rates the Federal Reserve charges or pays don't have a direct impact on any one person. However, because many financial institutions deal directly with the Federal Reserve on an ongoing basis, changes at the Fed do rapidly work their way across the spectrum of banks, lending institutions, and investment companies, and then they eventually reach your bills and account statements.

The Secrets of Nine-Figure Fortunes

Todd Wenning writes, "In a previous job, I helped manage a few nine-figure fortunes -- which was intimidating at first. I mean, an errant mouse click while making a multimillion-dollar trade and you're fired. But eventually the sweats subsided, and I learned the secrets behind this enormous wealth."

How did they do it?

In two easy steps ...

Wednesday, August 09, 2006

Benefiting from a pause

NEW YORK (Money Magazine) -- The Federal Reserve decided Tuesday not to raise interest rates for the first time in more than two years, noting that economic growth had "moderated."

So which sectors are likely to do well now? A recent study from Citigroup looked at the past five runs of Fed rate hikes and examined how stocks performed in the 12 months following each final rate increase.

What they found: Classic defensive plays like pharmaceuticals, financials, utilities and consumer staples (which includes companies such as Coca-Cola and Procter & Gamble) have historically gained twice as much as the S&P 500 once the Fed stops raising rates.

That's because consumers continue buying medicine, drinking soda and paying their electric bill, regardless of the state of the economy.

One-year gain after Fed stops raising rates
Financials: + 24.7%
Health Care: + 23.4%
Consumer Staples: + 17.6%
S&P 500: + 9.9%


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[8/22/06] The above seems to contradict this fact ""Since the Fed's inception in 1913, the average historical DJIA return after the Fed's terminal interest-rate hike is negative (i.e., the DJIA goes down, not up), 4, 6, 8, 10 and 12 months thereafter."

Friday, August 04, 2006

Growth Investors

[8/16/06] 2 Things I Learned From Philip Fisher (by Tim Beyers)

[8/4/06] Just as there is Benjamin Graham for value investors, there is Philip Fisher for growth disciples.