Everyones favorite investment
mantra is buy low, sell high.
The problem is that nobody actually
buys low and sells high. Rather,
we buy high and (we hope) sell even
higher.
The stock market is the only market
on earth where the merchandise
becomes more popular as it becomes
more expensive. Why? Because investors
feel comfortable staying with the
herd when it comes to buying stock.
After all, if everyone loves a stock and
its price is rising, it must be worth
buying, right?
The problem is that investing with
the herd is a surefire way to lose
money. Look at all the technology
stocks that soared in the late 90s only
to come crashing down. Everyone wanted to buy
those technology stocks when they
were skyrocketing and trading at extreme
prices; nobody wanted to buy
them when they crashed.
Successful investing is all about
forcing yourself to do the smart thing
even when your emotions are telling
you otherwise. And the smart thing
to do as an investor is to buy low and
sell high.
Fortunately, strategies exist that
force investors to buy high-quality
stocks when they are down and to sell
them when they are up.
I call them my worst-to-first strategies.
These strategies emerged as a product of my research into the Dow Jones Industrial Average. As an investment newsletter editor and a money manager, Ive been following the
Dow for more than 40 years. During
my research of Dow stocks, one
theme that jumped out was how the
Dows losers in one year (that is, the
Dow stocks showing the greatest percentage
price decline in one year) became
winners the next.
For example, in 1999,
the worst-performing stock in the
Dow was Philip Morris (now called
Altria). An investment in the tobacco
giant lost a whopping 54% of its value
in 1999. In 2000, however, the story
was much different for Philip Morris
shareholders. To say Philip Morris rebounded
would be an understatement;
the stock was the best-performing
issue in the Dow in 2000, returning
105%. In fact, Philip Morris triple-digit
return in 2000 was nearly twice
the return of the runner-up that year,
aerospace giant Boeing. Even more
impressive was that while investors
were more than doubling their
money in Philip Morris in 2000, the
Dow actually lost money (nearly 5%)
during the year.
In 2000, same story, different players.
The two worst-performing stocks
in the Dow in 2000 were AT&T
(down 65%) and software behemoth
Microsoft (down 63%). In 2001,
Microsoft and AT&T went from worst
to first. Microsoft was the Dows best
performer in 2001, rising 53%. And
AT&T was the third-best performer in
the Dow that year, returning 37%.
(For the record, IBM, which rose 43%
in 2001, was the meat of the
Microsoft/AT&T performance sandwich.
Interestingly, IBMs big gain in
2001 came on the heels of a 21% decline
in 2000.) And those big gains in
Microsoft and AT&T (and IBM) came
during a year when an investment in
the Dow lost money (about 5%).
While the
worst-to-first story for years 2001-2002 is not as compelling, it still
makes for interesting reading. The worst-performing Dow stock in 2001 was
Boeing, losing 40% of its value. And while Boeing still showed a loss in
2002 (a decline of 13%), that performance still outpaced the 15% loss in the
Dow.
The worst-to-first
phenomenon returned to prime form in 2002-2003. The Dows two worst
performers in 2002 were Home Depot (down 53%) and Intel (down 50%). However,
in true worst-to-first form, these two stocks provided huge returns in
2003. Indeed, Intel was the best-performing stock in the Dow in 2003.
Home Depot, too, enjoyed a big rebound in 2003.
Of course, four
years is too short a time frame to evaluate any investment strategy. Thus, I
decided to undertake one of the most comprehensive studies of Dow returns
ever attempted. I gathered data on the Dow and its components going back to
1930 to test a variety of worst-to-first strategies. (The basic
worst-to-first strategy entails buying equal amounts of the five
worst-performing Dow stocks each year). This research resulted in my book, Winning With The Dows Losers (HarperCollins).
What I discovered
was that buying a basket of the Dows worst-performing stocks (I call
these underachieving stocks Dow Underdogs) and holding them for a year
has been a very productive investment strategy.
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