How To Roll with Momentum
Think you can’t beat the market? All of the portfolios we’ve built in Investment Finder are up strongly so far this year, with the best gaining 50% on the backs of Oracle (NYSE:ORCL), Cracker Barrel (NASDAQ:CBRL), and United Natural Foods (NASDAQ:UNFI) over. Investor SuperModels
The Dow Jones Industrial Average’s leap above 18,500 this year has obscured one sad fact: Most of the stocks you own have probably not done nearly so well.
For while the huge-cap stocks in the Dow have surged 2.5% in the last days,after two months in which even a 50-point move in the Dow Jones Industrial Average was reason for excitement, investors were shaken out of their slumber as central bankers signalled reluctance to extend stimulus and sent US stocks to their worst week since February.
That makes this a great time to consider how our Investing — portfolios of stocks built from Investment Finder screens that we’ve borrowed from some top investors and investment researchers — might add more juice to your returns and discipline to your investing.
Think that it’s impossible to beat the broad averages? Perhaps this will change your mind.
- A portfolio of stocks picked last Jan. 2 has trounced the market with a 51% gain through friday; the S&P 500 is up 15% in that period. All of the stocks in the group are winners, led by Best Buy (BBY, news, msgs) with a 93% gain so far this year and Yahoo! (YHOO, news, msgs) at 89%. The worst in that group, Arterial Vascular Engineering (AVEI, news, msgs) is up 12%.
- On March 20, we started five new SuperModel portfolios — another Flare-Out Growth, Sparkling Splits, Keystone Growth, Beating the Dow and Sensational Sectors — to coincide with the launch of Investor Version 5. Four of them are beating the S&P 500 Index by up to five-fold. The single laggard, Keystone Growth, is behind the S&P 500 by one percentage point.
- Among the stocks in the five new models, 27 of 40 were beating the market through Monday; among the sector funds, four of five have beaten the market. The biggest winner, Yahoo!, is up 49% in the period while the worst loser, Intermedia Communications (ICIX, news, msgs), is down 17%.
To understand why these portfolios are working, it’s important to understand the difference between stock “screens” and stock “models.”
- Screens are lists of securities you can create in Investment Finder by searching the Investor database of 8,900 stocks and 7,700 funds for ones that meet certain price, volume and value criteria. For many investors, screens are just a starting point; they’re used to find stocks that merit further research. An investor may buy only one or two of the stocks netted in the screen, if any. See our help section for assistance in building screens with Investment Finder.
- Models are mechanical, programmatic ways to use screens to buy stocks. They provide a discipline for an investor to purchase the top five, 10 or more stocks netted by a screen — and hold for a set period. Models also tell an investor when to sell those stocks and start over. Models are used by investors who believe that it’s easier to find groups of stocks likely to turn in great performance than to pinpoint individual stocks that will outperform.
All of our SuperModels have been developed and tested against historical data by veteran outside researchers, then tweaked slightly by Investor. All can provide extremely valuable discipline to investors who have a hard time deciding exactly when to move into and out of stocks — and that includes just about everyone. While they can be rewarding in the right market climate, however, any model can also be highly volatile. Ours can be especially nerve-racking because all but one — Beating the Dow — are built from screens that seek high-momentum growth stocks under certain conditions. The Flare model, for instance, went into the red for one day a couple of weeks ago, though it quickly recovered.
Get Ready to Roll
Our momentum models should probably only be used for a portion of one’s total portfolio that is set aside for more aggressive growth. Our Beating the Dow model, however, can be considered a candidate for core positions since it seeks out undervalued stocks in the Dow Jones Industrial Average and holds them for a year.
This type of investing is not tax-efficient, so trying it in an untaxed Individual Retirement Account may make the most sense. Our models also require up to 100% to 300% turnover every year — like many popular mutual funds — so using a deep-discount broker charging $5 to $15 per trade to minimize costs is also recommended.
To execute a model strategy, decide first on an amount you wish to invest and the number of stocks you wish to buy. Then subtract commission costs from your kitty, and divide that number by the number of securities you plan to purchase. That’s the amount you’ll invest in each stock. Finally, divide that figure by the current price of the stocks you plan to buy, and you’ll have the number of shares to buy. Don’t worry if they’re odd numbers like 31, 62 and 102.
For example, if you have $20,000 to invest in 10 stocks and plan to have an $8 commission, then subtract $80 from $20,000. That’s $19,920. Divide that by 10, and you’ve got $1,992 to spend on each stock. If the first stock is selling for $63 per share, you’ll buy 31 shares.
Now let’s take a look at three of our SuperModels in greater detail. I’ll cover the others in my next update in May.
This has been our best SuperModel over both the most recent three-month and one-month periods. It offers a disciplined program for purchasing strong, large-cap stocks on dips and selling them into strength.
The model run since the beginning of the year is up more than 50% on the strength of PC hardware maker Dell Computer (DELL, news, msgs), biotech firm Immunex (IMNX, news, msgs), air-freight outfit Airborne Express (ABF, news, msgs) and Internet search engine Yahoo!
We recommended a three-month holding period for the model, then followed up with a new portfolio on March 20. That version is up better than 11% on the strength of network PC software maker Citrix Systems (CTXS, news, msgs) and rubber-glove maker Safeskin Corp. (SFSK, news, msgs).
The model seeks companies with market capitalization greater than $1 billion that appreciated the most in the past 12 months but have entered a period of price consolidation in the most recent quarter and particularly in the most recent month. Technical analysts have learned to look for stocks like these in their charts since they are considered explosive — and the Flare-Out screen essentially recreates this pattern.
We use a formula developed by researchers at Ford Investor Services in San Diego, Calif. that subtracts a stock’s most recent three-month performance and 3 times the most recent one-month performance from the one-year return. Theory suggests that stocks should regress to their mean (a high trajectory) after the period of consolidation. By the same token, as stocks appreciate very fast in the near term, they sink in the rankings; that’s the discipline that helps you sell into a rally.
To devise your own set of Flares in Investment Finder, create this screen:
- Click in the Field Name box or on the down arrow next to the box and select Company Basics from the pull-down menu. Then select Market Capitalization. Choose “greater than or equal to” (>=) in the Operator field and type “1 billion” in the Value field.
- Click in the next line under Field Name. From the pull-down menu, click Stock Price History, then select % Price Change Last Year. Type a minus sign (-) after the word “year.” Click the arrow next to the box. From the pull-down menu, select Stock Price History, then click % Price Change Last Quarter. Next, type another minus sign, then the number 3 and then a multiplication sign (*). Then, Click the arrow next to the box. From the pull-down menu, select Stock Price History, then click % Price Change Last Month.
- The final formula in this second field should look like this: “%Price Change Last Year-%Price Change Last Qtr.-3*%Price Change Last Month.”
- In the Operator field, select “High As Possible” from the pull-down menu.
Ford researchers recommend purchasing the top 10 stocks netted in the model and holding them for three months. Then they suggest re-running the screen and selling any stocks that have fallen out of the top 20 in the ranking. Replace them with the highest-ranking stocks in the new screen, and you’re in business.
I have been testing a variation on this model that lowers the minimum market cap to $300 million and requires a minimum On Balance Volume figure of 150. On Balance Volume is a measurement that determines whether a stock is rising on increasing volume. Generally, a figure over 100 is good and over 200 is excellent. In the Finder, you’ll see On Balance Volume as an option under the Field Name “Trading & Volume.”
Because this is the Flare-Out model with the volume turned up, I call them Loud Flares.
Stocks in the new portfolio on April 20: Excite (XCIT, news, msgs), IGEN International (IGEN, news, msgs), American Eagle Outfitters (AEOS, news, msgs), EarthLink Network (ELNK, news, msgs), Adelphia Communications (ADLAC, news, msgs), Cyberonics (CYBX, news, msgs), Yahoo! (YHOO, news, msgs), CMG Marketing Services (CMGI, news, msgs), FileNET (FILE, news, msgs) and SFX Broadcasting (SFXBA, news, msgs).
Value investors will turn their noses up at momentum stocks like these, but their derision misses the point that the market today — as since the beginning of time — is driven as much by emotion and psychology as by fundamental value. Strategic momentum investing is not a lot different than walking into a restaurant and asking the waiter to bring you the night’s most popular dish. Chances are that you’ll walk out happier than if you had asked for the meal least popular with your fellow diners. That unpopular meal might have the fewest calories, the least fat and the most exotic ingredients — but if it’s not also the most tasty, no one’s buying it. And neither should you.
This model, also devised by Ford Investor Services, has gained 11% in the past month, soundly beating the market. Over the past 12 years, the model recorded 27% annual gains on average. It seeks out-performance from stocks that have split in the past month, beaten securities analysts’ estimates over the past two quarters and seen mean earnings estimates raised over the past month.
Here’s how to create the screen in the Investment Finder:
- Click in the Field Name box or on the down arrow next to the box and select Advisor FYI. Hover over the Analyst Projections submenu and choose Earnings Estimate Increased. In the Operator field, select Since. In the Value field, select In the Last Quarter from the drop-down menu.
- Click in the next line under Field Name. Select Advisor FYI and then Analyst Projections again, but then choose Exceeded Analyst Estimates for 2 Quarters. In the Operator field, select Since, and in the Value field, select In the Last Quarter.
- Click in the next line under Field Name. Select Advisor FYI, and then hover over Stock Price History and select Stock Has Split. In the Operator field, choose Since. In the Value field, select In the Last Month.
- Click in the next line under Field Name. Select Analyst Projections, and then Recent Qtr Surprise %. In the Operator field, choose “greater than or equal to” (>=). In the Value field, type “5.”
|Running the screen on April 20 yielded these stocks: Mastech Corp. (MAST, news, msgs), Siebel Systems (SEBL, news, msgs), Monaco Coach Corp. (MCCO, news, msgs), Sterling Software (SSW, news, msgs), CIBER Inc. (CBR, news, msgs), Information Management Resources (IMRS, news, msgs), Century Telephone Enterprises (CTL, news, msgs) and Renaissance Worldwide (REGI, news, msgs). If you wanted to stick with just the stocks that had good On-Balance Volume figures, you’d eliminate Monaco, Siebel and Renaissance.|
Beating the Dow
Beating the Dow
|The traditional version of this model returned an average of 18.1% per year from 1961 to 1996, but we do it a little differently due to the “fuzzy logic” capabilities of Investment Finder. We seek the Dow Jones Industrials with the highest dividend yield, lowest price-earnings ratio and lowest absolute price. A valuable modification of this strategy, introduced by Robert Sheard of The Motley Fool, throws away the high-yielding stock if it is also the lowest priced.|
Here’s how to create the screen in Investor yourself:
The new stocks on April 20: General Motors (GM, news, msgs), Chevron (CHV, news, msgs), Caterpillar (CAT, news, msgs), Union Carbide (UK, news, msgs) and J.P. Morgan (JPM, news, msgs).
With any luck, when the Dow hits 12,000 next year by this time, most of your stocks will be ahead of the pack.
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