How You Can Put
This Winning Strategy
to Work for You
How I Made 14.9 Percent a Year—and How You Can Too
Most stock picking starts from the bottom up.
One method begins with some kind of formula for picking the best stocks by looking at the fundamentals of a company’s business: how fast the company is growing profits, its profit margin, the size of its debts, or its cash flow. The system then gives you a way to judge whether a stock with this or that fundamental character is cheap or expensive. A buy or a sell, in other words.
Another relies on charts and other indicators of a stock’s price momentum or some other technical measure of past performance that predicts future performance. This kind of technical analysis tells you how to use things called moving averages, Bollinger bands, relative strength indexes, cups and handles, and Japanese candlesticks to find stocks that are trending up or down.
The two approaches seem as different as night and day. But they do have this in common: both start with individual stocks, and both are wrong.
Picking individual stocks that beat the market consistently, using either method, turns out to be hard work. Research shows that most professional money managers can’t do it. And most individual investors can’t either. Most investors who try to run their portfolios this way wind up trailing the stock market indexes such as the Dow Jones Industrial Average or the Standard & Poor’s 500. They’d be better off simply buying a fund that tracks a market index.
I think the reasons for that are pretty simple. Identifying the past characteristics of an individual stock, using any system fundamental or technical, that will make a stock go up in price in the future is pretty much like looking for a needle in a haystack. An added challenge is that those “winning” characteristics change over time as the economy and market change, and that other investors are poking through the haystack too, bidding up the price of any easy-?to-?find needles.
I think this whole approach to stock picking is upside down.
Why? Well, because financial research has shown that a majority of the money you’ll make (or lose) in the financial markets comes from being in the right class of asset at the right time. If you get that big call right—the decision to have your money in oil stocks or drug stocks or technology stocks—then making money by picking the right individual stock or bond gets a whole lot easier. You’ve got the tide flowing with you, the wind at your back, the downhill ahead—pick whatever image you like. By picking the right asset class, you increase the odds that whatever individual stock, fund, or index you pick will be a winner that beats the market averages.
In this book I’m going to teach you how to beat the stock market averages by using exactly that kind of odds-?altering strategy.
And I know that what I teach you will work.
How do I know?
Because I’ve used exactly this strategy to run a public portfolio on the Internet for the last eleven years and counting. In the portfolio’s first ten years—the ten years cited on the cover—this strategy returned 339 percent. In the total eleven years that I’ve run this portfolio, called Jubak’s Picks, on the MSN Money Web site, this strategy has returned 360 percent. That’s an average of 14.9 percent a year since I started this portfolio on May 7, 1997.
That looks pretty good compared to the returns for the three major stock market indexes during the same period. The Dow Jones Industrials in that eleven-?year time span were up 6.1 percent annually on average. The Standard & Poor’s 500 Stock Index was up 5.8 percent. And the NASDAQ Composite Index was up 7 percent.
You can trust this performance number. The record isn’t the result of going back in time and reconstructing trades to make the numbers look good or turning vague buys into real buys when it suits me and ignoring them when it ?doesn’t. Every single buy and sell I’ve made in those eleven years has been clearly published as a buy or sell at the end of a column—marked out with the clever title of “Buy” or “Sell” and then tracked while I held the shares and for about a year after I sold them on the page that lists the complete Jubak’s Picks portfolio at the current time. Every quarter for those eleven years I’ve reported in my column how the portfolio has done in that quarter, for the year to date, and for longer periods. Some reports, such as those during the bear market of 2000–2, were downright painful to write. But the record is the record, warts and all. And it’s always been available to anyone who cared to click.
Let me give you a real-?life example—one from my online portfolio— that shows how my system works.
Start with a Top-?Down Approach by Finding an Odds-?Shifting Trend
Start with a macro trend in the United States or, better yet, the global economy. The bigger the better. You’re trying to put as big a wind at your back as you can in an effort to shift the stock market odds in your favor.
You don’t have to be an economist or anything with a fancy title to come up with these trends. You can uncover them with careful observation of everyday life and from reading the daily newspaper or whatever online source of news has taken its place for you.
But I’ve done the heavy lifting for you. In Part II (chapters 3–12) I’ll give you ten such odds-?shifting macro trends and name the best
individual stocks, mutual funds, and exchange-?traded funds you can use to profit from the ten trends.
What are those ten big trends? Let me list them very quickly. In the book you’ll find a chapter devoted to each.
• Go where the growth is—and that means putting some money in the developing economies of China, India, Brazil, and the rest of the gang.
• The rise of the global blue chips. These companies are emerging from the world’s developing economies to challenge Coke, IBM, and Wal-?Mart on the global stage.
• The world is getting wealthier and older at the same time. So who’s going to manage all that retirement money?
• Inflation, the beginning of a new era. After twenty years of low inflation, the world is headed for a decade of constantly rising prices.
• The world may not be running out of oil—then again, it might be— but it sure has run out of cheap oil. How to make back in the stock market what you pay at the pump and more.
• The commodities crunch. The developing economies are demanding more iron, more copper, more nickel, more coal—and that’s set off a boom for mining companies and the companies that equip them.
• Food, the new oil. It’s turning out to be as hard to increase food supplies as it is to find new oil. We’re looking at a decade of higher food prices driven by competition with biofuels and the fact that people in the developing world will eat more pigs, chickens, and other sources of protein as their incomes rise.
• We’ve delayed and dragged our feet, but environmental problems have become so pressing that it’s time to save the world—and make a buck doing it.
• The technology sector ?doesn’t look anything like it used to, but fortunately the same rules still apply to what I call “hidden tech” stocks.
• It used to be that stocks and bonds from the United States got a premium in the financial markets just for showing up. Investors were willing to pay more because the U.S. markets were so stable. They’re still among the world’s best in that category, but now they’ve got company from Canada, Australia, and, of all places, Brazil.
One of these—a trend that you’ve undoubtedly noticed yourself every time you fill up your gas tank or pay the electricity bill—is the rising cost of energy. And that, with a little elaboration, qualifies as a macro trend. I’d phrase it like this: oil and natural gas prices are headed up in the long term.
I then break that macro trend down into its parts. In this example, the trend really is made up of three parts:
• Global demand for oil and gas is headed up because of the fast-? growing economies of China, India, and other developing countries.
• Global supplies of easy-?to-?discover and easy-?to-?produce oil are headed down because the easily exploited reserves in easy-?to-? explore places have largely been discovered.
• Global energy supplies are increasingly subject to disruption by everything from governments intent on nationalizing their oil to terrorists to outright war.
I’ve made important progress even by this step. I’ve identified an asset class, a group of stocks that move together, that’s likely to be moving up. If you can figure out which stock groups are moving together and which aren’t, and then move between them in time to catch some of the ups and avoids some of the downs in those groups, then you should be able to beat the returns you’d get either from investing in a stock market index or from trying to pick the best stock.
By moving into strong stock groups, you pick up on the momentum effect. Common sense and any experience you may have as an investor say that stocks that have been going up tend to keep going up. Academic research says this effect lasts for anywhere from six to eighteen months and gradually gets weaker. Common sense says that a company delivering good news will continue to deliver good news for a while. A company with a product that clicks will see sales rise for more than just the quarter when the product was introduced. A company that discovers new efficienci...