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With the first quarter of 2013 recently ended, now is a good time to review the stocks that I have recommended as buys beginning in the third quarter of 2012[1]. To qualify as a pick, I must have written an article fully devoted to the stock. Within that context, every stock I have recommended as a buy is in the table below. I did not cherry-pick results to improve my performance.

The effect of dividends was not included, but as my average pick yields 2.3% vs. 2.0% for the S&P 500, the effect would have slightly widened my outperformance.

Figure 1: Performance of My Stock Picks Relative to the Market (click to enlarge)

(click to enlarge)

The average return you would have received making an equal investment in each of my picks is 12.67%, not including dividends, vs. an average of 7.77% for making an equal investment in the S&P 500 (SPY) at the same times. Thus, my suggestions outperformed the market by 4.90% over the past 9 months, but since half were made before and half after that midpoint, I would say this record is equivalent to one half of a year. Not a bad performance, but it could have been better.

It is worth making some general observations about my performance that will guide my stock selection in the future and hopefully, widen my outperformance:

  1. I have realized that my ability to pick tech stocks is rather limited. My worst pick was Apple (AAPL) and my second worst pick was Microsoft (MSFT). Removing these two picks would have widened my outperformance by over 400 basis points and nearly doubled it. Moving forward, I do not expect to be picking many tech stocks unless I feel that I have a unique perspective on the company.
  2. The more esoteric the pick, the stronger the performance if the investment thesis is proven correct. While stocks like Chevron (CVX) or Exxon (XOM) may give good risk adjusted performance, they are unlikely to outperform the market by a wide margin. There is no problem with that, and I still own both these stocks to provide ballast to my portfolio. However, you probably won't generate major alpha here. Johnson & Johnson (JNJ) has actually surprised me by outperforming the market as much as it has, but even just keeping up with the market, I expected the risk-adjusted performance to be very strong and the calls were so cheap, it enabled an interesting option based strategy. Thus far, that strategy has greatly outpaced the market with far lower risk. If you had followed it, you would have a 15% return over a period when the market returned 3.3%, with only 10% of your money in risk assets.
  3. It is the small unappreciated stocks with improving fundamentals that generated my alpha. Zimmer (ZMH), Universal Health Services (UHS), Jacob's Engineering (JEC) and Life Biotech (LIFE) are good examples. If you take the time to understand a smaller overlooked company better than most, you may be able to realize outperformance.
  4. Value investing is highly overrated. Most desirable companies on the market are reasonably valued, and while I would not recommend purchasing very overvalued companies, most considerably undervalued companies have considerable problems in their business model. If a company is very cheap during a raging bull market, there most likely is something wrong. Call me a speculator if you like, but I have little interest in buying a coal company and waiting 10 years in the hope that it does not go out of business. Very good returns can be had from fairly valued companies when the business fundamentals are improving. I find this method much more satisfying than buying companies that are "cheap" and hoping that someday a catalyst emerges to make the market price them more dearly.
  5. Avoid crowded trades at all costs. My performance was hurt the most by Apple, a great over-owned company. Dollar General (DG) also underperformed, even though the company has done very well since I recommended it. Hedge funds owning a stock just mean there are big fingers ready to hit sell. I now review 13-F filings and avoid stocks that are over-owned by actively managed funds.
  6. I highly recommend keeping a spreadsheet of your picks if you invest in individual stocks. Record your cost basis (including commissions) and the result of an equal investment in the S&P 500. In fact, if you are new to investing, I would recommend investing in an index fund and picking stocks as practice until you are comfortable with what you are doing. Also remember that outperforming the S&P 500 is not the only thing you should concern yourself with. If you buy a cyclical stock, which could expose you to a significant loss during an economic downturn, you must expect a better return to compensate for that risk. You could consider a metric that adjusts the gain by the drawdown that the stock suffered during the last bear market, or one which adjusts with the beta of the stock. The same return with lower risk is always the better path, although in my experience less risk often leads to higher returns.

In conclusion, one thing that I can say for certain is that the market is highly competitive. In order to outperform, you must appreciate something about the business fundamentals of the stocks you are buying that others do not. Before you make your next trade, ask yourself: what do I know that the guy selling to me does not? If the answer is nothing, you may prefer to stick with index funds.

1. I would like to make readers aware that I also do a fair amount of blogging for the Motley Fool under the name of brenoboyle. Simply Googling that name along with Motley Fool will bring you to a list of my articles, so if you enjoy reading my articles on Seeking Alpha, you may consider bookmarking the page. I included picks from both sites in my performance for this article.

Source: Analyzing My Performance Near Quarter's End

Additional disclosure: Several of the long positions above are calls on the underlying equity.