Abbott, Cisco Prove the Potential Folly of Stock Picking

 |  Includes: ABT, CSCO, XLK, XLV
by: Roger Nusbaum

There was a peculiar exchange on CNBC the other day between Mark Haines and a guest touting Abbott Labs (NYSE:ABT) as a value stock. Haines asked why anyone would want to buy such a stinker of a stock, noting that it has lagged badly since the March 2009 low. It is essentially flat since then, versus a 43% lift for the Healthcare Sector SPDR (NYSEARCA:XLV) and an 88% lift for the S&P 500.

The guest was making a value case for the name, simply concluded that he thinks the market will recognize the value in the name at some point, and that they will be rewarded for the pick. Later in the day, another analyst said he liked Cisco (NASDAQ:CSCO) for the valuation. Cisco seemed to be capturing the effect off of the March low, actually outperforming the Tech Sector SPDR (NYSEARCA:XLK) until a few months ago, when it started to rollover and lag before blowing up with an almost 20% drop in mid-November. Over the last 10 years it has lagged XLK most of the time, and is down 43% from where it was 10 years ago versus a 21% decline for XLK in that same time period. Maybe Haines would call this one a stinker too?

I don't really know anything about Abbott -- I know a little about Cisco -- but both create a point of understanding about the potential folly of stock picking. I am a big believer, obviously, of including individual stocks in a diversified portfolio, but clearly some picks work out and some do not. Picks can work or not work for a multitude of reasons, many of which are not foreseeable.

Buying a stock primarily because it is a compelling value is a very difficult thing to do. It is easy to understand that a stock is "cheap" by some objective measure, but the difficult part is assessing when the value gets recognized. It can also be difficult to discern why a stock is cheap. Cisco and Intel (NASDAQ:INTC) have been cheap for a long time. Are they value stocks or value traps? You may have an opinion, but it is a reasonable question.

The above tends to be more of a bottom-up process for stock selection. The way I pick stocks is from the top down. Top-down picks frequently come from country or theme selection. If you correctly pick a country that then goes up 50%, it will be very likely that a large-cap stock (still properly researched) with a large weight in the benchmark index for that country will go up a similar percent. There can be no guarantee, of course, but you have a pretty easy-to-understand tailwind. Conversely, are you willing to bet that you can find some stock in Portugal that will do well for the next year or two? I certainly would have no reason to think I can find a stock that does well if Portugal goes down a lot this year.

As I believe in top-down, I would obviously make that sound more compelling. Plenty of investors do very well with bottom-up stock picking, but I think this is the more difficult path. With the more top-down tailwinds you can correctly isolate the easier time you will have with your portfolio and, perhaps even more importantly, the more headwinds you can correctly isolate, the easier time you will have with your portfolio.