Guru Picks Gone Bad: 2 Screens That Weeded Out The Worst

by: David Pinsen


There's no way to avoid all investments that end up performing poorly, but there are two screens that can avoid some of them: past price performance and hedging cost.

We applied those two screens to a list of investing guru picks six months ago, and the ones that passed both screens significantly outperformed the others.

We elaborate on the two screens, discuss why they work, and ask what sector readers would like to see them applied to next.

Last Summer's Guru Picks Continue To Lag

Last December, we showed how two screens to avoid bad investments, when applied to a list of stock picks by top gurus such as Warren Buffett, Seth Klarman and David Einhorn (pictured below, image via DealBreaker), separated out most of the worst performers.

Although the guru picks as a whole performed poorly over the next few months, the ones that passed the two screens significantly outperformed the ones that didn't: the average three-month return for names that passed both screens was -4.88%, while the average three-month return for the names that didn't pass both screens was -22.75%.

In this article, we track the performance of both groups of picks over the last six months and show that, although the guru picks as whole have continued to do poorly, the divergence has increased: over the past six months, the names that passed both screens returned an average of -4.11%, while the names that didn't pass both screens returned an average of -29.86%.

We'll also detail both of the screens below, but first, here's a look at how the two groups of guru picks have performed over the last six months (in the case of Precision Castparts (BATS:PCP), until its acquisition by Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B) in January, and in the case of Altera, up until its acquisition by Intel (NASDAQ:INTC) in December.).

Guru Picks That Passed Both Screens, 6-Month Returns:

  • Advance Auto Parts (AAP), -7.84%
  • Precision Castparts , +2.35%
  • Cigna Corporation (CI), -2.23%
  • Danaher Corp (DHR), +11.55%
  • Humana (HUM), -1.28%
  • Perigo (PRGO), -23.06%
  • Shire (SHPG), -22.85%
  • Time Warner (TWC), +10.47%

Average 6-month return: -4.11%

Guru Picks That Didn't Pass, 6-Month Returns:

  • SunEdison (SEMI), -39.21%
  • SunEdison (SUNE), -86%
  • Williams (WMB), -61.12%
  • Baker Hughes (BHI), -15.5%
  • Office Depot (ODP), -13.74%
  • Altera (NASDAQ:ALTR), +7.3%
  • Icahn Enterprises (IEP), -7.53%
  • Brookdale (BKD), -40.18%
  • T-Mobile (TMUS), -12.82%

Average 6-month return: -29.86%

Screening Out The Worst-Performing Picks

In an article published in early September ("Investing Alongside Buffett, Klarman, And Other Top Investors While Limiting Your Risk"), we entered each of the guru stock picks above into Portfolio Armor's hedged portfolio construction tool. That tool works differently depending on whether you enter your own securities or not. If you don't enter your own securities, the tool populates your portfolio with the securities with the highest potential returns, net of hedging costs, in its universe (its universe consists of every stock and exchange traded product with options traded on it in the U.S.).

If you do enter securities, as we did with those guru picks, the tool performs two screens on the securities you enter before attempting to calculate potential returns for them.

Screen No. 1: Most Recent 6-month Performance V. Long Term

The first screen is one you can easily do yourself. The tool looks at how the ticker performed over the most recent six months and compares that to the average six month performance of the security over the long term (ten years, if a stock has been around that long, if not, it uses the long term returns of an industry competitor as a proxy, for exchange-traded products it uses since-inception returns if it hasn't been around for ten years). The tool will reject any security with a negative return over the last six months, unless the average six-month return of the security over the long term is greater than the absolute value of the most recent six months return.

To illustrate this, let's look at one of the guru picks that failed this screen back in early September, SunEdison. Below is a chart, via Yahoo, showing the performance of SUNE over the six months prior to when Portfolio Armor rejected it for inclusion in that September hedged portfolio:

SUNE was down 48% over the six months prior to early September. The only way it would have made it past this screen is if its average six-month performance over the last 10 years was greater than 48%, and, as you might guess, that wasn't the case, so SUNE failed the first screen.

Screen #2: Hedging Cost

Since SUNE failed the first screen, it was eliminated. An example of a stock that passed the first screen, but failed the second, was Williams. WMB was down 3.25% over the most recent six month period as of early September, but its average six-month performance over the previous 10 years was 4.81%, so it passed the first screen. But it was too expensive to hedge against a greater-than-9% decline over the next six months using an optimal collar, so it was rejected. We explained how to find optimal collar hedges in a previous article, if you're willing to do the work manually, or you could use an automated tool such as our hedging app.

Rationales Behind The Two Screens

Although these two screens don't eliminate all poor performers, they work to eliminate some of the worst performers. They both employ what New Yorker columnist James Surowiecki termed the wisdom of crowds:

Large groups of people are "smarter" than an elite few, no matter how brilliant - better at solving problems, fostering innovation, coming to wise decisions, even predicting the future.

The large group of people in screen No. 1 is the stock market, and the large group of people in screen No. 2 is the option market - the elite few would be the gurus who initiated or added to positions in these stocks last summer.

Applying These Two Screens To Sectors

In January, we applied these two screens to a list of leading REITs. We plan on updating the performance of those next month. If you'd like to see these screens applied to another sector, feel free to suggest one in the comments.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.