Matthew Kerkhoff, options expert and editor of Dow Theory Letters, continues his 14-part educational...
Winning with the Dow's Losers
05/01/2007 12:00 am EST
You only have to turn on the TV, pick up the newspaper or open your mail to be inundated with advertisements for ‘stock-picking systems’ – those ‘sure-thing’, ‘never-miss’, ‘beat the competition’ strategies for picking winning investments.
Unfortunately, most of them aren’t worth the paper they are written on. Sure, they may work for a year or two, or even an entire market cycle, but most just don’t have the staying power that investors are led to believe when cajoled into putting their hard-earned money into these programs.
However, there are a few that have proven themselves timely and successful over the years. And a nice plum to their investment returns is this advantage: they don’t require expensive software, hours of intensive labor or even the brain of a rocket scientist. Just such a system is profiled in this to me by Charles Carlson.
Mr. Carlson has written more than a handful of best-selling investment books, fostered by his long and successful tenure in the money world. They are all characterized by solid research and good, common-sense investment advice. And this volume lives up to his standards.
We usually profile recent books on MoneyShow.com. However, Mr. Carlson wrote this one in 2004, and because its premise still holds true today, we wanted to share it with you as an example of a time-tested strategy that has stayed the course – from 1930 – the first year tracked by the author – right up to today.
The strategy is simple: in general, the worst-performing stocks from the 30 equities represented in the Dow Jones Industrial Index (DJIA) in one year will be the best performing stocks the following year. Mr. Carlson calls this his “Worst to First Strategy”.
The premise rests on a tenet, common to many walks of life: reversion to the mean. Simply stated, nothing can exist forever at the extremes. At some point, things migrate to their long-run average, or equilibrium state. Consequently, if stocks are over-valued, they will eventually return – via any number of events – to their fair value. And vice-versa.
Nowhere has this been more aptly demonstrated than in the stock market. One must just look to the phenomena of bull and bear markets, and especially the tech boom and bust of the early century, to see that eventually, stocks do return to a reasonable, fair value. It’s just the mechanics of supply and demand driving prices up or down.
Mr. Carlson first noticed this worst-to-first event when analyzing the price motion of Philip Morris (now Altria) in 2000. He originally thought it an anomaly. Then it popped up again with AT&T and Microsoft. That prompted him to do a more thorough analysis, from 1983-2002.
His results demonstrated that had he invested $1,000 in the worst performing stock of the Dow each year then sold it the next year, he would have done five times better than the performance of the DJIA during that same time period. In fact, he would have turned that initial $1,000 into $68,000, compared to the $14,000 he would have attained had he chosen to invest in the DJIA.
His subsequent studies back to 1930 proved that this strategy had actually worked for more than 70 years! And lest you think that this approach will not work today, you need only go to Mr. Carlson’s Web site to see just how well it did last year.
In his book, Mr. Carlson shows investors how to add some advanced techniques to his original methodology in order to fine-tune the strategy to suit your individual needs. And along the way, he gives a history of the Dow, explains how it is compiled and offers some valid advice on evaluating any investment strategy, not just his own.
This book is an easy-to-read manual of common-sense investing, offering investors some essential, how-to strategies for improving their returns. Definitely worth your time.
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