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| The Basics | 10 Comeback Kid stocks for 2006
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My simple Comeback Kids strategy selected 10 stocks for 2005 that have gained 15% so far, twice the market's return. See which out-of-favor names it flags for 2006.
By Harry Domash
Just about a year ago, on Nov. 12, 2004, I ran a screen intended to turn up 10 out-of-favor stocks ripe for a comeback in 2005. Last week I was pleasantly surprised when I checked the progress of those Comeback Kids.
The kids returned 15%, on average, through Nov. 21, more than doubling the S&P 500s 7% performance over the same period. Even better, the portfolios return didnt depend on one or two stocks. Seven of the 10 recorded double-digit returns. Only one of the remaining three, Fifth Third Bancorp (FITB, news, msgs), down 15%, recorded a significant loss.
Here's a look at the full portfolio:
| Domashs Comeback Kids for 2005 | | Stock | One year return | | Merck (MRK, news, msgs) | 23% | | Marsh & McLennan (MMC, news, msgs) | 19% | | Applied Materials (AMAT, news, msgs) | 14% | | Intel (INTC, news, msgs) | 20% | | Charles Schwab (SCH, news, msgs) | 49% | | Clear Channel Comm. (CCU, news, msgs) | -1% | | Texas Instruments (TXN, news, msgs) | 31% | | Analog Devices (ADI, news, msgs) | -3% | | Fifth Third Bancorp (FITB, news, msgs) | -15% | | Washington Mutual (WM, news, msgs) | 13% |
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Id like to say that my Comeback Kids screen was based on my advanced research and stock analysis skills. It wasn't. As youll see in a minute, that screen, inspired by the Dogs of the Dow strategy, is incredibly simple.
Dow dogs need new tricks
Popularized by Michael OHiggins in his 1991 book Beating the Dow, the Dogs of the Dow strategy involves buying equal dollar amounts of the 10 most out-of-favor stocks in the Dow Jones Industrial Average ($INDU), holding them for a year and then repeating the process.
OHiggins defined out-of-favor stocks as those having the highest dividend yields. If youre rusty on your stock-market math, the dividend yield is the expected next 12 months dividends divided by the current share price. Since the yield goes up when the stock drops, OHiggins reasoned that high-yield stocks got that way because their share prices had been pummeled by unhappy investors. OHiggins limited his universe to Dow stocks because, being the biggest and strongest firms, they have the wherewithal and experience to overcome just about any adversity.
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The Dow dogs' performance has roughly equaled the major averages over the past 10 years, nothing to bark about. However, the dogs produced those results with much less volatility. For instance, in 2002, the dogs dropped only 9% compared to the S&Ps staggering 22% loss.
That said, OHiggins dog strategy has two glaring shortcomings.
First, the Dow 30 is just too small of a universe to produce a worthwhile list of candidates. Second, dividend yield doesn't work for picking out-of-favor stocks, even within the Dow 30. Yields are as much about individual firms dividend policies as they are about whether the companys stock is in or out of favor.
For instance, cigarette maker Altria (MO, news, msgs), up 26% over the past 52 weeks, is the Dows third-best performer in that period. But its 4.4% dividend yield, the Dows fifth highest, puts it firmly in the dog category. Similarly, aluminum maker Alcoa (AA, news, msgs), with a 21% loss, was the Dows third-biggest loser. But its 2.2% yield is too small to garner a dog rating.
OHiggins concept is appealing for its simplicity and relatively low-risk returns. Still, I couldnt resist the temptation to try to overcome those shortcomings.
New Kids for 2006
Heres how I modified it to devise my Comeback Kids strategy.
First, substituting the S&P 500 index with its 500 stocks for the Dow 30 is an obvious choice. Handpicked by Standard & Poors, the index includes all the Dow stocks and the leading firms in almost every industry.
Too big to fail
I limited the field to members of the S&P 500 with market capitalizations of at least $10 billion. Market cap is how much youd have to pay to buy the entire company. Its calculated by multiplying the recent stock price by the number of shares outstanding. I arbitrarily picked $10 billion because most would agree that a company that size is just as likely to survive whatever problems it encounters as any Dow 30 component. Feel free to adjust that figure up or down if you have a better idea.
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