Related Articles
New tricks for Dogs of the Dow
14 turkeys that could fly in 2005
Set yourself up for a stellar 2005
Jubak's Journal
Recent articles:
• Show us your CEO stuff, 12/17/2004
• 5 stocks for cautious times, 12/15/2004
• 10 energy stocks -- and when to buy them, 12/14/2004
More...
| | Jubak's Journal
10 hated stocks youll love in 2005
My Dog Stars strategy calls for buying hated stocks in December and holding them for a year. Heres how to screen for the right stinkers -- and 10 that look especially promising.
By Jim Jubak
Buy em when theyre hated. I dont mean out of favor. Or disliked. I mean HATED.
And buy em at the end of the year. Not in November. Not in January. But around the middle of December.
Thats the simple foundation of the Dog Stars strategy I laid out in my Sept. 24 column. And now that were in the middle of December, its time to pull the trigger and pick the 10 Dog Star stocks for 2005.
An improvement on 2 tested strategies
The Dog Stars strategy is a straightforward attempt to build on two very successful buy-em-when-theyre-hated strategies.
First, theres the Dogs of the Dow strategy, which works like this: Every Dec. 31, you buy the highest-dividend-yielding stocks in the Dow Jones Industrial Average ($INDU). Because a stocks dividend yield goes up as the price of a share falls, this is a simple way to buy shares of the 10 most-battered stocks in the index. You then hold the shares for a year and rebalance the portfolio by selling these stocks and buying a new group of losers next December.
This extraordinarily simple strategy has yielded market-beating returns decade after decade. From 1928 to the end of 2003, the Dogs of the Dow strategy returned an average annual compounded rate of 13%. That was almost 2 percentage points a year better than the return on the Dow industrials and 2.5 percentage points better than the return on the Standard & Poors 500 Index ($INX).
The Dogs of the Dow strategy turns in its best monthly performance in January. Thats led Yale and Jeffrey Hirsch to propose an improved approach, called the Free Lunch strategy. As laid out in the Stock Traders Almanac, their strategy calls for buying all the New York Stock Exchange stocks selling at their lows in mid-December and holding them to Feb. 15. The average gain on the strategy since 1974 through 2003 comes to about 13% in six weeks. That compares to the average 5% gain in the NYSE Composite ($NYA.X) for the period.
My Dog Stars strategy is designed to take advantage of the two reasons that these successful strategies work.- First, the Dogs of the Dow strategy works because the 30 stocks that make up the Dow Jones Industrial Average tend to be long-term survivors. These companies have enough financial strength to weather short-term troubles without going out of business. They survive bad times long enough to see the return of better times. Boeing (BA, news, msgs), up 28% in 2004, is an example of the benefits of being financially strong enough to survive the worst of times.
- Second, the two strategies work because they buy already beaten-down stocks that decline even further in the last days of the year as investors sell their losers to lock in tax losses for the year. When the selling pressure is relieved in January and February, these stocks bounce back from deeply depressed to simply depressed levels.
Dog Stars membership rules
In the screen that Ive built to identify potential Dog Star stocks, Ive replaced membership in the Dow Jones Industrial Average with a series of tests to ensure that these are stocks of companies with the financial strength to stick around long enough for a rebound. In my screen, I required a market capitalization of $1 billion or more, a debt-to-equity ratio of 1 or less so that the company has plenty of access to the capital markets to raise new cash if necessary, and a quick ratio of 1 or more. (The quick ratio divides liquid assets by current liabilities. The higher the quick ratio, the more liquid assets the company has to meet current liabilities if all revenue dries up.)
When I first built my Dog Stars screen, I looked for beaten-down stocks by requiring that the shares made a 52-week low in the last quarter, and that the current share price was within 20% of that 52-week low. Ive run this screen several times since then and each time I do, I am more dissatisfied with the pricing criteria I used to surface hated stocks. So this time, Ive tweaked my two price rules to come up with this combination:- Relative strength of 20 or less in the last three months. A stock with a relative strength of 20 has been outperformed by 80% of the stocks in the market. I think membership in the lowest fifth of all stocks is a good sign that investors hate these shares.
- Previous days closing price is within 20% of the stocks 52-week low. One of my two original price rules that assures me Im buying shares that are not just hated, but also cheap when judged by their own recent history.
10 stinkers that could really pay off
That screen (you can find it here) identified 55 stocks when I ran it on Dec. 17. I took a stock-by-stock look at such gauges as price-to-sales ratio (looking for cheap stocks with low ratios) and StockScouter sub-ratings that showed solid fundamentals despite lousy technicals. Finally, I read through recent news and company reports looking for both improving conditions and warning signs for 2005.
| 10 Dog Stars to buy | | Company | Dec. 17 price | 52-week low | 3-month relative strength | Price-to-sales ratio | | 3M (MMM, news, msgs) | $80.62 | $73.31 | 18 | 3.17 | | Claire's Stores (CLE, news, msgs) | $20.20 | $18.03 | 5 | 1.62 | | Eli Lilly (LLY, news, msgs) | $56.02 | $50.34 | 7 | 4.75 | | Gannett (GCI, news, msgs) | $79.26 | $79.34 | 11 | 2.81 | | Medtronic (MDT, news, msgs) | $48.65 | $43.99 | 18 | 6.07 | | Micron Technology (MU, news, msgs) | $11.31 | $10.89 | 10 | 1.62 | | Perrigo (PRGO, news, msgs) | $17.58 | $15.50 | 7 | 1.38 | | Reynolds & Reynolds (REY, news, msgs) | $24.03 | $21.11 | 20 | 1.92 | | SanDisk (SNDK, news, msgs) | $22.77 | $19.28 | 7 | 2.3 | | SBC Communications (SBC, news, msgs) | $25.70 | $22.98 | 18 | 2.09 |
|
So, for example, Reynolds & Reynolds qualifies as a potential Dog Star because:- Investors know what the company did wrong (sent current business into a tailspin as the company tried to cram five years worth of new products and restructuring into three years).
- The near-term fix is relatively easy (hired a CEO to restore the morale in the companys sales force).
- Fiscal 2004, which ended in September, was such a stinker (even with fewer shares outstanding, earnings per share fell 12%).
The companys financial strength (it generated $160 million in operating cash flow in 2004) means that it will have time to right itself. And in the midst of all this mess, Reynolds & Reynolds continued to add new products to buttress its leading position in information-management systems in its core automotive market.
I dont expect any of these stocks to soar overnight, but theyre all financially solid enough to weather bad times. And with 2005 shaping up as a very volatile year, I think buying the downtrodden instead of the flavor of the moment makes sound investing sense.
After all, how hard will it be for any of these companies to exceed investor expectations next year?
New developments on past columns
Vicious cycle: Rising oil prices, falling dollar
I guess we shouldnt be expecting the Japanese to use their savings to bail us out of our deficit problems. Faced with a huge and growing deficit and an almost complete lack of interest in buying Japanese bonds by foreign investors, the Japanese government is going on the road to pitch its debt in the United States and Europe. The 10-member delegation will visit London and New York in January in an attempt to raise the anemic foreign purchase of bonds issued by the Japanese government. Foreign investors have cut their holdings to 3.3% of outstanding Japanese government bonds from 8% five years ago. Thats a big problem for a government that makes Washington look like a model of financial discipline: National debt outstanding hit 130% of Japanese gross domestic product in 2003, the highest debt burden among developed countries. The Japanese roadshow faces a tough sell: 10-year Japanese government bonds yield just 1.4% in comparison to 10-year yields of 4.1% on U.S. Treasurys and 3.6% on the 10-year German government Bund.
Changes to Jubaks Picks
Sell Analog Devices
Time to take my medicine (and get my tax loss in under the wire). My buy of Analog Devices (ADI, news, msgs) on June 18 at $45.73 a share just never worked out. The late-summer rally I expected in technology shares didnt materialize, and chip stocks havent fared especially well in the otherwise very respectable year-end rally of Nasdaq stocks. Because this was a seasonal play and the seasonal forces didnt lift the stock, I dont think theres any point in hanging on and hoping. Im taking a 20% loss on this position. (Full disclosure: I will be selling my personal shares of Analog Devices three days after this column is posted.)
Editor's Note: A new Jubaks Journal is posted every Tuesday and Friday. However, Jim will not publish new columns on either Friday, Dec. 24, or Friday, Dec. 31.
E-mail Jim Jubak at jjmail@microsoft.com.
At the time of publication, Jim Jubak owned or controlled shares in the following equities mentioned in this column: Analog Devices and Micron Technology. He does not own short positions in any stock mentioned in this column.
|
