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5 keys to beating the market
My Jubaks Picks portfolio gained 33% in 2005, while the S&P 500 rose only 5%. But how I did on these key measures could prove more important than the numbers game.
By Jim Jubak
How did you do in 2005?
By the numbers, Jubak's Picks had a good year. My picks were up 33% for 2005 versus a 0% return for the Dow Jones Industrial Average ($INDU, news, msgs) and 4% for the Nasdaq Composite ($COMPX, news, msgs).
But numbers aren't the only way to measure a portfolio's performance. (You will, however, find complete performance numbers at the end of this column for Jubak's Picks benchmarked against the indexes for the quarter, year, three years, five years and the life of the portfolio. Also this quarter, I've added a new number: the percentage of closed picks that were profitable vs. those that showed a loss.)
The other ways to measure performance are far more squishy and subjective, but I think they're just as important for anyone who wants to make a consistent profit -- in good years and bad years -- in the stock market.
They're so important because it's scoring well on these subjective measures that keeps a portfolio on course over the long term and prevents a good year or two (or a bad year, for that matter) from leading a portfolio into dangerous territory.
Here are the other ways that I measure my performance - and my judgment on how I did in Jubak's Picks in 2005.
Don't fight the market
Did I take what the market gave me or did I try to force profits? Those of you who like sports analogies should find this very clear. A good offense in basketball doesn't keep forcing the ball into the hands of the center when the defense has collapsed on that player. It takes what the other team is giving it and shoots the uncontested three-pointer from the perimeter. Same in football: Instead of throwing an interception deep into double-coverage, the quarterback picks apart the opposition with short passes. In baseball, the smart batter doesn't try to pull every pitch but often goes to the opposite field.
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It works the same way in the stock market. What do you do if you feel that technology stocks must go up, but market trends are telling you that the technology sector is dead money and that energy is where the action is? All investors have a tendency to favor what we know -- to put our next buy order in on the sectors that have rewarded us in the past and that we know better than others. But not all sectors work in all markets. That was certainly the case in 2005, when the energy and utility sectors were far more rewarding over the stretch of the entire year than, say, technology.
I'd give myself a grade of good on this performance measure this year: I did a decent job of taking what the market gave me by overweighting the energy and gold sectors. I do wish, however, that I'd put more money in utilities and transportation stocks.
Did I keep the wind at my back at all times? Investing, to continue the sports metaphors, resembles batting in baseball. A successful batter still makes an out roughly two-thirds of the time. No investor hits a home run every time up. No investor makes money every trade. A successful investor strikes out at least 40% of the time, I'd guess. The difference between success and failure lies at the margin. Do 40% of your trades make money? Your portfolio is under water. Do 55% of your trades make money? Your portfolio is profitable. (The record for Jubak's Picks since inception in May 1997 shows that 60% of closed picks have been profitable.)
With so little separating profit and loss, it makes sense to me to keep the wind at your back as much as possible. To me, that means going long in periods of the year when market history shows stocks have a tendency to go up -- from the end of October to the end of January, for example. It means being invested in specific sectors when history, again, shows these sectors outperform -- natural gas and oil stocks in March, April and May, for example. And it means staying away from even the most attractive stocks in weak sectors. It is, of course, possible for a stock to climb when the rest of its sector is down, but weak sector performance stacks the deck against that stock. I'd give myself a grade of good on this measure. For example, I largely stayed out of financials when interest rates were climbing, and out of technology until the end of the year.
Running the risks
Did I minimize my risk at all levels? When you buy a stock, you take on more than one kind of risk. There's market risk -- the risk that the market as a whole will go down. There's sector risk -- the risk that all stocks in an industry will go down. And there's individual-stock risk -- the risk that a specific stock will go down even as its sector or the stock market as a whole go up. Many investors who understand how this applies to the downside of a stock investment don't grasp that it applies to the upside as well. You can correctly identify an upward trend in the market, and in a sector, but still pick the wrong stock and miss out on all the profits. The goal is to create a match between the profit opportunity you identify and what you buy to participate in that opportunity.
I did only a fair job on this measure in 2005. Buying one of the strongest railroad stocks, Burlington Northern Santa Fe (BNI, news, msgs), was a smart way to participate in the upward trend in the railroad sector and transportation stocks in general. But buying Cell Geneysis (CEGE, news, msgs) as a way to profit from the upward trend in the biotechnology sector created a huge mismatch between opportunity and risk. The opportunity was sector-wide, but by picking just one small-cap stock, I took on more individual-stock risk. I compounded the mistake when I kept Cell Genesys and sold off the Biotech HLDRS (BBH, news, msgs) position that gave me exposure to the entire sector. Today I'm looking at a 25% loss in Cell Genesys. If I'd held onto the Biotech HLDRS, I'd be showing a 43% profit from that purchase.
Did I stick to a trading strategy that I'm comfortable with? It's tough to stay in your own comfort zone when buying and selling, but I think it's essential. It's tough because all of us see, from time to time, opportunities to make money that just require an adjustment to our normal investing behavior. This year, in October, I thought I saw a good opportunity to make money twice by short-term trading. First, after the energy sell-off after Sept. 30, I thought adding volatile energy-sector stocks, such as Ultra Petroleum (UPL, news, msgs) and Dril-Quip (DRQ, news, msgs), would result in good short-term trading profits. Second, I thought I could load up on technology stocks, such as Arris Group (ARRS, news, msgs), at the end of October and pick up short-term profits in the year-end rally.
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