Unsenimental Journeys : 3 Emotion-Free Investing Formulas Show Impressive Gains
The Motley Fool section of America Online has become synonymous with the hype, hopes and fears of investing in the new era of wired market analysis.
But largely ignored in the debate so far has been an online laboratory at Fool headquarters in which a former University of Kentucky lecturer of contemporary English literature has invented and publicly tested an intriguingly simple formula for mechanical, emotion-free stock investing that has yielded gains in recent years far above market averages.
Or maybe soulless year-to-date returns of 72%--and 10-year returns of 40% a year--don’t interest you.
Robert F. Sheard’s premise is simple: Almost anyone can buy a few hot stocks occasionally using sound, fundamental analysis, but few people know when to sell them. Investors get attached to their winners even when the stocks’ rise slows down, and make excuses when their stocks inevitably begin to slip, or even plunge.
“They’ll look at the paper every morning,” he says, “and start to panic: Should I sell, should I buy more, should I close my eyes?”
When emotions take over, he notes, decisions are inevitably bad.
Sheard’s answer to the dilemma is a tad heretical in an era when stock pickers are exalted, because he turns both choosing stocks and selling them over to a formula that doesn’t require a supercomputer the size of Rhode Island to execute. In fact, there’s very little math required at all.
Certainly, there are a number of similar highly regimented techniques around: Motley Fool has repopularized the “Beating the Dow” method of earning market-beating returns in stocks of 30 of the nation’s biggest companies. And the 20-year-old NoLoad Fund*X newsletter has done much the same for mutual funds.
But neither of those has produced eye-popping results like Sheard, who runs his operation out of a house in Kentucky bluegrass country while his 4-year-old son scampers about.
His idea sounds too simple, but perhaps that’s the genius. Here’s how it works: Once a month, go to the public library and pull down the latest issue of the Value Line Investment Survey. Turn to the page that lists the 100 stocks rated 1 for timeliness, and copy it. Stocks rated high in timeliness by Value Line are those that the survey believes will perform best over the next 12 months.
Next, go to the newspaper rack and find the month’s first Monday issue of Investor’s Business Daily. Turn to the page that ranks stocks by earnings-per-share growth, from the highest at 99 to the lowest in single digits. Then highlight the top five to 10 stocks on the IBD list that are also listed on your ValueLine timeliness sheet, and you may be minutes away from becoming the next George Soros.
To execute the strategy, purchase those stocks in even dollar amounts through a deep-discount brokerage that charges less than $34 a trade--and preferably more like $12-$19. Then rebalance the portfolio every month. If you go for the more volatile but higher-yielding five-stock method, there will typically be four to eight trades a month as you sell two stocks that fell off the list, buy two that moved onto the list, and make two or three additional transactions to rebalance the dollar amount in each stock.
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Sheard contends that his five-stock model returned 72.3% through Oct. 24 this year, while his 10-stock model gained 37.5%. He and his legion of online followers back-tested the technique by examining past issues of Value Line and Standard & Poor’s monthly stock guides, and found the five-stock model raked in annual gains of 41%, while the 10-stock model has returned 32% annually.
But the gains come with a lot of volatility. In the market crash month of October 1987 Sheard’s five-stock model lost 37.5%. Over this year’s sour summer the model gained 14% in May before losing 5% in June, 0.5% in July and 5% in August. It then gained 11% in September.
Because of the volatility Sheard recommends investors use his model as a complement to the Fool’s safer Dow Dividend Approach, which is based on choosing the Dow Jones industrial stocks with the highest dividend yields.
Before you skeptical, bear-faced stock pickers groan that Sheard’s 10-year testing of his stock-picking model isn’t long enough, note that his technique is really just a high-earnings-per-share-growth overlay on the proprietary Value Line timeliness screen--a screen proven effective since 1965.
Why has Sheard’s method apparently worked? It offers the advantages of both “momentum” investing and sector rotation. You will always be fully invested in stocks that are growing earnings much faster than their peers in each industry cycle. And you will never get dragged down by an emotional attachment to once-beautiful, now-hopeless stocks.
Or as Sheard puts it: “All I’m trying to be is tremendously above-average. And that’s usually good enough. Consider the game of professional golf. If all you did was shoot par on the PGA tour, you’d be in the top 60 of the money list every year. You don’t have to win the tournament every week to be successful.”
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Across the continent in San Francisco, Janet M. Brown offers a similar, though considerably more complicated, approach to regiment the purchase of mutual funds.
As with Sheard, Brown’s NoLoad Fund*X newsletter ([415] 986-7979) defies the conventional buy-and-hold wisdom. Investors need to overcome inertia and keep their money moving, she says. Apply strict criteria to dump former stars as they slow down, she says, and buy rising new stars as they accelerate to stay fully invested in money managers with the hot hands.
Brown’s technique, which is best followed in her $125-per-year newsletter: She ranks the 742 funds in her universe of growth-stock funds in three classes, from the most-speculative in Class 1 to the highest-quality in Class 3.
She forgets about long-term performance and instead ranks funds according to the average of their growth rates in each of the past 12-, six-, three- and one-month periods. If you keep upgrading your portfolio to include only the five top-performing funds in your chosen risk group every month, she says, you’ll be freed from fears of spending your retirement in the back of a trailer park eating cat food.
Well, maybe. According to the newsletter-tracking mavens at Hulbert Financial Digest in Alexandria, Va., Brown’s top-rated Class 3 funds grew at a very respectable 16.9% annual rate over the past 15 years.
This year, however, her top funds in the bellwether Class 3 have lagged the S&P; 500, only earning 10.9% so far. Her excuse: Stocks of large companies have outperformed the stocks of small firms in the last year, and the majority of growth funds in her universe hold smaller stocks.
That proves a theory can explain anything.
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Doing It by the Numbers
Here’s a look at three trading models and their current recommendations.
Robert Sheard’s Unemotional Growth Model
A high-EPS growth overlay of Value Line’s Timeliness screen. Buy either all 10 or the top five in even amounts each month.
Stocks for week of Oct. 18: Tellabs, Peoplesoft, 3Com, Cisco, HBO&Co;, Mosinee Paper, JLG Industries, Oxford Health Plans, Robert Half International and Papa John’s International
See his weekly updates in the Investing for Growth Statistics Center of the Motley Fool section of America Online. On the Internet, point your Web browser at https://fool.web.aol.com/ifg/ifg_63.htm
Robert Sheard’s Unemotional Dow Value Model
A slight variation of the Dow Dividend Approach. Take the Dow 30 stocks with the highest dividend yield, then sort them by price from cheapest to dearest. If the cheapest stock is also the highest yielder, throw it out. Then buy the five cheapest stocks in even amounts and hold for a year.
Stocks for year starting Jan. 1: International Paper, Chevron, 3M, Eastman Kodak, DuPont. (Year to date: 24.47% gain through Oct. 18.)
Stocks starting today: AT&T;, International Paper, General Motors, Chevron, 3M
See his weekly updates in the Dow Statistics Center of the Motley Fool section of America Online. On the Internet, point your Web browser at https://fool.web.aol.com/ddow/dow_61.htm
Janet Brown’s No Load Fund*X Model
Funds with highest average growth over last 12-, six-, three- and one-month periods.
October Class 1 (most speculative growth funds): PBHG Tech & Comm, Invesco Emerging Growth, Invesco Strategic Technology, Dreyfus Aggressive Growth, Fremont U.S. Microcap
October Class 2 (speculative growth funds): PBHG Large Cap Growth, Invesco Growth, Strong Growth, Price Science & Technology, SIT Growth
October Class 3 (higher-quality growth funds): Dreyfus 3rd Century, SIT Growth and Income, Vanguard US Growth, Reynolds Blue Chip, Lexington Growth and Income
