HOW WE PICK STOCKS
Picking stocks seems like a huge challenge, involving vast amounts of research on hundreds or even thousands of names. But a few simple principles can make the process easier
1) They’re All Good. - We’ve just been through a rough decade, but it’s still true that stocks—all of ‘em, as represented by the S&P 500 and other indices—offer your best path to a comfortable retirement. They’re all good! The best mindset is one that asks “Do I have a good reason why this stock should not be in my portfolio?”
2) Summer Better Than Others. - Over time, the most-popular stocks (those with the highest PE ratios) will underperform the market, while the least-expensive and least-loved companies outperform. Inexpensive stocks have bigger dividends and bigger earnings—yes, they have bigger earnings!—and they often shrug off bad news because investors were already expecting the worst.
Buy good companies. John Convery’s definition of a “good” company is one that’s run by competent people who know their business and stick to it—and who are working not for themselves but for the benefit of the shareholders.
3) Get On Your Cycles and Go. - Some industries grow faster than others, and there’s a huge and predictable difference in their performance at certain points of the business cycle. If we’re entering a recession you want to own various kinds of utility stocks, but you should be selling them now unless you expect another downturn soon. We don’t. We happen to have a very good economist (Paul Wright), but even if we didn’t we’d hang our hats on the simple truth that recessions and expansions eventually come to an end—although right now we need to add that a very-slowly-growing economy can grow for a very long time.
4) Diversify. - Humility is an essential trait for a stock picker—you don’t have to work to acquire it, because it will be imposed on you soon enough—so we spread our bets around. You’ll want to keep some of those steady-Eddie stocks even when you expect the economy to boom.
5) Diversify More. - Up until now we’ve been talking about the S&P 500, but small-company stocks offer better returns over time. We think they’re expensive now, but we own some and always will. Emerging economies, such as those in Southeast Asia, are growing faster than our own . . . . Spread some money into the rest of the world as well.
6) Take Some Chips Off The Table. - If one of your stocks has tripled, it’s now a larger percentage of your holdings—and a much bigger bet than it was when you bought it. Chances are it’s also become a popular stock, and you know how we feel about popular stocks. So sell some. You might want to sell it all, but at least trim it back so that it’s not an oversized holding.
And if a stock goes down, swallow hard and consider buying more. The same rules apply to your bonds, cash, and other holdings. Diversify in ways that will protect you from inflation (and rising interest rates), recession (and falling interest rates), famine, flood, and everything else you can think of. Buy what’s unpopular, and sell when it becomes popular. And keep your emotions in check.