Still Looking for a Plan? Some Ideas

The broad market has zoomed beyond most expectations over the last two years, but it’s a safe bet that most private investors’ portfolios have not.

That’s due to the stinker factor. Because they fail to choose and stick to a disciplined strategy, most private investors regularly suffer 30% to 50% declines in particular stocks that drive down their portfolios’ total returns.

So for the new year, consider buying into a strategy first--and demanding that every individual stock choice fit the criteria.

This view is summarized best by James P. O’Shaughnessy, a quantitative analyst who is one of the most strident advocates of choosing strategies over stocks. “The day of hot-shot money managers and stock-picking cowboys is done,” he says from his soapbox in Connecticut.

Over the last two months, this column has highlighted several successful stock-picking systems. Here’s how a few of them have played out since publication, and how to get started if you wish to start them tomorrow.

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The “Unemotional Growth” strategy devised by Robert Sheard of Lexington, Ky., has far outpaced the competition this year.

When profiled in October, Sheard’s five-stock method of picking fast-growing, high-momentum stocks was up 72% for the year. It’s now up 89.4%, not including trading costs or taxes. The 10-stock model, a less-volatile variant, is up 45.9% for the year.

Over the last 10 years, Sheard says, the five-stock model has nailed down 42% compound annual returns. That means a $50,000 investment begun on the first Friday of 1987 would be worth $1.7 million today. The figures do not include taxes, dividends or trading costs, but the net would still buy a lot of college education for the kids--even if they stayed at the Four Seasons Hotel in Boston while attending Harvard.

The real beauty of the strategy, prosaically nicknamed UG-5, is its simplicity. My first column glossed over a couple of the steps, so here’s a clearer shot at the approach.

One caveat: The technique can require two to 10 trades per month, so it is best exercised in a tax-advantaged account such as an IRA, and at a deep-discount Internet brokerage that charges less than $20 commission per trade.

First, find the latest issue of the Value Line Investment Survey newsletter at any public library. Make a copy of the page that lists the 100 stocks ranked 1 for timeliness. These are the stocks Value Line believes have increased earnings faster than their peers over the last 12 months and will continue to do so for the next 12 months.

Next, find the latest issue of the newspaper Investor’s Business Daily, and turn to the New York, American and Nasdaq stock exchange tables. Look at the first two columns of numbers listed with each stock: First is the stock’s earnings-per-share, or EPS, ranking, from 1 to 100; second is its relative strength, or RS, ranking, from 1 to 100. Stocks that are ranked highest for earnings-per-share growth are growing profits much faster than their peers. Stocks ranked highest for RS have seen their stock price rise much faster than their peers.

Then mark down Investor’s Business Daily’s EPS and RS rankings for each stock on your Value Line list. Depending on your stomach for volatility, start your portfolio by buying equal dollar amounts of either the five or 10 stocks on the list that are ranked highest for EPS. Break any ties with the RS ranking.

On the same day each month--e.g., the first Friday--repeat the steps. If a stock drops off the list, sell it and buy the replacement. To prevent any stock from dominating your portfolio, rebalance at least once per quarter so that you have equal dollar amounts of each stock again.

Sheard’s strategy has worked in both bear and bull markets because it is essentially a price-momentum overlay on top of a high-earnings-growth screen. And if any stock blows up, it’ll never stay in your portfolio longer than a month.

The top five stocks through Dec. 20 were Ensco International (ESV), 3Com (COMS), PeopleSoft (PSFT), Mosinee Paper (MOSI) and Oxford Heath Plans (OXHP). The next five were Cisco Systems (CSCO), Parametric Technology (PMTC), HBO (HBOC), CKE Restaurants (CKR) and McAfee Associates (MCAF).

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To prove that it’s strategies, not stocks, that matter, next consider starting a “Beating the Dow” portfolio. This excellent technique--popularized but not invented by the folks at the Motley Fool section of America Online--has racked up impressive gains over the last three decades with an approach that’s almost the opposite of UG.

Rather than picking fast-growing darlings, the BTD model forces investors to buy the four to 10 securities in the 30-stock Dow Jones industrial average that have most fallen out of favor over the preceding year. Through Dec. 27, the four-stock variant of the approach gained 32.8%--nicely beating the Dow 30 gain of 28.2% and the Standard & Poor’s 500 index gain of 22.8% in the same period. To execute the four-stock strategy, rank the Dow stocks by dividend yield, from highest to lowest. Then rerank the highest-yielding 10 by share price, from lowest to highest. Throw out the lowest-price stock, then buy equal dollar amounts of the next four. Hold for one year.

At the Motley Fool, you’ll find about 19 variations on the theme, including a popular model in which an investor just buys equal amounts of stock in the 10 highest yielders (29.3% return through Dec. 27).

The BTD4 stocks to buy tomorrow are AT&T; (T), General Motors (GM), Chevron (CHV) and 3M (MMM).

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Another portfolio you can launch tomorrow and leave alone for the rest of the year combines value and growth. Developed by O’Shaughnessy in Greenwich, Conn., the “Cornerstone Growth” strategy buys 50 stocks that have market capitalizations larger than $150 million, have higher earnings in the current year compared with the previous year, have strong relative strength rankings and, most important, have price-to-sales ratios lower than 1.5.

This technique, which O’Shaughnessy devised after crunching 40 years of stock market data, leaves an investor highly diversified in cheap but fast-growing companies. In 1996, the model gained about 30%; it has earned an average of 18.2% per year since 1955. For the current 50 stocks, see list below.

Since the technique of buying low price-to-sales ratio stocks was profiled, a mutual fund replicating its strategy went on the market. The Cornerstone Growth Fund has gained just one penny since Nov. 24--but this is a strategy that requires a full year to play out. The fund can now be purchased through the Fidelity Investments, Charles Schwab and Jack White mutual fund network.

In addition, O’Shaughnessy said he hopes to launch a new type of security on the American Stock Exchange in April that he calls a strategic index mutual fund. The Market Leaders index will buy a basket of large-capitalization stocks that have 1 1/2 times the sales growth rate of their peers--sort of a supercharged S&P; 500 index fund. Like the index derivatives known as Standard & Poor’s Depository Receipts, or “spiders,” the open-end fund will trade as if it were a single stock.

Cornerstone Growth Strategy’s current 50 stocks: AEP Industries (AEPI), American Travellers (ATVC), Apogee Enterprises (APOG), Bally Entertainment (BLY), Brightpoint (CELL), Chart Industries (CTI), Coachmen Industries (COA), CompUSA (CUSA), Computer Data Systems (CDSI), Computer Task Group (TSK), Conseco (CNC), Dell Computer (DELL), DT Industries (DTII), Eagle Hardware & Garden (EAGL), Elf Acquitaine ADR (ELF), Fairchild Class A (FA), FPA Medical Management (FPAM), Gardner Denver Machinery GDMI), Gateway 2000 (GATE), Genesco (GCO), Greenwich Air Services Class A (GASIA), Health Images (HII), Helen of Troy (HELE), Imperial Holly (IHK), Inacom (INAC), Insight Enterprises (NSIT), Manitowoc (MTW), Mesaba Holdings (MAIR), Morningstar Group (MSTR), Mosinee Paper (MOSI), National Beverage (FIZ), NGC (NGL), Noram Energy (NAE), Olympic Steel (ZEUS), Philip Environmental (PEV), Plains Resources (PLX), Pomeroy Computer Resources (PMRY), Pride Petroleum (PRDE), Riser Foods Class A (RSR), Ross Stores (ROST), Shaw Group (SGR), Smart Modular Technologies (SMOD), Sunsource Class B (SDP.B), Tuesday Morning (TUES), Tyco Toys (TTI), US Industries (USI), US Office Products (OFIS), Veritas DGC (VTS), Watsco (WSO), Wet Seal Class A (WTSLA).

Street Strategies explores investment tactics. Jon D. Markman, a Times staff writer, can be reached at [email protected]