The bummer about investing your own money is that it's so hard. Value, momentum—no matter your style, there's work involved. If only there were a La-Z-Boy method: Follow a simple rule, put your feet up and watch the wealth roll in.
I read somewhere that a reliable way to invest is to buy stocks that have hit new highs for the year, and short-sell the ones that have hit new lows. Stocks that have gone up tend to keep going up, and vice versa. The theory was based on U.S. stocks. It sounded like slackers' paradise, but would it work in parochial Canada?
I did a little experimenting. The big caveat in what follows is that it's light on formal statistical validity. That said, the buy-high and short-sell-low theory seems to hold up. The trouble is that it doesn't spare you hard work.
I started by going back a year and looking at the lists of TSX stocks that closed at 365-day highs and lows on three trading days in late September, 2005. At first glance, the theory didn't seem to work at all, because so many of the stocks hitting new highs back then were oil stocks. Oil prices up, or oil prices down? Who knows? So I excluded any stocks whose fortunes are tightly linked to the price of any commodity or to exchange rates.
That left 13 stocks on the new-high list and 37 hitting new lows. I then compared their share prices at the end of this past September with those a year earlier. The "high" bets (assuming an equal investment in each company) returned 11%. That was roughly the same as the S&P/TSX Total Return Index, but perhaps less risky because of the smaller exposure to commodities. The biggest winner was Lakeport Brewing Income Fund, up more than 70%, followed by Medicure, a mid-sized manufacturer of heart drugs, which was up 35%. Shares of three of the new-high companies declined.
For the 37 companies on the new-lows list, I came up with the percentage gain (or loss) by calculating how much the share price fell (or climbed). The average return from short selling was a 9.3% gain. The biggest "winner" was FMF Capital, a home-mortgage lending company, which yielded a 95% gain. I had some "losers," though: notably Allen-Vanguard, which makes anti-terrorist gear. Its share price climbed from about $1.50 to $3.25, and a year later it had moved from the new-low to the new-high list. Caveat slacker.
Still, the overall return from the La-Z-Boy strategy wasn't bad. The next step was to tweak it to try to boost returns. This implied effort, but I hoped for a minimal amount. Two of the companies on the new-high list didn't earn a profit. Excluding unprofitable companies meant losing Medicure, the second-best stock market performer, but the overall average return improved slightly to 12%.
On the short side, the problem was that there are so many income trusts with fat distributions. If you sell short an income-trust unit, you have to pay the owner any distributions it pays. It's hard to make a buck shorting income trusts unless you can pick ones that will slash payouts soon. Associated Brands and Entertainment One both did so, and they fell roughly 75%. But that's work, so I decided to just exclude all income trusts from the new-low list. Less pain, but no gain—the overall return from shorting the new-low list didn't change much.
Finally, and with some reluctance, I put down my cocktail, studied the names on both lists and reviewed their prospects in the fall of 2005. Among the new highs then, Lakeport looked like a buy—it was winning market share with cheap beer, and it paid a decent distribution. Telus announced this past fall that it will convert itself to an income trust, helping it to make a 28% gain. That conversion was a possibility a year ago, and besides, Telus enjoys lots of juicy wireless revenue. Royal Bank was also on the new-high list. Banks are almost always a solid bet, but I'm not sure seeing Royal's name on a list would prompt me to buy it.
The new-low list was more demanding. TLC, an eye care company, looked like a good candidate a year ago, and indeed, short selling it would have produced a 31% gain. Its shares sank when a new eye treatment had disappointing test results. Shermag, a furniture maker, was and is getting hammered by Chinese competition. Dexit, the loopy card system for small change? The slacker rejoices. But there were traps—notably papermaker Cascades and travel provider Transat.
Still, the new-high and new-low list approach isn't a bad place for a small investor to start. Look for companies facing positive/negative industry trends or with good/poor management. Don't be afraid of stocks that have had big moves already—they tend to keep going in the same direction. But, sorry, you will have to rouse yourself from the recliner.
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