If you ask people how they are investing now, the answer tends to be look at the list of the stocks and which ones have risen. The theory is those winning companies will continue to rise and you will make money. According to Ian McGugan writing in the Globe the research shows recent winners have a tendency to go on performing well, for a while. Chasing performance can actually work if you do systematically and rigorously.
Nicolas Rabener, managing director of FactorResearch, a market analystics firm in London demonstrated some of the realities of the momentum approach in a recent study of what works for investors in US mutual funds.
Mr. Rabener examined what happened if someone invested in equity mutual funds, each month changed their holdings by selling and buying the top performing 10% over the past 12 months. It turns out, if you can figure out a low cost way to avoid fees, the strategy works. If you held redid your portfolio once a year, the performance level drops.
If you are a momentum strategy investor you need a strict strategy and rebalance your portfolio frequently at low cost. The downside is you need to invest in hot stocks of the day or month.
A different approach is to examine poorly performing companies to become average companies. Losers often revert to the mean or the average of their peers.
Linking to dividend paying stocks, stocks can go out of average for multiple reasons – to much debt, crisis in the executive suite, government policies but it is possible to see if these elements will correct themselves. If the company is making money, it has a good base to continue and the other elements will slowly correct themselves. As they do, the stock will be value higher which will push the stock up because it is trading at a lower multiple than its earnings. If you invest in losers, ensure you have good protection and a dividend is very good protection to start with.
There are more questions than answers, till the next time – to raising questions.