ANNANDALE, Va. (Dow Jones) -- The financial markets on Tuesday were tailor- made to induce investors to put more money into the markets. Crude oil hit a 14- month low, encouraging many to think that oil is now cheap enough to unleash a surge of consumer buying; perhaps not surprisingly, the Dow Jones Industrial Average (DJI) hit a new all-time high.
But there's a depressing reality about days like Tuesday that you should keep in mind: Even if happy days are here again, as the markets seem to be discounting, the greatest investment profits do not come from investing at times like these.
On the contrary, as I have mentioned repeatedly in this column, above-average profits accrue to those who are willing to invest when, as Nathan Rothschild famously once said, the blood is running in the streets.
A just released study provides yet more evidence that Rothschild was right.
The study was conducted by the publishers of a newsletter called Ford Equity Research Investment Review. This newsletter has an impressive record, according to the Hulbert Financial Digest. Since the beginning of 1998, which is when the service inaugurated the stock-picking methodology currently in use by the newsletter, it has produced a 7.5% annualized return, in contrast to 5.7% annualized for the Dow Jones Wilshire 5000 index (97199001) .
In the study, Ford Equity Research focused on "turnaround" plays, by which they mean stocks of companies that, in the two quarters prior to the most recent one, had flat or falling earnings per share, and which in the most recent quarter showed improved earnings. The hypothetical portfolio that the firm constructed contained the 20 stocks from this larger group of turnaround issues with the largest quarterly earnings improvement in the latest quarter. Each stock was kept in the portfolio so long as the company continued to show earnings improvement; if not, it was replaced with whatever new turnaround company was at the top of that quarter's ranking.
Ford first started tracking this stock-picking approach at the end of 2000, early on in the 2000-2002 bear market and not a particularly auspicious time to start investing. Nevertheless, Ford's hypothetical turnaround portfolio since then has produced a 28.4% annualized return; over the same period, the Dow Jones Wilshire 5000 gained just 2.9% annualized, and the average stock in Ford's universe produced a 15.9% annualized return.
To be sure, because Ford did not include transaction costs in its calculations, this approach's returns on an after-transaction-costs basis would be lower than 28.4% annualized. But not enough less to eliminate the approach's attractiveness. Ford calculates that the portfolio had an average annual turnover rate of 83.3%, which means that even if we assume a 4% round-trip transaction cost (probably high, but with relatively illiquid turnaround stocks, you never know) this portfolio is still a big winner.
With returns like these, why wouldn't everyone, including Ford itself, just buy stocks recommended by the strategy? In an interview, Ford's director of research, Rich Segarra, said there are at least two major reasons. First, the strategy is risky; its returns are significantly more volatile than the average stock - 79% more, to be exact. So the strategy is not for the faint of heart.
Secondly, the stocks that the strategy favors tend to have very small market caps. That's no problem for an individual, but means that when too many individuals, or an institutional investor, try to buy such stocks their prices will skyrocket - thereby eliminating much, if not all, of the approach's profits.
This second worry may be more theoretical than practical, however. Turnaround stocks are never popular; after two quarters of flat or declining earnings, many investors will not be interested in a firm, no matter how good its most recent quarter's earnings might have been. So competition for the shares of such a firm will be nowhere near as intense as it is for the latest Wall Street growth stock darling, whose earnings will be on a tear.
In any case, here are a few stocks that, according to Ford Equity Research, currently most satisfy the firm's definition of a turnaround stock: ATI Technologies Inc. (NASDAQ-NMS:ATYT) (ATYT) , Centerplate Inc. (AMEX:CVP) (CVP) , Retail Ventures Inc. (NYSE:RVI) (RVI) , Trex Inc. (TWP) and Wheeling Pittsburgh Corp. (NASDAQ-NMS:WPSC) (WPSC) .
(END) Dow Jones Newswires 10-04-06 0128 Copyright (c) 2006 Dow Jones & Company, Inc.
