Here is John Dorfman’s latest article on Bloomberg. It’s called John Dorfman’s Do Nothing Club. They are stocks that have prices that are within 1 percent 12 months ago. These stocks have moved sideways for the past 12 months and have not done much.
The three stocks he picked were Allstate (ALL), CBS (CBS), and Comerica (CMA). Although he has had decent results in his past picks, I’d rather use a different mechanical stock picking screen than this one. This one does not make much sense to me and I’d rather use a screen that I believe in, because people use strategies that they do not like will quit once things go wrong.
I understand that he uses the screen as an initial filter before he looks into the stocks more closely, but I don’t think that the initial screen makes much sense. The stocks still fluctuate a lot between the 12 month period, but they just happen to be within the 1 percent they were 12 months ago. A lot of mechanical stock picking strategy perform well, but that does not mean that they will continue to do well in the long run.
One example in the Intelligent Investor was the Motley Fools “Foolish Four” strategy. Here is the commentary done by Jason Zweig.
“According to Motley Fool, you would have ‘trashed the market averages over the last 25 years’ and could ‘crush your mutual funds’ by spending ‘only 15 minutes a year’ on planning your investment. Best of all, this technique had minimal risk. All you needed to do was this:
1. Take the five stocks in the Dow Jones Industrial Average with the lowest stock prices and highest dividend yields.
2. Discard the one with the lowest price.
3. Put 40% of your money in the stock with the second-lowest price.
4. Put 20% in each of the remaining three stocks.
5. One year later, sort the Dow the same way and reset the portfolio according to steps 1 through 4.
6. Repeat until wealthy.
They claimed that this strategy over a 25 year period beat the market by 10.1 percent per year annually.
His problem with this strategy was “what type of thorough analysis could justify discarding the stock with the most attractive price and dividend- but keep the four that score lower for those desirable qualities?
How could putting 40% into one stock be minimal risk?
And how could a portfolio of only four stocks be diversified enough to provide safety of principal?
“The Foolish Four, in short, was one of the most cockamamie stock-picking formula ever concocted. The Fools made the same mistake as O’Shaughnessy: If you look at a large quantity of data long enough, a huge number of patterns will emerge- if only by chance. By random luck alone, the companiesthat produce above-average stock returns will have plenty of things in common. But unless those factors cause the stocks to outperform, they can’t be used to predict future returns.”
Those returns of mechanical investing will not persist in the future. If they were flawed in the first place, time will show that in was not a good strategy. On the other hand, if is was something like the January effect, then “market pundits always erode or eliminate the ability to do so in the future.”
Source: Taken from The Intelligent Investor: Pg 44-47.
