January 3, 2008

The Market's 10 Best Stocks Revealed

The Market's 10 Best Stocks Revealed
In picking on yesterday's post theme, here is another example of useless media posts. Well may be it is not useless but the context presented to the reader is unbalanced and somewhat deceiving.

The article argues that small , ignored and obscure companies are the best companies to invest in. And these companies over the long term are better performers than large companies. It is true that smaller companies on average have outperformed large ones, many studies back this notion. It is also true that ignored companies by the street makes for better investment because if you do your research correctly you will have an information advantage over wall street and earn better returns. So what is my problem with such an article?

Well here is where the article fails the reader:

The article is written in hindsight, if the writer is that good, we should read his name in Forbes richest people. My point is the article and many like it do not help you to be a better investor but it paints a picture of rosy optimism and hope, which should not be an investment strategy at all. Risk management is what you need to succeed as an investor. Home runs are nice but they are rare and the article makes it seem it easy to do.

Risk of smaller issues is much larger compared with larger well capitalized companies. The article should present risk adjusted returns for these companies rather than absolute figures. You have got to realize that investing in micro cap stocks of $10 million market cap is highly risky and carry odds akin to lottery tickets.

There are 7000+ small, obscure and neglected companies which one do you invest in? the article does not direct you to what characteristics makes for good investment. Well there is none. You have to assess each on its face value by looking at its competitive advantage and management capabilities.

I still agree with the premise of small, obscure and neglected companies makes for better returns however I have the following to add:
  1. Limit the portfolio exposure to these companies to no more than 10% of overall capital
  2. You need to do a lot of research and for these small companies, you can call the CEO or CFO and ask questions they will be very receptive and helpful
  3. Do not put all of the 10% into one or two stock pick maybe 5-8 to enhance your odds of success
  4. Research, research and research some more until you are satisfied. You have to be able to sleep at night knowing the risks and rewards of these companies.
Articles and media like this are really a disservice to average investors designed for the sole purpose of selling their media rather than helping you.


John said...

I agree with your conclusions with one potential “build”.

Your advice only applies to people with a really big portfolio. Why? I believe that unless you can afford to buy 1000+ shares at a time (and use the $9.99 deals) the transaction costs will kill the average small investor.

I read lots of blogs for fun and notice that the authors have only 90 or so shares of each position. The transaction costs are killing them and they would be better off with a few TD eFunds or some iShares.

It hurts them even more when they buy US stocks. The brokers charge them 2% plus exchange on the way in and the small stocks do not have DRIPs so any dividends get converted back to Canadian at 3%.

What do you think?

Sami said...

Yes I completly agree. decreasing your costs is key to successful investing. too many positions will kill your returns as well as your ability to monitor the businesses and research them. I like to keep my portfolio concentrated into areas where I know it well.

as a rule I do not buy below $400-500 million in market cap and I do not care for any excess returns that a smaller company will bring me.