Stock Investing Tips

A lot of the online investment press provide quick ratings for various stocks. Sometimes they rate them as “buy,” “sell,” or “hold” and other times they rank them on a scale of 1-10. Most serious investment managers know these ratings are worthless, but the investing public sometimes gives them a little credence.

I normally do not pay much attention to these ratings, but lately, thestreet.com caught my eye. They downgraded a stock that I am heavily invested in, Luby’s (LUB) from a “hold” to a “sell.” I read their reasoning and wasn’t quite impressed. Long story short, their earnings and margins were bad. No kidding. That’s why the analyst (who has it rated as a strong buy) forecasted those earnings, which Luby’s pretty much matched. Luby’s is a higher-end cafeteria chain, so the consumer slowdown is heavily impacting it.

Luby’s positives are that it owns its own land and buildings on the vast majority of its locations, many of these locations are 20-30 years old, so its book value is likely understated.  They also are managed by perhaps the most famous Texas restauranters, who also own about a 29% stake in the company. Its margins are terrible now, but again, that’s something that may be turned around. I’d rather buy a company that has depressed margins that may increase in the future than artificially high margins that are likely to decrease.

I then looked at TheStreet.com’s rating history for Luby’s and noticed that it seemed to be well….wrong. When they initially rated Luyb’s a buy on Nov 17, 2006, it has since lost 50.7% compared to a 35.7% drop in the S&P. They then downgraded it to a neutral on  March 24, 2008 and since then Luby’s has slightly outperformed the market, losing 30% compared to the S&P losing 33%

I decided to check some other stocks I follow to see how thestreet.com does. On RIMM, they got it right. They rated and have kept it a buy since 9/29/2006 and RIMM has trounced the market since then. Of course, that is mainly because RIMM did well in 2007, they have had a horrible 2008, losing 62% compared to the S&P losing 39%. So while they are still up on that call, they never decided to scale back on it when they should have.

Now, some of their other calls have just been downright hilarious. Let’s start with the oil bubble. On 05/31/2008, they rated the USO a buy. We all know what has happened since then. The USO is down 68% compared to the S&P dropping 36.6%. As oil dropped, thestreet.com began downgrading USO. On 8/31/2008, they downgraded it to a hold. In fairness, most of oil’s drop happened since then, so at least thestreet.com theoretically scaled back on oil’s position as the price plunged. As of  10/31/2008, they now have the USO as a sell.  So far, a good call. USO is down 39% and the S&P is down 7%. The question though is if oil is about to rebound, especially given the Fed’s decision to print money like crazy.

My favorite call was their analysis of Citigroup. On 12/5/2006, they rated it a buy. Actual shareholders of Citigroup have lost about 85% of their money since then. They downgraded it to a hold about a year later, and stuck it with the sell rating on 11/25/2008. Now, I’m going to give thestreet.com the benefit of the doubt and believe they did in fact make that downgrade AFTER the Fed rescued Citi. If they made that sell call before the rescue, C would be up 85% since the sell rating. Assuming it was after, Citi is up 18% compared to the S&P up 4.23%. Of course, that is a very short time frame for now.

Lastly, let’s see how thestreet.com has done on super volatile stock Dryships, DRYS. On 2/20/2008, they upgraded it to a buy and then later downgraded it to a hold on 10/21/2008. During the buy period, DRYS lost 73% compared to the S&P losing 29%. Since they downgraded it to a ‘hold,’ DRYS is down 54% compared to the S&P being down 10%, so they did trim some of their losses.

In short, be skeptical of online snapshot ratings of stocks. Most of the time, they seem to just follow the trend of whatever the stock is doing. They may make for great contrarian indicators. I, for one, am going to start looking at thestreet.com for recent downgrades when I am bottom fishing for stocks. After the stock market rebounds (which may be several years) and we may be due for a downturn, looking at their thumbs up signals may be good indictators of overvalued companies.

Disclaimer: Author is LONG USO, C,  and LUB.

A bear market is when the stock market is down 20% from its highs. Not only has 2008 been a bear market, the last two months have in of themselves been a bear market.

The economic slowdown caused by the housing collapse and credit crisis has spready worldwide. At first, 2008 looked to be a commodities bull market. Oil went over $140 a gallon and commodity stocks like Freeport-McMoRan Copper & Gold (FCX) and Potash (POT) recorded huge gains.

Then, the full effects of the economic slowdown on global demand for commodities kicked in and commodites plunged. Freeport McMoran is down almost 70% over the last 3 months, and the price of oil has been slashed by over 50%.

The election brought a severe drop in stocks as well. Most believed that the market fully anticipated an Obama victory, but stocks still plunged 10% in the two days after his election. The day after, this past Friday, stocks managed to regain some of those losses with about a 3% rally.

Bear markets is what separates the men from the boys. Many investors have been killed by margin calls and speculations that went south. The CEO and founder of Chesapeke Energy Corporation (CHK) was forced to sell a significant amount of his holding in the company due to a margin call. While it is in a way reassuring that the CEO believed so much in his company that he bought stock on margin, it greatly hurt him and investors in the company when he was forced to sell a large chunk of his holdings to meet a margin call.

As bad as 2008 has been with the S&P 500 down about 37%, the year still isn’t over. If the year ended today, it would be the worse year since the Great Depression. The only two worse years were 1931, when the market lost 52.7% and 1907, when it dropped 37.7%. For us to get back to only the second worse year since the Great Depression, we’d have to beat 1974’s brutal returns of -29.7%. Hey, if we managed that, we’d have a nice little year-end rally from here on out!

For those of us on this side of Wall Street, investing can be quite the challenge. Many amateur investors compound this issue by speculating in companies that are a part of a sector they know nothing about. To get an edge on the market, it is imperative to invest in what you know. 

To truly break the market, one must know what others to not know. Buying companies that you know little about it not too unlike throwing darts at a board. Such a strategy isn’t necessarily bad if the market is primed to make a run. But on that token, why not just buy an ETF (like SPY) to ride the upswing so and avoid exposing yourself to companies you know little about?  

The market is pretty efficient at taking into account earnings reports and analyst expectations. These numbers are available to anyone, anywhere. There is no money to be made in knowing something that everyone else knows. It’s like coming up with an idea for a device that turns on the lights when you clap. Sure, it’s a good idea, but someone already thought of it before, so you’re not going to make any money off of it. Stocks work in precisely this same fashion. 

When you’re ready to stop throwing darts at a board and truly start investing, play to your strengths. What do you know that others might not? Is there a restaurant chain in your area that Wall Street might lack awareness of their upside? Is there a company within the industry you work for that is slowly gaining a competitive edge while not seeing an improvement in their stock price? Look around you. You don’t have to be a seasoned investing professional to find a gem of a stock pick.  

Remember, when you invest in what everyone else wants to invest in, you’re not on the cutting edge, you’re merely part of the herd. This has been a conundrum that Jim Cramer has had to face with the increasing popularity of his show, Mad Money. There is an inverse correlation between the value of his stock tips and the number of viewers of his show who buy the stocks he recommends.  

Sure, you might squeeze out a buck or two by investing with the herd. But like I said earlier, if you’re going to invest with the herd, why pretend to be doing otherwise? Just buy an ETF and spend your time elsewhere. There’s absolutely nothing wrong with that. But if you’re ready to break the market with your portfolio, you have to get out on the cutting edge by investing in what you know [and that others don’t know].

To beat the market, you need to do something better than other investors. Sure, you can just get lucky sometimes. Luck can ever propel some people to better-than-market returns for several years. But to beat the market in the long-run, your investing approach must be superior than the average investor.

There are many ways to go about this. The most basic way is pick stocks that outperform on average. You can use fundamental analysis or technical analysis to do this. With fundamental analysis, you believe the market is undervaluing an aspect of the company. In essence, you feel that you understand the company a little better than the market, and that the market is currently undervaluing its potential.

With technical analysis, you hope to beat the market by trading on trends. You analyze the psychology of the market and hope to beat the market by predicting what other investors will do. You look at the chart of the stock and predict its future course of action. In a sense, you are betting that your ability to predict the future of the stock’s movement is better than the average investor’s.

There are other ways to get an edge on the market as well. In fact, you don’t even need to be the one that picks and chooses the stocks. If you believe you have a keen ability to evaluate mutual funds and know which one’s will outperform the market over time, then picking mutual funds might be for you. While many funds are duds, some are super stars. If you are able to choose the ones that outperform the market, you will beat the market that way.

Another way is if you feel you can choose sectors that will perform well. You might believe you don’t know which stocks will do well, but you feel that you know which sectors will outperform. This is pretty tough since it involves a lot of macro-economic understanding that most people don’t have. But nevertheless, some people can beat the market this way. Investing in sector ETFs is an efficient way for these types of investors to beat the market.

If I’m going to have a blog about “breaking the market,” I think it’s only prudent to define the term to begin with :). Some people hope to get 50-100% returns in a year. They see an informercial on TV about people turning a couple thousand into millions and think they could be them.

Quite frankly, these people are delusional and only end up getting defrauded or losing their entire investment. To me, breaking the market just means beating the market consistently over time. So, if the S&P 500 returns about 10% on average over 5 years, breaking the market would imply 13% returns or better. If the S&P was up only 4% over 5 years, gaining 8% is definitely amazing.

Beating the stock market isn’t easy, but it can happen. With the right amount of discipline, smarts, and sometimes just plain luck, it’s entirely possible to beat the market.