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In the aftermath of England’s early exit from this year’s Rugby World Cup came an intriguing but sadly familiar tale of misadventure in the stock market. During the tournament preparations it’s alleged that the team’s kit manager shared a tip about the ‘exciting prospects’ of a micro-cap oil exploration company. This apparently lulled some players into parting with tens of thousands of pounds for the stock. Like the team’s on-field performance, there were high hopes for shares in LGO Energy, but the hype failed to live up to expectations - as the price chart shows...
Sucker Stocks have very little exposure to the Quality, Value and Momentum factors that have historically generated the strongest returns in the stock market. Typically they have blue sky business models or operate in highly speculative sectors that may be experiencing cyclical downturns.
Occasionally, they will be broken firms that have lost the confidence of most of the market. But unlike Value Traps, the appeal of their story to some investors often means that these low quality, low momentum shares remain over-priced.
Moreover, these stocks are often small and attract scant coverage from analysts. That means their poor quality and stretched valuations may not be obvious to gullible investors. It makes them particularly vulnerable to the kind of rumour and conjecture that is rife on internet bulletin boards. All these factors can easily suck in the unwary.
The profile of these shares is well known in academic finance. Some of the best analysis was done by Robert Haugen, the groundbreaking financial academic who sadly passed away recently. In his wonderful book, The Inefficient Stock Market, he referred to them as Stupid Stocks.
Haugen’s research into long term expected returns found that the best performing shares had the characteristics of what many would recognise as GARP stocks - or Growth at a Reasonable Price. These were low priced, low volatility shares with a strong growth profile.
By contrast, the shares that delivered the lowest returns were generally exposed to a heap of negative factors (although not all at the same time). Haugen defined the ultimate Stupid Stock as “relatively small, and illiquid, risky, financially shaky, negative momentum, unprofitable now and getting worse, yet selling at high prices relative to current sales, cash flow, and earnings”.
The strong link between poor returns and the sorts of negative factors Haugen highlighted has led some to use them for short selling strategies. James Montier, during his stint as Global Strategist at Societe Generale, wrote extensively about the tendency for expensive, deteriorating, poor quality stocks to systematically underperform.
To prove the point, he created an ‘Unholy Trinity’ strategy. It deliberately looks for stocks with a high price-to-sales ratio (ie. expensive), a low Piotroski F-Score to isolate deteriorating fundamental health, and high total asset growth as a signal of poor capital discipline. Between 1985 and 2007 a portfolio of such European shares rebalanced annually would have declined over 6% per year against a market that was rising 13% per year over the same period. Stockopedia’s tracking of the Unholy Trinity strategy has also seen very poor performance (as it should). You can see the performance here.
These negative characteristics echo the profile of stocks that score badly against Stockopedia’s ranking of Quality, Value and Momentum (QVM). Specifically, shares with low StockRanks will be afflicted by a combination of:
Over the past two and a half years, a portfolio of shares with a minimum market cap of £50 million and StockRanks in the bottom 10% of the market has limped to a 50% loss. Portfolios with StockRanks in the bottom 20% and 30% of the market lost around 29% each. By comparison, a portfolio holding shares with the highest blend of Quality, Value and Momentum produced a 63% return.
We have previously looked at the relatively poor performance of Momentum Traps, Value Traps and Falling Stars. Each of these categories relies on just one of either Momentum, Value or Quality to drive a return. What we found in each case was that there were periods in recent years when they did well. But over time they all underperformed.
In contrast, with Sucker Stocks, periods of ascendancy have been virtually non-existent. With the exception of a brief spell in the summer of 2013, the low ranking portfolios have endured a steady decline. This dire performance strongly suggests that this is an area of the market that, if not avoided entirely, needs extremely careful handling.
Using the Stockopedia Screener we scanned the market for companies with some of the lowest Quality Value and Momentum rankings using the following rules:
As expected, the results are weighted towards small-cap companies in commodity sectors like oil & gas and mining, and speculative areas like biotech/ healthcare and technology.
While the evidence suggests that investing here has a statistically low success rate, roaring individual successes obviously do happen. This may be the reason why investors are so attracted to investing in these shares. The allure of Lottery Ticket type payoffs can be immensely attractive.
Here are some of the notable names on our current Sucker Stock list.
Name | Mkt Cap £m | Stock Rank™ | Quality Rank | Value Rank | Momentum Rank | Sector |
Ophir Energy | 629.8 | 17 | 26 | 28 | 33 | Energy |
Gulf Keystone Petroleum | 251.9 | 4 | 2 | 19 | 26 | Energy |
RM2 International SA | 182.9 | 5 | 12 | 6 | 33 | Basic Materials |
Horizon Discovery | 140.2 | 13 | 21 | 18 | 39 | Healthcare |
Quantum Pharma | 133.1 | 17 | 28 | 24 | 34 | Healthcare |
Gama Aviation | 121 | 12 | 8 | 31 | 35 | Industrials |
Nanoco | 114.4 | 4 | 39 | 5 | 3 | Technology |
Rare Earth Minerals | 51.8 | 10 | 21 | 20 | 27 | Basic Materials |
Flowgroup | 50.4 | 4 | 1 | 37 | 8 | Industrials |
Bango | 50.4 | 8 | 35 | 4 | 21 | Technology |
Perhaps the words used by executives to name some of these companies should instantly ring alarm bells? Horizon, quantum, rare, nano, gama, discovery, bang…. these all sound other-worldly to us.
What normally happens when we publish lists of ‘sucker stocks’ is that defensive shareholders come out in waves to unleash a torrent of reasons why their favoured stock shouldn’t be in the list. Some of the usual suspect reasons are:
Nearly every sucker stock always has a strong story behind it that will (apparently) lead it to redemption. But we humans are blinded by the allure of a good story. The facts are plain. Just as with lottery tickets, some sucker stocks may do well but, if past trends persist, the majority are likely to underperform. We can almost guarantee that every investor holding one of the above stocks will believe that their stock is ‘the one’ which will outperform. But everyone can’t be right.
The really sad truth is that individual investors just love loading up on these losing plays. If we look at the most discussed shares on UK bulletin boards and put them into the Stockopedia Bubble Charts it’s obvious that there are far more sucker stocks (bottom left) heavily discussed than super stocks (upper right). Perhaps we should learn from Odysseus and block our ears with wax so we don’t succumb to the siren song of story stocks.
The major lesson here is that shares which rank badly for their Quality, Value and Momentum should immediately raise red flags in the minds of investors and require very detailed research.
Warren Buffett once remarked in a letter to shareholders of Berkshire Hathaway:
“...if you aren't certain that you understand and can value your business far better than Mr. Market, you don't belong in the game. As they say in poker, ‘If you've been in the game 30 minutes and you don't know who the patsy is, you're the patsy’.”
To varying degrees, portfolios are dragged down by exposure to shares that are overvalued, poor quality and on a deteriorating trend. Yet, for various psychological reasons, this class of share still holds great appeal. And while there may be individual cases of remarkable recovery, evidence suggests that the odds are stacked against it. So when constructing a portfolio it’s best to keep to an absolute minimum the number of sucker stocks held.
For investors and rugby players alike… it’s worth treating tips and bulletin board hype with great caution. The prospect of quick riches from speculative story stocks is likely to end in tears… or at least an early bath.
To find out more about the taxonomy of stock market winners, you can browse through the entire series:
About Ben Hobson
Stockopedia writer, editor, researcher and interviewer!
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I admire your rationality Phil and think myself mad for being less rational but is a constant battle with myself! As a part time investor it is a hobby and I'm interested in companies and therefore stockpicking. But that's mad. I could do better with less hassle by following the odds. Oh no. There I go again. It's hard to be ruthless.
Hi Richard,
it's weird isn't it.
I encounter it in my work sometimes too, e.g. with addiction issues and the intervention goes like this ...
"I walk up to you in a pub and offer you some new amazing substance.
I tell you that the initial hit will be the MOST amazing feeling of contentment that you've ever experienced EVER!
but ... it'll be short lived and you'll forever be chasing that first seductive embrace.
It'll be your primary focus, the first thing you think about when you wake up until you score and the last thing you think about before you sleep.
Over time IT will come to control you, whispering it's sweet seduction but it will destroy you and those you care about as you prioritise IT over everything else."
I ask them what they would say to my offer and the client usually tells me that they would tell me where to go ...
Only when a client really faces up to the stark reality of their relationship to IT, whatever IT is, can they begin to take a more rational perspective; consider what they actually want and consider change to achieve it effectively.
If I sidled up to you in a pub and said I'm offering two investment opportunities; one which generally has a hit rate of 30% and the other has a hit rate of 60%, but I pay a lot closer attention to the first option what would you say to me?
I know what I'd ask ... "what is the risk adjusted return of each strategy?"
My suggestion would be if you love picking stocks based on analysis, stick em in fantasy fund and pat yourself on the back (either when you pick a winner or when one goes badly wrong and you have the satisfaction of knowing it's just a fantasy fund). In the meantime, invest your hard earned lukka and your families future in a less risky and more lucrative alternative.
Well this is all a good natured debate I hope. I don't personally try to find sucker stocks. My point is that we are buying the future. I try to see how a stock will be rated in a year or two's time rather than now.
I am happy to bet 2 to 1 that EU Supply (LON:EUSP) will generate a positive return over 2 years and will not be rated as a sucker stock in 2 year's time (say May 2020 after full year results for 2019 have been reported). It is almost impossible that the quality rank for EU Supply (LON:EUSP) will be two in 2 year's time. So I don't perceive it as buying a sucker stock in the sense of one that will always remain in this category. I do accept that most sucker stocks are fairly dire i.e. companies like Torotrak etc. They never make any money and just continue to bleed cash.
I think the difference between me and you guys (Ed/PhilH) is that I am willing to get into the fundamentals of a business to see how it will look going forward. I understand that other people prefer a statistical approach. Fair enough. But some of the highest ranked stocks on screens actually look fairly poor to me. They are cheap for a reason i.e. cyclical sectors or own wasting assets (mines).
All my posts have been thumbed down here ;( I don't disagree with the statistical approach I just think understanding the existing business is very powerful. This is what Buffett and Terry Smith does. Are we saying that those guys are idiots and should just be doing things off the back of statistical screens? Buffett has bought some stocks at the bottom that would no doubt be rated at sucker stocks at the time of purchase.
Hi ratioinvestor.
Not quite sure why your comments are getting the “thumbs down”. Seems a bit puerile when all you’re doing is challenging the latent group think that factor investing is the only way to go.
Ultimately we all run our portfolios to suit our own ends and means and it’s up to each individual to work out what gives them the best financial return together with a number of other “soft” benefits such as peace of mind that they’re not taking undue risk and the satisfaction from picking a winner against the form book. To my mind, part of the attraction of a sucker stock is the chance to beat the system. Would you prefer to make a £1 gain from a purely mechanistic factor approach or 90p from a carefully researched sucker stock that everyone else is calling a dog? Rationally, you take the £1 every time .... unless you maybe have enough £1’s already and enjoy the challenge of playing a different game strategy and derive an added satisfaction from that (and just maybe the possibility that the 90p becomes £5).
I’ve been investing in shares for about 30 years and have tried various methods from fundamental research through a chart/technical based approach. It’s quite common, I find, for advocates of each method to become quite evangelical that they’ve chosen the “one true path”. I’ve been a Stocko subscriber for about three years and have used the tools it provides to accumulate quite a diversified portfolio with a fairly large portion of the total now based on factor based principles. I am, however, very much still learning the game and am happy to experiment with alternative strategies. Likewise, I wouldn’t suggest anyone try and copy my approach.
Looking through my portfolio, of my 150 or so holdings, of the top 10 total returns none are Super Stocks. Of the top 3, (all of which have made over 300% returns) IQE (LON:IQE) , Boohoo.Com (LON:BOO) and Falcon Oil & Gas (LON:FOG) , we have one Neutral, one Momentum Trap and one Falling Star. At the other end of the spectrum, of the bottom 10 performers 4 are (now) Sucker Stocks, although 4 are Contrarian and one, Spaceandpeople (LON:SAL) is now classified as a Super Stock (even though I’m down 40% since acquiring it). Does this prove anything? Probably not, or if it does, I’ve not figured it out yet.
Am I 100% happy with the stocks I own? Not really - it’s a constant exercise weeding out the failures and deciding where best to reallocate the capital. Could I have made a better return from doing something different? Almost certainly, and I freely admit I’m still regularly making mistakes. Am I getting better at it? I like to think so, but it’s a complex game with many variables and you only really find out when (if ever) you reach the end. All said and done, however, I enjoy the challenge of trying to get better and would encourage everyone else to do the same and find their own path.
Gus.
I don't disagree with the statistical approach I just think understanding the existing business is very powerful. This is what Buffett and Terry Smith does. Are we saying that those guys are idiots and should just be doing things off the back of statistical screens? Buffett has bought some stocks at the bottom that would no doubt be rated at sucker stocks at the time of purchase.
I have analysed Terry Smith's portfolio before and I'll do it here again. These are his top 10 holdings.
As you can see - it's a portfolio full of low risk (conservative/balanced), large caps - all but one a 'winning style' in our classification system. His style is very aligned with the "High Flyer" archetype. i.e. rather expensive, high quality and good momentum businesses. There's not a sucker stock in sight !
Stocks with strong fundamentals tend to have a higher quality rank. Terry Smith buys high quality businesses - but that quality (profitability/cashflow/margins etc) is present now.... not in an imagined future. The problem with forecasting future quality is that humans are terrible at forecasting! I recommend reading the "Folly of Forecasting" in this paper - The Seven Sins of Fund Management'.
Something like 80% of people think they are a better than average driver. It's no different in investing. We just aren't as good at predicting the future as we think we are. It's called 'illusory superiority' and is one of the more expensive of the common biases!
I just prefer to avoid low probability bets, and I think it's wise, when constructing a portfolio, to minimise the number of them across one's portfolio. It doesn't matter if you are a systematic or a discretionary investor - the stats will win out - that's why even Terry Smith & Warren Buffett put the stats in their favour !!!
You misunderstand though ratioinvestor ... the screens I use are driven by fundamental data so I too invest based on fundies except I don't dig into the detail.
I buy high quality stocks, that are winning, exhibiting cheap growth and appear to be in favour through price momentum. They are usually either HighFlyers or SuperStocks.
btw I don't ever recall thumbs downing a post and I think it's out of order personally.
I like the debate as it can draw out details of your own approach.
I'm not saying Buffet, Smith, Paul, Graham are idiots ... but each person has to be honest with themselves ... Am I as talented as Warren Buffet?
Hi ricky65.
Oddly enough, I used to run a concentrated portfolio of about 20 stocks and found it way more stressful. One bad RNS and a meaningful chunk of the portfolio disappears. Although 150 holdings sounds excessive, this gives me the protection of diversification while also allowing me the freedom to dabble in the occasional long shot. So far, I seem to have avoided falling in to the trap of ending up with a passive tracker although that is clearly a risk with so many positions. It’s much easier to monitor positions nowadays with a real-time facility like Stocko than it used to be so the day to day admin is pretty straightforward (the tax return can be a bit of a ‘mare though!) and most of the time is spent dealing with a relatively small number of “awkward” stocks.
Gus.
Ed, thanks for the reply. Yes Terry only buys high quality stocks. He did by Novo Nordisk when it was experiencing a weak patch and also Domino's Pizza (US) when customers weren't fond of it.
I think this debate is largely driven about whether we can forecast the future. I think for high quality stocks we can but I understand that some people think we can't. Most human beings forecast things that are not predictable and don't impact returns anyway. If you try to forecast things that are predictable and impact on returns then it can make sense. Forecasting is discredited in the sense that people predict unpredictable things like election results or macroeconomic trends. But I can predict that we will all use shower gel tomorrow and brush our teeth.
I don't think the statistical approach is awful it just has limitations and implies a fair bit of trading. I do think qualitative analysis is very important for things like moats, customer franchise etc. At the end of the day you are forced to do qualitative analysis for IPOs for example.
I understand the view that taking "low probability bets" is irrational. But I think that if you have the ability to see which ones will be winners it can make sense. I don't mean to mention this company so much but the only reason I looked at EU Supply (LON:EUSP) is because I met them at an investment fair. The have recurring income and switching costs for customers. I wouldn't recommend anyone buys them as they are too small. But they illustrate to me that qualitative judgements can work.
I do absolutely agree that you shouldn't have too many sucker stocks in your portfolio as on average they are awful. I just think it is worth doing the homework on some of them. I don't disagree that the "stats will win out" I am saying that sometimes we can identify sucker stocks that will move into other categories and subsequently perform well. That is a different question really. Can we identify sucker stocks that will eventually change category and deliver good results.
I do agree in principal that starting with sucker stocks to look for ideas probably isn't great. I only have one sucker stock and it is a small part of my portfolio.
When it comes to Terry Smith you are almost actually illustrating my point. His last position was Facebook which he added recently. My argument would be that he should of added it at say $30 when it was unloved. Instead he added it at the recent price of $155. I think Facebook was reasonably predictable: network effects, a loyal customer base and growing online advertising. Terry Smith also added MercadoLibre late into his FEET fund. If he had added it when the fund had started he would of done much better. Both stocks were high quality and appeared to be predictable.
The response may be that no one could have forecast Facebook's success when it was US$30? But Google had tried to compete and failed, network effects are the most powerful moat and they also drive growth by attracting more users.
But we can all agree that you should only look at sucker stocks at your peril. I know some people trust statistics but for me I have to look at the business to see what it is all about.
I also think it is easy to misconstrue Terry Smith's approach. He doesn't buy of statistical stock styles he tries to understand the business. That is largely the key to his success. Many stocks here have had high ratings and subsequently had issues. Terry Smith has avoided this largely by seeking to understand the business. I agree he doesn't tend to buy sucker stocks but he has done well by trying to understand whether a business will do well long-term. Smith also attributes part of his success to low turnover. That isn't really possible with a statistical approach and you need to focus on the business. I.e. £G4M recently rated a sucker stock.
Probably best we pause this debate as it could go on forever! I guess we will have to agree to disagree on some points and agree to agree on others.
PhilH - good point there. If you don't have the time to look into the business a statistical kind of approach probably works best. I hope to own businesses for ages and so don't view looking into them as a waste of time. Also interesting that Buffett lost everything on Dexter Shoes. So if he can lose the lot we all can.
I think your results certainly show that your approach of focusing on HighFlyers and SuperStocks works. I should maybe have a go at trying it myself. I find it hard instinctively, though, not to try to get underneath a business to see what it is all about. I don't really trust the statistics or want to turnover my holdings too much. I think as small investors we can follow the statistical approach as we can exit and enter positions easily. Larger investors are forced to take a fundamental approach as they can't enter and exit so easily.
Thumbs down - not a huge fan of that myself. An alternative might just be to have a "report this post." People should be able to have an alternative view.
Great points and will probably leave this debate now as otherwise we will be here forever! Good luck on your run.
Hello .
Please allow me to be somewhat facetious here .
Why not just rename the dreaded word to " nag " , since such reminds me of my early days as a racetracker .
But beware ; l once saw a really really ultimate nag streak home by eight lengths , and , yes . it was well swabbed by the stewards and declared the winner !
Take care .
Sirius Minerals springs to mind. I was a brave gallant and fool hardy novice invester and also a new user of Stockopedia. I checked SXX on Stockopedia and it came back described as a "Sucker Stock" Did I believe Stockopedia? Of course I didn't and invested in Sirius!
Luckily managed to get out by the skin of my teeth and only lose a small amount of money. The whole situation was rather embarrassing and I was simply sold a story to good to be true.
I have a more cautious approach to investing now after that hard learnt lesson.
I see that Wizz Air recently went from sucker stock to neutral. Why?
https://simpleflying.com/wizz-...
Expanding while there is a pandemic in full swing looks reckless to me. Latest net debt has gone from 388 to 1690 million euros.
The revenue prediction for 2023 looks daft: a 365% increase on the 2021 figure.
I reckon there is more of a case for Wizz Air being a sucker stock than Ryanair.
In the last few days, International Consolidated Airlines Sa (LON:IAG) has now become a sucker stock, but £RYA is no longer one.
Given that UK covid figures are accelerating rapidly day by day, has the time has come for all airlines to be considered sucker stocks?
What is happening with Ryanair Holdings (LON:RYA), no rankings and no share price chart since last year.
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Hi Ed
That's rather spooky I was just posting this across on the Stockopedia at Mello thread and have just now seen your post. I think this posting (apologies for repeating it again here), adds to the points you are articulating.
Not sure this is the most suitable thread for this snippet (my apologies if it is inappropriate).
On this Saturday morning reflecting on the recent market and catching up on some Tweets. I thought the following from the very knowledgeable Mr Tim Bennett, to be a useful reminder of what our minimum investing goals ought to be. But also, a reminder that maybe we ought not expect the performances I know many of us experienced last year.
He wrote ........
A Look at the Historical Record Over the Last 120 Years
Equities have delivered the following annualized returns since 1900:
• 6.12% nominal, price only.
• 9.48% nominal, including dividends.
• 3.06% real, price only.
• 5.67% real, including dividends.
[Nominal is before taking inflation into consideration; Real is after adjusting for inflation.]
Before we go any further, let’s all try to agree on one thing. The only returns that matter are real total returns. Why? Because the whole point of investing (putting your life savings at risk) is to accumulate real wealth, net of inflation. Real wealth is defined in terms of purchasing power, not as net worth.
From this article https://www.zeninvestor.org/ex...
Building on this theme. Another statistic I value is from the 'Intelligent Investor' By Benjamin Graham whereby he explains that if you can make 7.1% annualised, you will double your money in ten years.
To me Stockopedia has definitely placed me on track to match both these challenges, and I suspect but cannot of course be certain, beat them over a ten year period.
Regards
Howard
EDIT: I made a mistake. The research is not by Tim Bennett, he tweeted the research which is by an Erik Conley. Sorry for the mistake