Sucker Stocks - why do we love to own the worst prospects in the market?

Thursday, Nov 19 2015 by
38
Sucker Stocks  why do we love to own the worst prospects in the market

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...

564dbf0c9c343LGO_Energy.png
This was a classic case of story over substance tempting investors into a stock where the statistical likelihood of a good result was low. The share wasn’t obviously cheap, it had low quality characteristics and its momentum was declining. But it did have vocal supporters who were prepared to talk-up its prospects to anyone that would listen. In the  Stockopedia taxonomy of stock market winners, we classify these shares as Sucker Stocks.


The traits of a Sucker Stock

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.

Robert Haugen’s “stupid stocks”

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…

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Disclaimer:  

As per our Terms of Use, Stockopedia is a financial news & data site, discussion forum and content aggregator. Our site should be used for educational & informational purposes only. We do not provide investment advice, recommendations or views as to whether an investment or strategy is suited to the investment needs of a specific individual. You should make your own decisions and seek independent professional advice before doing so. Remember: Shares can go down as well as up. Past performance is not a guide to future performance & investors may not get back the amount invested. ?>


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95 Comments on this Article show/hide all

Andrew L 28th Apr 76 of 95
1

In reply to post #358398

It is a bit of a provocative title. Not sure it is 100% accurate as lots of sucker stocks will change into other categories and do well. As discussed before I wonder how a portfolio of sucker stocks does without category changes? So starting year X with a fixed portfolio of sucker stocks then seeing how they perform over 10 years. I think the system of changing the categories to evaluate the performance may be flawed. People buy sucker stocks in the hope that their category will change. So if they buy them they will hold over the long-term.

A performance evaluation system that kicks out sucker stocks that have changed category doesn't make any sense to me. That is not how people invest. It also means that the performance of sucker stocks will look much worse than it would otherwise be. Who would buy a portfolio of sucker stocks and sell out of the ones that are no longer sucker stocks and keep the ones that are?

I am surprised that Gear4Music could be a sucker stock. I personally don't have a huge issue with the sucker stock label. It is a bit tongue in cheek and provocative. I am not really sure how accurate it is though. Some sucker stocks are just early stage companies that will look poor until they reach profitability. Personally I don't take the labels too seriously but for people who do maybe the term sucker stock doesn't work.

It is good, probably, to have a wake up call when looking at companies that appear to be very weak. However, taking EU Supply (LON:EUSP) it is pretty clear that in two year's time it won't be labelled a sucker stock. Is it appropriate to dismiss it now just because it is labelled a sucker stock. That makes no sense to me.

So my issue with the sucker stock label is that it is only fair if it takes the sucker stocks at a point in time and then assesses their long-term performance excluding category changes.  I.e. it doesn't throw out a sucker stock if it changes category.  On that basis it would be interesting to see how many sucker stocks do well.  

A few are likely to be recovery/early stage growth stories and do spectacularly well.  Probably sucker stocks contain some of the companies that have gone onto be the biggest winners out there.  Maybe Boohoo.Com (LON:BOO) was a sucker stock after its post-IPO profit warning.  If it is the case that some sucker stocks do spectacularly well if held as their labels changed then maybe the sucker stock label is somewhat misleading. Sucker stocks could be the place to look to find the biggest winners which seems counter-intuitive!

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PhilH 28th Apr 77 of 95
6

In reply to post #358423

People are getting hung on the application of the term (whether it be SuperStock or SuckerStock) to one stock or another. That is not what the StockRanks and classifications are about.

Rather it is if you hold a portfolio of 'Sucker Stocks' you are likely to lose on ~60% of the trades and if you hold a portfolio of 'Super Stocks' you are likely to win on ~60% of trades.

Given those figures what would you call someone who had a portfolio of 'Sucker Stocks'?

Talk about trying to push an elephant uphill!

Best of luck
Phil

Professional Services: Sunflower Counselling
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Andrew L 28th Apr 78 of 95

In reply to post #358438

Phil, I understand your point. But investment is about the future. I can certainly accept that sucker stocks will generally do badly. However, if you see a stock and you are 90% sure it won't be rated as a sucker stock in a year or two year's time does that mean you are buying a sucker stock? For me it doesn't really mean that. In reality you are buying a stock that will have a different label down the road. I agree that buying a stock that will always have the sucker stock characteristics is not good. But if you can predict a rating change then are you really buying a sucker stock?

EU Supply (LON:EUSP) - I think it will be almost impossible for this to be rated as a sucker stock in a year's time. They will be profitable this year and the valuation is very modest. So in reality I am buying a stock that will not remain a sucker's stock. But lets come back in a year and see if EU Supply (LON:EUSP) is still rated a sucker stock.

My issue is that if the classifications change a lot, as they do, it is hard to be a long-term investor on that basis. For example, apparently £G4M became a sucker stock recently. But I am more of a fundamentals and business person. Stockopedia's algorithms while no doubt very good are always using past data. For investors we are concerned with the future. Yes the past can be a guide to the future but it does not determine the future. It is useful to use our heads to see what the future may bring IMO.

When I think of EU Supply (LON:EUSP) I don't think of it as a sucker stock.  I think of it as a highly rated stock in a year or two's time.  If I was buying the past it would be a sucker stock but I am buying the future.

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shipoffrogs 28th Apr 79 of 95
1

In reply to post #358443

EU Supply isn't currently rated a Sucker stock - it' Style Neutral. But won't Brexit make it a sucker stock in a year's time?

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Andrew L 28th Apr 80 of 95

In reply to post #358448

shipoffrogs - in my Stockopedia it is still rated as a sucker stock. Maybe it has changed I don't know. But my one still says sucker stock. It was definitely rated as a sucker stock before. Brexit and EU Supply - no I don't think so.

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Edward Croft 28th Apr 81 of 95
3

In reply to post #358423

As discussed before I wonder how a portfolio of sucker stocks does without category changes? So starting year X with a fixed portfolio of sucker stocks then seeing how they perform over 10 years. 

@ratioinvestor - I think you've got the wrong mental model of how the performance studies work.   Do let me explain it more clearly.

We've just completed a 5 year test of their performance from the launch of the StockRanks back in April 2013. At the start of each annual period, all stocks are classified into one of 9 buckets (4 "winning" styles, 4 "losing" styles and 1 style neutral).   Each bucket is turned into an equal weighted portfolio.  The 9 portfolios are then 'held' for 1 year for performance tracking purposes.  After each year is complete, the process is repeated - a new portfolio is created for each classification and then it's tracked again.   i.e. these are annually rebalanced, equally weighted portfolios. 

During any year, each stock's classification will change - possibly multiple times.  So something classified 'sucker stock' at the beginning of the period - may well shift within days or weeks to a different category - possibly even to a winning style classification over the course of the year.  In spite of this, it remains in the original 'sucker stock' portfolio for performance tracking purposes until the next rebalancing date.  

I believe emulating a 1 year holding period is appropriate as it reflects the typical private investor holding period for a stock.  In fact the data suggests that the average holding period is a lot shorter - more like 8 months.  So 1 year holding periods is actually conservative. 

Here's the output:

5ae450981c367CloudApp_Annotation_2018-04


I've excluded the 'style neutral' chart for clarity from the above graphic... but it sits in the middle. 

People buy sucker stocks in the hope that their category will change. So if they buy them they will hold over the long-term.

The point I'm making is that the average return of sucker stocks over 1 year holding periods has been extremely negative - however you look at it.  I presume if we extended the holding period to 2 years, or shortened it to 6 months we'd see a similar result.  

These findings are completely in line with all the academic research on the subject.  It's just that we're making the findings a bit more accessible through some colourful language.

It is good, probably, to have a wake up call when looking at companies that appear to be very weak. However, taking EU Supply (LON:EUSP) it is pretty clear that in two year's time it won't be labelled a sucker stock. Is it appropriate to dismiss it now just because it is labelled a sucker stock. That makes no sense to me.

I can't comment on individual companies - but I'll explain my own perspective on this point - and it comes down to opportunity cost.  Yes there may be many early stage companies that are labelled sucker stocks - and many may have promising long term business plans.  But the average return has been -11.2% annually over the last 5 years for these shares.     

Given the average returns across 'winning' styles has been approximately +10% annually in the last 5 years... the real opportunity cost of owning sucker stocks has been greater than 20% per year!

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PhilH 28th Apr 82 of 95
3

In reply to post #358443

Well I agree that investing is about the future. But the question ... are you Mystic Meg or Septic Peg?

I don't buy stocks with certainty in the companies, I buy a basket of stocks knowing some of them will fail and others will do well. And perhaps that whole strategy will fall apart if conditions change.

With respect to EU Supply (LON:EUSP) ... that's the point ... I'm not interested. I have a system based around probability based upon academic research and that system says £EUSP won't at this point match my criteria ... if it does I'll consider buying it. In the meantime it might well do well and there will be loads of stocks I don't buy that will do well, including Sucker Stocks. *shrug*

I am full of admiration of the ability of Paul & Graham to deconstruct companies, sectors, markets, sentiments, management teams, etc. ... but really ... come on ...

Every reader has to answer the question ... Can I do what they do for myself? or Do I even need to do that?

Every morning up reading RNS's, sifting through thousands of spun missives from CEO, CFO's and PR departments?

Maybe it might help one's ego to think that one can do it?

Or perhaps what I suspect is going on, many people follow the views of influential posters and buy what others like. They kid themselves they are doing well but really if the source of the influential posting is removed they are rudderless.

If I can generate 25% annualised over 5 years (that's not hypothetical btw) without seeking guidance from an external locus and not having to do all of that work digging through the context of a business or even knowing really what a company does beyond the Stockopedia headline of the company's activities then why should I waste so much time digging through tons of fools gold hoping to find a nugget?

I'd imagine most people here are not full time investors, they are doing some sort of full time job, maybe managing a family too. For me it's about efficient use of my time and maximising returns whilst limiting downside.

I think some people strongly identify their ego with their ability to 'know' businesses and the idea of letting go of that is challenging to them.

Professional Services: Sunflower Counselling
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Andrew L 28th Apr 83 of 95

In reply to post #358463

Ed - thanks for the detailed reply. I personally don't believe a one-year holding period is appropriate. I agree that sucker stocks will trend lower in aggregate over a year. That makes sense. However, contrarian investors buy a sucker stock with the intent of holding for a long-time. That is the point of them. My main point is that the sucker stock performance analysis will always look bad if you kick out stocks that are no longer sucker stocks at the end of the year. You are forcing yourself to divest of sucker stock winners. Who would do that?

A one year holding period doesn't really answer the question in my view. I.e. what percentage of sucker stocks will eventually do well over the long-term? I understand that the average private investor may hold for one year. But I don't think we can extend that to a test type scenario. The average private investor doesn't do very well. I personally wouldn't do a test based on the behaviour of an average private investor. Or start with an assumption that we will hold for one year.

A test without any assumptions, in my view, would give more powerful results. I.e. buy a basket of sucker stocks and hold for say 10 years. What percentage eventually do well? Your general finding is still likely to hold. However, we may also find that there are spectacular sucker stock winners. The proportion that are winners would be interesting.

I agree it isn't good to focus on individual stocks and nothing here is a tip. However, EU Supply (LON:EUSP) is expected to be in profit this year and has a good track record of revenue growth. I am just using it as an example.

Opportunity cost - I understand the argument but am not sure I agree. I could buy €EUSP for example (not a tip) when it goes to say 20p (hopefully) and everyone likes it. Or I could buy it now when it is rated as a sucker stock for say 11.75p (my entry price). So I think if you can pick the sucker stocks that will change rating, and will eventually be winners, there is an opportunity cost to not buying them early on.

It is of course a different question as to whether we think we can identify the sucker stocks that will eventually be winners. I personally don't think it is rocket science to do so. I agree there is an opportunity cost if the sucker stock does nothing. However, part of the rating category momentum it is likely that a sucker stock will go up in price before it changes category. I agree largely with the Stockopedia system and would generally not look at sucker stocks. However, I personally don't think we can rule them out. But this is based on a qualitative assessment and I guess Stockopedia doesn't really focus on that. I wouldn't specifically try to find opportunities amongst sucker stocks but if I found something I liked and it was a sucker stock it wouldn't put me off.

With regard to EU Supply (LON:EUSP) (again just as an example not a tip) in 2020 it is forecast to be on a P/E of 10X and have £1.1m net cash. The current market value is about £9.5m. So it is pretty obvious that it won't be a sucker stock if the forecasts are met. I agree, though, that the sucker stock label is not discriminatory and the reason EU Supply (LON:EUSP) is very cheap (on face value) is that it appears to have missed forecasts before. So how much weight can we put on forecasts this time? Not least with one broker.

My overall point is that if you have sufficient confidence in a company you shouldn't ignore it just because it is labelled a sucker stock. You should just be more careful (EU Supply (LON:EUSP) is a small position for me). There are many who would say it is best to wait for the rating to improve. But I personally wouldn't want to give up the early gain as the rating moves from sucker stock into other categories.

For private investors, though, I think the sucker stock rating is very useful as it stops them buying into story stocks. We have to note that the sucker stock rating is effectively saying the past of this company is not great. Statistically the past is in aggregate a reasonable guide to the future but it isn't for every individual company.

If Facebook or Google had been listed when they were loss making and a financial crisis had come along they would could have been rated as sucker stocks. Past losses are not necessarily bad if a company is building a platform i.e. Amazon. So I prefer to make a case by case assessment.

The overall point that most companies at the UK Investor Show were awful still holds. However, there were some early stage companies that were building a platform that might do well. These included Sosandar (LON:SOS) and Franchise Brands (LON:FRAN). I guess those who go for sucker stocks and do well are looking at early stage stories. This takes considerable skill to get right with UK VCTs generally performing poorly. However, I think it is potentially possible to pick early-stage winners although many other people would disagree.

I also personally think we have to use our heads.  EU Supply (LON:EUSP) is rated by Stockopedia as 2 on the quality front.  That seems crazy to me and makes no sense.  They have seen good revenue growth and have just become profitable.  It is obvious that in a year's time the quality rating from Stockopedia on EU Supply (LON:EUSP) will be higher than 2.  We can also reflect that the quality rating on Conviviality was over 90 a few months before it went bankrupt (someone posted that a while back).  So while I look at these metrics I prefer to think for myself.

So while I look at the Stockopedia ranks I don't necessarily agree with them.  In my view, we shouldn't invest in individual stocks unless we can think for ourselves.  But I have a relatively concentrated portfolio and this is therefore a necessity.

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Andrew L 28th Apr 84 of 95
2

In reply to post #358468

Phil - Not mystic Meg unfortunately. I don't disagree that buying stocks that are rated highly in the Stockopedia system will do well. Your returns are very impressive and Stockopedia is a very easy to use system. I am only saying that personally I wouldn't rule out a company if it was rated as a sucker stock. I just met EU Supply (LON:EUSP) at a show (Cenkos/shares magazine) earlier this year and they seemed ok. I could well be wrong though. I was just using it as an example.

I agree that most sucker stocks will not do well. In reality for all shares, over the long-term, the performance is driven by business fundamentals. I think we can assess the fundamentals for early-stage shares as well as more mature companies. But maybe I am wrong and the opportunity cost is that I am spending time on weaker companies rather than fishing in the more attractive pool of stocks. Personally I like to get my head around the fundamentals of a company. I think you and Ed would do more of a portfolio/statistical approach. Hopefully there are many ways to skin a cat that can work!

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Howard Adams 28th Apr 85 of 95

In reply to post #358463

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

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Richard Goodwin 28th Apr 86 of 95

In reply to post #358468

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.

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PhilH 28th Apr 87 of 95
2

In reply to post #358558

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.

Professional Services: Sunflower Counselling
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Andrew L 29th Apr 88 of 95
3

In reply to post #358563

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.

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gus 1065 29th Apr 89 of 95
3

In reply to post #358643

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.

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ricky65 29th Apr 90 of 95

In reply to post #358648

Gus, 150 holdings?! I'd have a nervous breakdown trying to keep up with all those!

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Edward Croft 29th Apr 91 of 95
3

In reply to post #358643

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.

5ae5d6e09395cCloudApp_Annotation_2018-04

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 !!!


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PhilH 29th Apr 92 of 95
1

In reply to post #358643

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?

Professional Services: Sunflower Counselling
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gus 1065 29th Apr 93 of 95

In reply to post #358683

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.

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Andrew L 29th Apr 94 of 95
1

In reply to post #358688

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.

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Andrew L 29th Apr 95 of 95
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In reply to post #358698

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.

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