Welcome to the Forecasts

10/6/2008


In a recent survey of our subscribers, the Forecasts discovered that many of you have questions — about what we do, and how and why we do it. Today, we answer some of those questions.

Q How do your analysts pick stocks?
A We use a two-step process.

First, we harness the power of Quadrix®, a time-tested quantitative stock-rating system that considers more than 100 statistics. We calculate Quadrix scores for nearly 5,000 stocks, using a percentile scale of 0 to 100, with 100 the best.

Statistics are broken up into six categories: Momentum considers recent operating results. Value looks at valuation ratios. Quality rates long-term growth and returns on equity, assets, and investment. Financial Strength assesses debt levels and profit margins. The Earnings Estimates score reflects trends in consensus profit estimates. Performance considers stock-market returns.

Quadrix calculates a score for each of the six categories. Those six scores determine the Overall score, which is designed to rate the investment appeal of any stock relative to that of all the other stocks in our research universe. As the chart below illustrates, stocks that earn high Quadrix scores have substantially outperformed lower-scoring stocks. For more information, including Quadrix scores and other data for individual stocks and industry groups, visit the “Quadrix Tools” section.

The second step is old-fashioned company analysis. While Quadrix works well overall, as evidenced by the historical returns of high scorers, it isn’t perfect. Our quantitative system does an excellent job of capturing a company’s history, and also looks ahead at analyst profit estimates. But by their nature, quantitative systems cannot capture the effect of many company-specific factors.

In our search for new Buys, we focus on stocks with Quadrix scores of 80 or higher, then consider the merits of individual companies within that select group.

Q That chart above is impressive. Why don’t you just buy the high Quadrix scorers?
A The Quadrix system does a fine job of separating the wheat from the chaff, as the chart shows. But for practical purposes, only wealthy investors could afford to rebalance a 50-stock portfolio every quarter without seriously crimping returns. Most of us must make do with a substantially smaller portfolio — or less-frequent rebalancing — which substantially increases risk.

To create our lists, we must deal with three issues:

Bad apples: Even within the most attractive groups of stocks, a few will buck the odds and perform poorly, though the numbers and company analysis suggest they should do well. Suppose that 35 of the stocks in a 50-stock portfolio outperform, and 15 lag. You’d probably be happy with the result. But if you only purchase, say, 20 stocks, selecting even a small number of stinkers can really hurt.

Diversification: Some sectors, such as energy, earn very high Quadrix scores. It wouldn’t be hard to fill half of the Buy List with energy stocks. But in a small portfolio, we cannot afford to concentrate our investments, because it would leave subscribers vulnerable to weakness in a market sector.

Trading costs: We could probably boost returns on paper by simply switching into new stocks all the time, keeping the portfolios in only the highest-scoring issues. But for all of you who invest $1,000 or even $10,000 in each of the stocks on our list, such a strategy is impractical. Trading costs would eat up much or all of your profits.

We have to select a precious few stocks to purchase, then sell them at the right time. And we’re not always right. Sometimes we’ll buy the wrong stock, sell too soon, or sell too late. But the key to success is being right more often than you’re wrong. And over the years, we’ve done a good job of presenting market-beating portfolios small enough to be investable, yet large enough to limit risk.

Q So, how well have your portflios performed?
A Since 2000, when we started using the Quadrix system to select stocks, all three of our stock lists have outperformed the S&P 500 Index.

According to the Hulbert Financial Digest, a newsletter that tracks the performance of investment newsletters, the Forecasts is among a select group of newsletters that have outperformed the Wilshire 5000 over the last one, three, five, 10, and 15 years. Over the last 25 years, the longest period Hulbert measures, the Forecasts rates in the top five.

Q Do I have to wait until I receive the Forecasts in the mail? I want to read my newsletter right now.
A The Forecasts is mailed every Thursday morning, but subscribers can read the newsletter online one day earlier, after the close of business Wednesday.

Q How can I get to the Subscriber Area on the Web site?
A To log into the Subscriber Area at dowtheory.com, use your customer number (which can be found above your name and address on the envelope in which you receive your weekly issues) as both the username and password. Once you log in the first time, you can change your username and password to something easier to remember.

Q How can I access your hotlines? And why aren’t they available by e-mail?
A We publish hotlines twice a week — Wednesdays after the close of business, and around midday on Fridays. Both are available by e-mail.

You can check the hotlines in three ways:

-Log into the Subscriber Area at dowtheory.com. You will find a link to the current hotline next to your editor’s photograph.

-Call (800) 931-2295. To access the hotline via phone, you’ll need the monthly passcode, which can be found in the box on page 6 labeled “rank changes.”

-Call our customer-service department at (800) 233-5922 and ask to be put on our e-mail list to receive our twice-weekly hotlines.

If you have already given us your e-mail address, but are not receiving our hotlines, try the following:

1) Call us to make sure you haven’t opted out of receiving our hotlines.

2) Add our e-mail addresses alert@horizonpublishing.com and horizon@horizonpublishing.com to your address book.

3) Designate our e-mail addresses as safe with your spam filter.

Q What’s the difference between a Buy and a Focus List Buy? And what is a Neutral, anyway?
A The Forecasts uses five ratings.

Here is what they mean:

Buys are our top selections for 12-month returns. The Buy List is a diversified portfolio of 25 to 35 stocks, and any stock on that list is a candidate for immediate purchase.

Focus List Buys are our favorite selections among the Buys. Many investors don’t want to own more than 20 stocks. If you seek a more focused portfolio, and are willing to accept the added volatility that comes with fewer stocks, consider the Focus List.

Long-Term Buys are our top investment-grade selections for 24- to 48-month returns. They tend to be large, sturdy companies — you probably know most of the names on the Long-Term Buy List.

Neutrals are stocks we don’t want to own, either because we expect them to perform roughly in line with the market, or because we aren’t sure about their future direction.

Underperforms are exactly what they sound like. We expect these stocks to lag the market and suggest you sell them immediately.

Q I own a stock you rate Neutral. What should I do?
A To us, a Neutral rating implies that we expect a stock’s performance to be either average or unpredictable. For investors seeking to beat the market without taking on excess risk, neither of those outcomes is desirable. Neutrals — and any other stocks not ranked Buy, Focus List Buy, or Long-Term Buy — represent sell candidates. In general, we advise subscribers to sell the stocks we don’t recommend and mimic the Buy List, Focus List, or Long-Term Buy List.

Q Where can I find a list of the stocks you recommend?
A In the Follow-Up section of every issue of the Forecasts, you’ll find all the stocks rated Buy or Long-Term Buy, along with their target weightings.


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