Reader Q & A: Greatest Hits

2/24/2014


I've answered a lot of subscribers' questions in the nearly 20 years I've been editor of this newsletter, and I've answered some of the same questions many times. So, in the interests of customer satisfaction and editorial expediency, here are frequently answered questions from readers just like you — except you actually exist.

Q My newsletter arrived late. What's the deal?

A While we go to great lengths to get newsletters delivered as soon as possible, systemwide postal delivery times have worsened considerably in recent years. Given the losses and other problems faced by the U.S. Postal Service, we're not confident service will improve anytime soon.

By far your best option is our website, www.DowTheory.com, where the newsletter is posted every Wednesday evening, five days before the publication date printed on the newsletter. If you go to the Subscriber Area of our website and hit "click to view current issue" at the top of the page, you can print out a weekly newsletter exactly like the one that will arrive
in your mailbox in five to eight days.

Q Among your recommendations, what's your favorite stock now?

A Last week pages 4 and 5 featured reviews of my favorite year-ahead picks — Google ($1,211; GOOG), Helmerich & Payne ($93; HP), Skyworks Solutions ($32; SWKS), United Rentals ($85; URI), and Wells Fargo ($46; WFC). If forced to pick one name, I'd go with Helmerich & Payne, followed by Skyworks. For the one stock to buy and hold for the next decade, I'd go with Google. Remember, though, that owning one stock is a lot riskier than owning 20 or even 10 stocks.

Q It seems like most stocks move together. So how can a one-stock portfolio be much riskier?

A Glad you asked. Consider the tables below, which show the riskiness of hypothetical randomly created portfolios of S&P 500 stocks for the 60 quarters ended Dec. 31. For each portfolio size, we created 1,000 random portfolios for each selection date, then measured the volatility and risk of quarterly loss over the entire 15-year period.

HOW MANY STOCKS SHOULD I OWN?
Below are results from a study of randomly created portfolios of S&P 500 Index stocks for the 60 quarters ended Dec. 31. Based on standard deviation, which measures the dispersion of quarterly returns, the pace of risk reduction diminished considerably after portfolios had 40 stocks. For all portfolio sizes, standard deviation and the risk of a quarterly loss were lower with top-ranked stocks based on Quadrix than with bottom-ranked stocks.
----- Standard Deviation -----
Likelihood Of Quarterly Loss
--- Quadrix Overall Quintile ---
--- Quadrix Overall Quintile ---
No. Of
Stocks In
Portfolio
Top
(%)
Middle
(%)
Bottom
(%)
No. Of
Stocks In
Portfolio
Top
(%)
Middle
(%)
Bottom
(%)
1
16.2
13.6
21.6
1
40.7
42.2
43.3
10
4.9
4.1
6.5
10
31.1
36.8
38.7
20
3.3
2.8
4.4
20
29.5
35.8
37.5
40
2.0
1.7
2.6
40
28.5
35.4
37.0
60
1.3
1.1
1.7
60
27.8
35.6
36.7
80
0.8
0.7
1.1
80
26.7
35.8
36.8

Based on standard deviation, a measure of the dispersion of quarterly returns, a 10-stock portfolio of Quadrix leaders had 30% of the risk of a one-stock portfolio. A 20-stock portfolio had 20%, while one with 40 stocks had 12%. After that, risk decreased only slightly as stocks were added.

Based on the risk of suffering a quarterly loss, a 20- or 40-stock portfolio was only slightly riskier than a 10-stock portfolio. But all three had much
less risk than a one-stock portfolio.

Q If risk falls as you move to 40 or 60 stocks, why don't you have that many on your buy lists?

A We typically have a hard time finding that many stocks we truly love — and I've found that our Quadrix-driven investment process works best with a love-it-or-leave-it mentality.

Q So, which of your buy lists should I follow?

A If you are adding to an existing portfolio, mimic our Focus List, which typically has 12 to 17 stocks. If you are using our recommendations for the bulk of your portfolio, mimic the Buy List (with 20 to 30 stocks) or the Long-Term Buy List (with 30 to 40 stocks). The Buy List and Long-Term Buy List overlap considerably, but the Long-Term Buy List tends to be more patient with out-of-favor or slightly expensive names.

Also consider the amount of trading activity that works for your temperament. For stocks dropped from the Focus List since year-end 2008, the median time on the list was 8.9 months. That compares to 13.3 months for the Buy List and 17.4 months for the Long-Term Buy List.

Q Why bother? Most of what I read suggests owning individual stocks is a waste of time, since I can get broad stock-market exposure with an index fund.

A First, our lists tend to outperform the broad indexes. All three of our buy lists have outperformed handily relative to the S&P 500 Index since the introduction of Quadrix in early 2000. According to the independent Hulbert Financial Digest, Dow Theory Forecasts delivered a 6.6% annualized return for the 15 years ended Dec. 31, versus 4.7% for the S&P 500 Index. A $200,000 portfolio grows to $521,661 in 15 years with a 6.6% annualized return. At 4.7% annually, the same portfolio grows to $398,318.

Second, you only need to get rich once, and you only need to spot one opportunity to make it happen. By staying engaged with business and the stock market, you are more likely to spot that opportunity, whether it is finding a sector or company you really like or realizing it is time to cash in.


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