Here's What We're Not Buying

3/22/2010


Acquaintances talking to a doctor at a cocktail party may ask for advice about their aches and pains. Carpenters get used to being grilled on how to plug holes in drywall or install doorknobs. And it seems as if everybody who meets a stock analyst wants to know what he’s buying.

Just the other night, a parent at my older son’s Boy Scout meeting asked what to buy for long-term growth. That’s an excellent question, but it’s not the only question.

If you want to know what we’re buying, click here for a table listing all the stocks we currently recommend for purchase. At the Forecasts, we look for stocks with strong fundamentals, growth potential, and attractive valuations. And we like to dip into different pools. Diversification matters.

We look at a lot more stocks than we end up buying. To better understand what we like, ask a different question — what are we not buying? Here are a few examples.

Story stocks. We do listen to some stories — starting with the story told by Quadrix®, our rating system that uses dozens of statistics to create percentile ranks for more than 4,000 stocks. Sometimes readers will tell me about this or that misunderstood company that looks bad by the numbers but has doubled down on a product with great potential. Such stocks can skyrocket, but too many of these stories are not supported by the fundamentals or stock-price action— and do not end well.

Deep values. Don’t misunderstand me; here at the Forecasts we like value stocks, which have historically performed well. But if the only reason — or even the chief reason — for buying a stock is its incredibly low valuation, you can probably do better. We believe you can earn higher returns — with less volatility — by looking for such attributes as growth, strong balance sheets, and rising earnings estimates in addition to attractive valuations.

High yields. I won’t harp on this topic, because it comes up fairly often in the newsletter. Here’s the short version: Historically, the stocks with the highest yields have not outperformed the average stock. Focus on stocks with high total-return potential, and if needed you can create income by selling shares periodically.

Individual foreign stocks. This is more a guideline than a rule. We do cover a small number of large, strong foreign companies, such as Canada’s Research In Motion ($75; RIMM), featured in Analysts' Choice this week.

Our stock-selection system relies on the use of a large number of statistics, and we cannot calculate Quadrix scores for most foreign companies. However, more foreign stocks are being listed on U.S. exchanges, which in turn should broaden our selection of prospects.

Investors seeking broad-based exposure to foreign equities should consider mutual funds. Our favorite foreign-stock funds are T. Rowe Price International Discovery ($38; PRIDX), Vanguard International Value ($31; VTRIX), Vanguard Total International Stock Index ($15; VGTSX), and Vanguard Emerging Markets Stock Index ($14; VEIEX).

Individual bonds. We prefer to get our fixed-income exposure through mutual funds, which represent a better deal for most individual investors. Funds allow investors to diversify their fixed-income holdings at a reasonable cost. We recommend five bond funds and two funds that contain both stocks and bonds — Vanguard Wellington ($30; VWELX) and Vanguard Wellesley Income ($21; VWINX). Four of our bond funds have expense ratios of 0.22% or lower, and the Wellington and Wellesley funds have expense ratios of no more than 0.34%.


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