In spite of a rough start to 2009 (the S&P 500 was down over -26% at its worst by March 3rd), the year produced one of the most spectacular rebounds we’ve seen in history by the end (+67% from the lows and a very respectable +23% net gain for the year).
2009 will be remembered much like 2003 was: an amazing recovery after a brutal bear market.
But now it’s 2010.
So how do you want this year to be remembered?
Wouldn’t it be great if 2010 turned out to be even better?
(Queue the dreamy music while you daydream for a moment…)
OK, nap time’s over. Now it’s time to get to work and plan how you’re going to make that happen.
Plan for Your Success
As the saying goes: ‘if you fail to plan, plan to fail’.
Many stocks skyrocketed last year simply because they didn’t go out of business, and the market quickly tried to put value back into them.
Others were so beaten down that there was almost nowhere else to go but up.
Of course there were some truly fantastic companies out there that performed great — and rightly so.
In some ways, 2009 was both one of the toughest years and also one of the easiest years all at the same time.
And while I’m expecting 2010 to be another good year, I expect the path to success will look a little different than the one we just finished.
So putting together a game plan for how you’re going to get from point A to point B is mission critical.
Seems like a daunting task – but it really isn’t.
And I’ve got 3 tips to get you on your way.
Tip #1
I recently did a study to see how the different market caps performed over the last 8 years — from the bear market of 2002 and the rebound of 2003, to the bear market of 2008 and the rebound of 2009, and all the years in between.
I found that each market class (Small Caps, Mid Caps and Large Caps) had their day in the sun.
In fact, Large Caps were the top performing class in 4 of those 8 years, beating out Small Caps for that honor. Overall, Small Caps had the best performance over that time span. (The average annual return over those 8 years for Small Caps was 23.15%, Mid Caps was 15.33% and Large Caps was 13.45%, with the S&P 500 at 6.83%).
As you can see, each class performed great. But Small Caps will typically carry a higher degree of risk, i.e., volatility, while the Mid Caps and Large Caps generally see lesser volatility and drawdowns.
The point is: make a decision to flesh out your portfolio with a mix of each class. This should help you generate solid, market-beating returns, while also smoothing out your ups and downs.
Tip #2
Stick with the Top Industries.
Statistics have shown that roughly 50% of a stock’s price movement can be directly attributed to its group.
And in my testing I have found that just getting into an average stock in a strong group will often outperform even the best stocks in a troubled group.
Now imagine how picking the strongest stocks in the strongest groups would do.
Resolving yourself to picking stocks only from the best Industries will significantly improve your odds of success.
How much so?
The top 50% of the Zacks Ranked Industries outperformed the bottom half of the Industries by a factor of over 4 to 1. (Four to one!!!) And the greatest amount of excess return came from the top 10% of Industries.
Staying with the top Industries can give you a clear advantage over the market.
Make sure this is part of your plan for 2010.
Tip #3
I’m often asked what some of my favorite stock-picking items are.
My answer is, aside from the Zacks Rank (which truly is one of my all-time favorite stock picking items), it would have to be the Price to Sales ratio.
The Price to Sales ratio (or P/S ratio) is calculated as Price divided by Sales.
A P/S ratio of 1 means you’re paying $1 for every $1 of sales the company makes.
A P/S ratio of 2 means you’re paying $2 for every $1 of sales the company makes. (Not as good.)
On the other hand, a P/S ratio of .5 means you’re paying 50 cents for every $1 of sales the company makes. (Much better.) And paying less than a dollar for a dollar’s worth of something is a great bargain.
In general, I like to find stocks with a Price to Sales ratio of less than 1.
I will at times get into stocks with higher P/S ratios, but I definitely try to avoid excessively high P/S ratios.
And if I need a tie-breaker between picking one stock over another, it literally almost always comes down to the one with the better Price to Sales ratio.
Why do I like it so much?
Because after building and testing literally thousands of different trading strategies over the years, I’d be hard pressed to find a strategy that can’t be improved by adding the Price to Sales ratio to it.
This is true for Price Momentum strategies and Growth strategies to Value strategies and Growth & Income strategies, and almost every other style you can think of.
Of course, this one item isn’t magic. You still need to apply it smartly to other items that have proven to pick good stocks.
But if you’re not using the Price to Sales ratio in your trading now, definitely consider adding it to your stock-picking game plan for 2010.
Stick to Your Plan
The above 3 tips, as great as they might be, are just a few of the rules you should consider setting out for yourself as you perfect your trading plan for beating the market this year.
But if you only add a few tweaks to your current 2010 plan, these 3 tips, along with the Zacks Rank, should be at the top of your list for supercharging your stock picking.
The hardest part, however, will likely be sticking to your plan.
But don’t let it be.
The easiest way to stick with something is to have confidence that what you’re doing works.
And that’s why every idea you have should be put through its paces in a backtester.
With backtesting, you’ll quickly discover if your stock-picking criteria generally picks stocks that go up once they’ve been identified or if it picks stocks that get buried once they’ve been identified.
This is good stuff to know.
And it’s how I came to rely on the 3 tips explained above (along with many others).
Best Way to Apply These Tips
Once you know what works and what doesn’t, and where your probabilities of success are; be sure to stick to those proven methods and you’ll be a winner in 2010.
To get started in applying any of the 3 tips I just went over, you can do so quickly and easily with the Research Wizard. You can also pick and choose from our prebuilt trading strategies that come with it. Or you can create your own and put your best ideas to the test as you map out your 2010 trading plan.
Find out more about the Research Wizard
Thanks and good trading.
Kevin
Kevin Matras
Vice President, Zacks Investment Research
Zacks VP Kevin Matras is our chart patterns and stock screening expert. He also personally developed many of the built-in market-beating strategies that come with the Research Wizard.
