Streetwise

Lauren Rudd

Sunday, November 20, 2011

The End Game

They call the conclusion of a chess match the end game and it takes special skills to master that part of the contest. In the stock market, we have the end-of-the-year-game. What makes this time of the year so unique is the tax-loss selling and profit-taking that occurs as both individual investors, as well as professional money managers, tune up their portfolios ahead of the rapidly approaching New Year.

As a general rule, the period between mid-November and year-end can provide some of the best stock buying opportunities of the entire year. At the same time, no one would argue that the recent market history has diverged considerably from a so-called normal.

Daily volatility has hit extremes that exceed anything I have seen before. There is no question that in many respects Wall Street has become too scary for many investors, even the “old timers.” Nonetheless, this is no time to put money under the mattress or in a certificate of deposit, which are virtually equivalent.

Rather exactly the opposite is true. Now is an excellent time to consider re-balancing and rejuvenating your portfolio to match the economic outlook for the coming year. Specifically, you want to remove those holdings that when viewed in the harsh light of reality are not going anywhere and replace them with companies that are likely to have a brighter future going forward. Moreover, you do not want to let extraneous “noise” negate your taking advantage of investment opportunities.

End-of-the-year bottom fishing is quite simple. You are looking for companies whose shares have been beaten down because they are either being sold for a tax loss, or have succumbed to the understandable but over-done Wall Street sell-offs. Or maybe a company has simply been the victim of the malaise that seems to periodically wash over Wall Street. Regardless, there are numerous unloved and undervalued companies whose shares are looking for a munificent buyer.

Do not dwell on the negative. You should view the problem from the perspective that both the economy and the stock market are in a recovery mode, albeit a slow one. Regardless of whether a stock has posted a gain or loss over the past year, you cannot judge the efficacy of company solely on the performance of its share price.

Utilizing methodologies such as discounted cash flows and intrinsic value, your investment objective should be to create a return that at a minimum exceeds the sum of what a 30-year treasury bond would pay, combined with up what you will lose through taxes and inflation.

To simplify the equation consider that the guideline for my students is a minimum compounded annual growth rate over 3-5 years of 10 to 15 percent. However, it is foolhardy to believe that you can always pick winners. Swinging from the rafters is a game for monkeys, not investors.

A prudent stock selection process, combined with a reasonable asset allocation and risk profile will likely enable you to meet that objective without breaking a sweat

And while it may not make you the life of the party this holiday season, when someone asks if you have invested in the latest “hot” stock or commodity, simply tell them that you prefer to be the tortoise and not the hare.

What you are looking for are those companies that have been able to weather the economic downturn and are now following the economic revival as it unfolds, albeit slowly. To find those stocks you are going to need an edge. If you want to become a market-trouncing master strategist, your knowledge of a given company must be superior to that of the great unwashed. So where do you begin?

Each year about this time I offer up 12 investment ideas, the performance of which I then review a year later. The list is not intended to be an instant portfolio where you simply add water and stir. On the contrary, they are merely suggestions that are designed to be a catalyst to stimulate ideas and thinking on your part about possible sectors and companies you might want to investigate.

So start now with your own research and after the Thanksgiving holiday we will see how my picks of last year did. At the same time, I will offer up another list of 12 companies for your investing pleasure.