Wednesday, January 24, 2007

Major Insight?

On the Yahoo board the other day, a poster challenged me to use my database of 276 MFI stocks bought hypothetically January-June of 2006. He asked if an investor would do better by selling the MFI stocks when they dropped 20%. The answer is a resounding no!

I analyzed my database of 276 stocks (typically the 50 stocks greater than 100m for the 1st 6 months of 2006) with the rule that if a stock dropped 20% that you sold it. I did assume you were able to sell exactly at a 20% drop, probably not true as stocks sometimes gap down.

The results were very interesting. You really missed out on some big gains following that approach. Several of the stocks had been purchased after drops such as KOSP, PLAY & IVII. Others had big rebounds, such as DLX, JH, MRX and VPHM.

Of my universe of 276 stocks, I showed that 107 had at one point dropped 20% or more. Of those 107, 68 were now down less than 20%, while 39 were down more than 20%. So 63% of the stocks after having dropped 20% eventually went up from that point.

The 276 stocks in aggregate, if you simply bought and held them per the MFI rules, would be up 11.9%. If you implemented the rule to sell when they dropped by 20%, you would only be up 7.3% (and with about the same amount of overall volatility). Now this measure does not figure out if you sold the107 stocks and invested in other MFI stocks where you would be. To be fair, you should probably add at least a point to the 7.3% for putting the cash in a money market account.

Now suppose you did the reverse and bought stocks after they dropped 20%, giving you a basket of 107 stocks. You would be up 14.8% today and you would have also gotten some investment income as you were not fully invested the entire time.

As I said, interesting findings. I am not sure that it implies that buying stocks after they drop 20% is a good strategy, I think that’ll take further study… though it does suggest that. The study may be a bit biased as many of the stocks were sold when the market was dropping in the summer with the Israeli war and fear of recession. My big takeaway is that selling at a 20% (or really any amount) dip does not seem like a worthwhile strategy.

Final point – one might ask: what stocks are currently down more that 20% that were in my universe of MFI stocks and are still on the list? I think I may try this as an approach for my next basket of stocks in February.

Looking at my own portfolio, pretty similar results. 14 of 35 stocks have dropped by 20% or more. Of the 14, 5 have remained below 20% and 9 have bounced back. My overall return is about 11%. If I had sold at 20% drops I’d be at 7.3%. I will try and update this study in about 6 months as I think it is ground-breaking.

Here are some stocks that are down 20% right now and still on MFI lists. Again, I may consider some of these for my Feb purchases.


My porttfolio was up about 0.72% today. Gotta be happy, though the benchmark was up slighty more. SHOO was my big gainer, up about 3.3%.


Kelly Monaghan said...

I am considering instituting a policy of selling stocks if they decline 25%, BUT reinvesting the money in another stock, which would then be held for a year.

Any guess as to how that would affect the results?

justadrone said...

I think it would narrow the difference as many of the sales were during the "bear" stretch in late June/July and the reinvested amount would be in other stocks that were temporarily depressed.


Jason said...

Nice article mate.

I would interested to see what the results would be if you only purchased the companies when they dropped 20% from the time you added them to your watch list.

justadrone said...

15% compared to the overall 12%. Plus your money has been invested for shorter time frame.


Nick said...

Wow, nice little spike in traffic on Thursday.

Buying after a drop might be very a nice long-term strategy. Out performance of even 1% per year could significantly boost returns of 15-30 year period.