Charles B. Carlson, CFA

Everyone’s favorite investment mantra is “buy low, sell high.” The problem is that nobody actually buys low and sells high. Rather, we buy high and (we hope) sell even higher. The stock market is the only market on earth where the merchandise becomes more popular as it becomes more expensive. Why? Because investors feel comfortable staying with the herd when it comes to buying stock. After all, if everyone loves a stock and its price is rising, it must be worth buying, right? 

The problem is that investing with the herd is a surefire way to lose money. Look at all the technology stocks that soared in the late ‘90s only to come crashing down. Everyone wanted to buy those technology stocks when they were skyrocketing and trading at extreme prices; nobody wanted to buy them when they crashed. 

Successful investing is all about forcing yourself to do the smart thing even when your emotions are telling you otherwise. And the smart thing to do as an investor is to buy low and sell high. Fortunately, strategies exist that force investors to buy high-quality stocks when they are down and to sell them when they are up. I call them my “worst-to-first” strategies. 

These strategies emerged as a product of my research into the Dow Jones Industrial Average. As an investment newsletter editor and a money manager, I’ve been following the Dow for 30 years. During my research of Dow stocks, one theme that jumped out was how the Dow’s losers in one year (that is, the Dow stocks showing the greatest percentage price decline in one year) became winners the next. 

For example, in 1999, the worst-performing stock in the Dow was Philip Morris (now called Altria). An investment in the tobacco giant lost a whopping 54% of its value in 1999. In 2000, however, the story was much different for Philip Morris shareholders. To say Philip Morris rebounded would be an understatement; the stock was the best-performing issue in the Dow in 2000, returning 105%. In fact, Philip Morris’ triple-digit return in 2000 was nearly twice the return of the runner-up that year, aerospace giant Boeing. Even more impressive was that while investors were more than doubling their money in Philip Morris in 2000, the Dow actually lost money (nearly 5%) during the year. 

In 2000, same story, different players. The two worst-performing stocks in the Dow in 2000 were AT&T (down 65%) and software behemoth Microsoft (down 63%). In 2001, Microsoft and AT&T went from worst to first. Microsoft was the Dow’s best performer in 2001, rising 53%. And AT&T was the third-best performer in the Dow that year, returning 37%. (For the record, IBM, which rose 43% in 2001, was the meat of the Microsoft/AT&T performance sandwich. Interestingly, IBM’s big gain in 2001 came on the heels of a 21% decline in 2000.) And those big gains in Microsoft and AT&T (and IBM) came during a year when an investment in the Dow lost money (about 5%). 

While the worst-to-first story for years 2001-2002 is not as compelling, it still makes for interesting reading. The worst-performing Dow stock in 2001 was Boeing, losing 40% of its value. And while Boeing still showed a loss in 2002 (a decline of 13%), that performance still outpaced the 15% loss in the Dow. 

The worst-to-first phenomenon returned to prime form in 2002-2003. The Dow’s two worst performers in 2002 were Home Depot (down 53%) and Intel (down 50%). However, in true worst-to-first form, these two stocks provided huge returns in 2003. Indeed, Intel was the best-performing stock in the Dow in 2003. Home Depot, too, enjoyed a big rebound in 2003. 

Of course, four years is too short a time frame to evaluate any investment strategy. Thus, I decided to undertake one of the most comprehensive studies of Dow returns ever attempted. I gathered data on the Dow and its components going back to 1930 to test a variety of worst-to-first strategies. (The basic worst-to-first strategy entails buying equal amounts of the five worst-performing Dow stocks each year) 

What I discovered was that buying a basket of the Dow’s worst-performing stocks (I call these underachieving stocks “Dow Underdogs”) and holding them for a year has been a very productive investment strategy. 

 


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