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Many funds focus exclusively on one particular type of stock, such as large-cap value picks. But different types of stocks come in and out of favor in the market over time. Allowing your portfolio free range to go wherever the best values are at a particular time can enhance your long-term returns. The 2015-16 NBA season is fast approaching, and many teams are getting ready to show off the off-season changes they made in hopes of shoring up their weaknesses and improving their squads. Take the Toronto Raptors. Last year, the Raptors scored the fourth most points in the NBA, but gave up the 18th most points. Advanced metrics showed an even wider gap, indicating that Toronto had the third most efficient offense in the league, but the eighth least efficient defense, according to ESPN. Not surprisingly, the Raptors have made several moves in the off-season to try to bolster their defense. The name of the game, of course, is balance. In basketball, just as in any other sport, you are not going to get too far if your team has several weaknesses that counterbalance its strengths. So you of course want a mix of players whose skills complement each other. Building a team of only big, strong centers or only small, lightning-quick point guards would give you certain strengths in certain situations, yes. But it would also both limit the pool of talent from which you could choose, and leave you with some major weak spots in certain aspects of the game. Unfortunately, when it comes to picking stocks, that’s just what a lot of fund managers – and the investors who buy their funds – do. Many funds will focus only on a specific “style-box” category – large-cap value stocks, for example – filling the fund primarily or entirely with just that type of stock. To be sure, style boxes serve a purpose, particularly for institutional investors, who often are required to put a certain portion of their portfolios into certain categories of stocks. But for individual investors, I think style-box investing significantly eats away at returns. Why? Because, much as with basketball players, good stocks come in all different styles and sizes; focusing on one style and size simply limits your opportunities to find winners. Sometimes, for example, the small-cap growth area of the market may be offering the most attractive values; other times, mid-cap value plays may feature the best opportunities. Why not allow yourself to go where the best opportunities are, regardless of size and growth/value distinctions? In addition, much like basketball players, the size and style of a stock often means that it will perform better in certain situations than others. Sometimes, for example, large-cap value stocks will go out of favor, and a portfolio that is focused only on them will get hit hard. A portfolio that includes stocks of various sizes and styles, however, has some natural hedges built in that should smooth out returns – making it more likely you’ll stick with it over the long haul. This “free-range” approach is what I do with my Validea Hot List portfolio, which looks for consensus from all of my Guru Strategies (each of which is based on the approach of a different investing great) when choosing stocks. At any given time, the portfolio could be tilted towards smaller stocks or larger stocks, growth-oriented picks or value plays. The strategy has paid off, with a 10-stock version of the Hot List more than doubling the S&P 500 since its July 15, 2003 inception, and a 20-stock version nearly doubling the index. What sort of stocks is this approach on right now? Here’s a look at a handful of picks that are in my 10- and/or 20-stock portfolios. The Travelers Companies, Inc. (NYSE: TRV ) : Minnesota-based Travelers ($31 billion market cap) provides property casualty insurance for auto, home, and business. The 162-year-old company does business in the US, Canada, the United Kingdom, Ireland, and Brazil. Travelers’ mix of solid growth and reasonable value helps it earn strong interest from my Peter Lynch-based strategy. Its 17% long-term earnings per share growth rate (I use an average of the three-, four-, and five-year EPS figures) and high sales ($27 billion over the past year) make it a “stalwart” according to the Lynch approach – the kind of large, steady firm that Lynch found offered protection during downturns or recessions. To find growth stocks selling on the cheap, Lynch famously used the P/E-to-Growth ratio, adjusting the “growth” portion of the equation to include dividend yield for stalwarts, since they often pay solid dividends; yield-adjusted P/E/Gs below 1.0 are acceptable to my Lynch-based model, with those below 0.5 the best case. When we divide Travelers’ 9.2 P/E by the sum of its growth rate and dividend yield (2.4%), we get a yield-adjusted P/E/G of 0.43 – a sign that it’s a bargain. South State Corporation (NASDAQ: SSB ) : South State provides retail and commercial banking services, mortgage lending services, trust and investment services, and consumer finance loans. It serves customers and conducts its business from about 130 financial centers in South Carolina, North Carolina, and Georgia. South State ($2 billion market cap) is a smallish mid-cap growth stock that gets strong interest from my Martin Zweig-based model. It likes the firm’s long-term EPS growth (17%) and long-term sales growth (22%). It also likes that recent EPS growth has been even better, coming in at 38% in the most recent quarter (vs. the year-ago quarter). Alaska Air Group, Inc. (NYSE: ALK ) : Actually based in Washington state, Alaska Air is the parent of Alaska Airlines and Horizon Air Industries, which with partner regional airlines serve 90 locations in the US, Canada, and Mexico. The smallish large-cap or big mid-cap, depending on how you look at it ($10 billion market cap) is a favorite of my Lynch model, in part because of its stellar 40% long-term EPS growth rate. Shares trade for 14.4 times earnings, making for a strong 0.41 PEG ratio. Alaska Air also has a very reasonable 34% debt/equity ratio. MYR Group (NASDAQ: MYRG ) : This small-cap specialty contractor ($571 million market cap) serves the electrical infrastructure market throughout the US and Canada. The Zweig strategy likes that it has grown earnings per share at a 27% pace and sales at a 24% pace over the long term, and that both EPS and sales growth accelerated last quarter. It also likes MYR’s 0% debt/equity ratio. Chicago Bridge & Iron Company N.V. (NYSE: CBI ) : Based in The Netherlands, CBI is involved in engineering, procurement and construction services for customers in the energy and natural resource industries. The $4.7 billion market cap mid-cap was founded more than a century ago in Chicago as a bridge designer and builder. The model I base on the writings of hedge fund guru Joel Greenblatt is particularly high on CBI as a value play. Greenblatt’s approach is a remarkably simple one that looks at just two variables: earnings yield and return on capital. My Greenblatt-inspired model likes CBI’s 16.7% earnings yield (Greenblatt uses earnings before interest and taxes divided by enterprise value for that) and 177% ROC (EBIT/tangible capital employed), which combine to make the stock the most attractive in the entire U.S. market right now, according to this approach. CBI’s 24% long-term EPS growth rate and bargain priced 0.32 PEG ratio also help it earn strong interest from my Lynch-based model. Scalper1 News
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