I am not sure I understand the concept but he says nice things about AMD's stock! <g>
moneycentral.msn.com
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SuperModels: Choosing stocks by the buddy system
A pair of great stocks that work together as well as Woody and Buzz could put you on the road to profitability. Here's a screen test to help match them up.
By Jon D. Markman
Back in the good old days of Hollywood, "buddy movies" were a staple. Frank Sinatra and Dean Martin. Bob Hope and Bing Crosby. And more recently, Woody and Buzz. When cares of the world weighed down one buddy, the other would belt out a song or tell a joke to lift his spirits. They rounded each other out, showing that even celebrities work better in teams.
Wouldn't it be great if our star stocks had buddies, too? Just when one is getting kicked in the face with a downgrade by some bully analyst who just doesn't understand how profitable its genomic e-widget.com business is going to be in 2005, the other one would leap 15% on the wings of a new deal with a Brazilian beverage conglomerate.
The best stock buddies would be ones that ended up in the same place -- let's say, up 30% or more by this time of year -- but via diametrically opposite routes. Plotted on the same chart, their lines would look sort of like bow ties or gap-toothed smiles -- mirror images that start and end in the same place but seldom travel together. Whenever one zigs, the other zags, but ultimately their prices end up in the upper right quadrant of the chart.
The idea of finding stock buddies isn't new -- value-oriented money manager Nancy Tengler in Walnut Creek, Calif., says it's "what we all try to figure out: how to find stocks that dampen each others' volatility without damaging results."
But finding suitable twisted pairs is remarkably hard. Hedge-fund managers for decades have tried to do it with sectors rather than individual stocks. For instance, in a period of rising inflation, they simultaneously initiate long positions in commodity-related industries and take short positions in interest-sensitive industries. The theory is that higher prices will help producers of things like aluminum and oil, but harm outfits like insurers that hold bonds. If well executed, the strategy would render the fund manager profitably market-neutral.
Most individual investors, though, don't try to make big macroeconomic calls with their positions, and really shouldn't be shorting. But we can still try to create orthogonal, or market-neutral, positions in our portfolios by teaming up stocks that benefit independently from sector rotation.
On the hunt for dynamic duos
To take a first crack at this concept quantitatively, I've combined a little-known feature of the Investment Finder stock-screening engine with my new slug-to-whiff ratio spreadsheets (introduced last week in this column). The ideal pair of stocks would be expected to record a greater number of positive vs. negative days together than either would record alone, as well as more terrific days (change greater than 10% to 15%) and fewer bad days (change worse than -10% to -15%). While their average daily return might be lower than one of them individually, the diminished volatility should make each easier to own in times of extreme volatility.
To begin the hunt for dynamic duos, I started by determining the base stock -- the one I really wanted to own. Then I would find its match. To do that, I ran our MVP Growth screen and determined the minimum one-year gain necessary to make the top 25; it was 70%. I then sorted this list by lowest price-to-sales ratio relative to its industry. You can see an up-to-date list of 25 using this link. Technology value has been a great theme this year, and it is likely to continue.
The top two names in the list through June 23 were semiconductor makers Advanced Micro Devices (AMD, news, msgs) and Micron Technology (MU, news, msgs). They've returned 408% and 347% respectively over the past 12 months -- and 202% and 125% in 2000 alone. Yet they're still trading at substantial discounts to their peers: AMD trades at a 65% discount to the chip industry's lofty average price-to-sales figure of 12.2, while Micron trades at about a 32% discount.
To find potential buddies for each for the rest of the year, I ran their ticker symbols through Investment Matcher -- a feature of the Finder that shows you securities with statistical characteristics similar to a target stock. Because we're trying to reduce volatility, I added one criterion not in the Matcher default: The matches had to have recorded a 12-month beta of half the target stock. (Check this link for an up-to-date list of 25 matches for AMD.) I then sifted through the list of names, running them through my slug-to-whiff ratio spreadsheets until settling on final choices.
Dissimilarity provides a nice match
My top choice as AMD's buddy for the rest of 2000 is Quest Diagnostics (DGX, news, msgs), the world's leading clinical laboratory firm with $3 billion in annual revenues. Quest has the advantage of being in a business that's utterly uncorrelated with semiconductors; its workers perform more than 50 million routine medical tests a year for doctors, hospitals, HMOs, corporations and government agencies. Our financial tables show a price-to-earnings multiple of 388, but that's deceiving; the company actually trades at a very reasonable PEG ratio (price-to-earnings multiplier/earnings growth rate) of 1.0. Selling for $70, not far from its 52-week high, it's expected to grow earnings at a healthy 29% clip next year to $2.34 a share.
In 2000, the two stocks would have matched each other nicely: AMD recorded seven days with better than 10% gains, and only 1 day with a 10% loss, for a slug-to-whiff (SWR) ratio of 1.55. Quest recorded four days of better than 10% gains and no days with a 10% loss, for an SWR of 1.56. Put them together, though, and you get an excellent SWR of 1.71, with just two days of +10% and no -10% days. Considered together, the two recorded 65 positive days and just 54 negative days, for an excellent daily average return of 0.89%.
In the year's ultimate test of suitability for buddyhood, AMD suffered a 7% decline on April 14 -- Black Friday -- but had its spirits lifted by Quest's 4% gain that day, so that the net loss for the pair was just 1.4%. On Rebound Monday, meanwhile, AMD rose 10% while Quest rose 13%. Good friends, indeed.
The Buddy System
Advanced Micro Devices and Quest Diagnostics
might work better as a team than alone.
Timeframe AMD DGX Paired
+ 10% days 7 4 2
-10% days 1 0 0
Positive days 66 69 65
Negative days 53 50 54
Avg. % daily gain 1.01 0.77 0.89
Avg. % 5 best days 14.85 11.39 9.86
Avg. % 5 worst days -8.16 -5.37 -4.84
Data: Jan. 3 to June 23, 2000 |
