Yahoo Finance Becoming A Better Investor Can Change Your Life
We’ve all heard people say that becoming a better investor can change your life.
While it’s a great catch phrase, I don’t think anybody really stops to think about it, let alone believes it.
But it’s true.
Becoming a better investor can change your life.
For example: since 1988, the Zacks Rank #1 Strong Buy stocks have beaten the market in 29 of the last 35 years with an average annual return of 24.28% per year. That's more than 2 x the S&P’s 10.51%. And an annual win ratio of more than 82%.
That includes 3 bear markets and 4 recessions.
And being able to do this year after year, over and over again, can add up to a lot more than just 2 x the S&P.
While we can’t go back in time, let’s look at two investors over the next 10 years.
One is able to earn the average Zacks Rank #1 return of 24.28% per year, while the other earns the average 10.51% return of the S&P.
At 24.28%, a $100,000 investment, over the next 10 years, would show a compounded return of over 779%. That $100,000 would have grown into $879,048.
At only 10.51%, that $100,000 would’ve compounded into just 172%, increasing to only $271,652.
At 15 years, that’s $2.6 million vs. $448K.
And at 20 years, that’s $7.7 million vs. $738K.
Becoming a better investor can change your life.
Just ask the guy who’s going to retire on $738,000 vs. the guy who’s going to retire on $7.7 million, and tell me that the guy with $7.7 million isn’t living a different life than the guy with $738K.
Now imagine, you’re not even earning market returns. Sadly, too many investors aren’t even coming close to that.
Becoming a better investor can, indeed, change your life!
Earnings Estimate Revisions and Stock Prices
Great. So now what?
How do you become a better investor?
The first step is to focus on stocks with upward earnings estimate revisions.
Why?
Because studies have shown that earnings estimate revisions are the most powerful force impacting stock prices.
Simply put, stocks with rising earnings estimates, as a group, have outperformed the S&P 500 year after year. And stocks with falling earnings estimates have underperformed the S&P year after year.
This means that the stocks most likely to outperform are the ones whose earnings estimates are being raised. And the stocks most likely to underperform are the ones whose earnings estimates are being lowered.
For example, let’s say an analyst believes a company will earn $1.00 per share in earnings ($1 estimated EPS). If the P/E ratio is 20 (20 x earnings), then the fair value for that stock is $20.00. ($1 estimated EPS x 20 P/E ratio = $20.00 fair value.)
If the analyst then raises his earnings estimate to $1.10 per share ($1.10 estimated EPS), then the fair value would now be $22.00. ($1.10 est. EPS x 20 P/E = $22.00 fair value.)
Institutional investors then act on these changes in earnings estimates, typically buying those companies with rising earnings estimates, and selling those with falling earnings estimates.
Moreover, stocks that receive upward earnings estimate revisions are more likely to receive even more upward revisions in the future. This is true because many analysts will revise their earnings estimates slowly and incrementally. That means, if an analyst raised his earnings estimates last month, he’s likely to do it again this month. And other analysts are likely to do the same.
Since stocks respond to earnings estimate revisions, it’s very profitable to buy stocks who earnings estimates are being raised. And by getting into stocks whose earnings estimates are being raised, you’re likely getting into companies whose future earnings estimates will be raised as well, potentially influencing stock prices even more.
That’s why stocks receiving upward earnings estimate revisions tend to outperform over the next one to three months.
More . . .
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A Few Of My Favorite Things
The Zacks Rank has made the process of identifying stocks with upward earnings estimate revisions easy and very profitable.
But there are more than 4,800 stocks with earnings estimates. And while only the top 5% (about 240 stocks) with the best earnings estimate revisions can get a Zacks Rank #1, that’s still too many to trade at once. (Not to mention the 15% (about 720 stocks) that can get a Zacks Rank #2.)
So, the next step is to narrow that down to the best 5-10 stocks that you can buy.
• In addition to the Zacks Rank, I also like using the Zacks Industry Rank. Since roughly half of a stock’s price movement can be attributed to the group that it’s in, it’s important to get into the best groups. And since stocks in the top 50% of Zacks Ranked Industries outperform the bottom 50% by a factor of more than 2 to 1, this is an ideal way to find them.
• I also like a strong growth rate. But not crazy high growth rates, as stocks with the highest growth rates test nearly as poorly as those with the lowest growth rates. That’s because they are unsustainable.
For example, a company earning 1 cent a share that is now expected to earn 6 cents, has a 500% growth rate. But, if it receives a downward estimate revision to 5 cents, that’s a significant drop. Even though it still has a 400% growth rate, the estimates were just reduced by -16.7% and the price is likely to follow.
If you’ve ever wondered how a stock with a triple-digit growth rate could possibly go down -- that’s how.
Instead, I have found that stocks with ‘just’ double-digit growth rates typically outperform stocks with triple-digit growth rates. And I have found that focusing on stocks with growth rates above the median for their industry, but less than 50%, is the best way to find solid outperformers with a lesser chance to disappoint.
• I'm also a big fan of the Price to Sales ratio. In my studies, I have found that a P/S ratio of less than 1 has produced significantly superior results. Between 1 and 2 also do quite well. Solid returns can also be seen between 2-3, and even 3-4, but the returns taper off the higher you go. And those with a P/S ratio over 4, in aggregate, have typically shown to lose money. That doesn’t mean that all stocks with a P/S ratio of less than 1 will go up and those over 4 will go down, but you can greatly increase your odds of success by following these valuations.
These are just a few of my favorite things.
One Less Loser
Picking better stocks will help you become a better investor. And more winning stocks means less losing stocks.
But, no matter how great of a stock picker you are, you will have losers from time to time. It’s just a part of investing.
That’s why risk management is another key to becoming a better investor.
When you do find yourself in a losing trade, consider getting out sooner.
Nobody likes to take a loss. But don't let your unwillingness to do so ruin your portfolio. Smaller losses are easy to overcome. But big losses, like -30%, -40%, and -50% losers, or more can devastate your portfolio, not to mention your confidence.
If you found yourself driving the wrong way on a one-way street, you wouldn't keep driving the wrong way or speed up, you'd turn around and get off. Same thing with stocks. If you bought a stock expecting it to go up, and it's now doing the exact opposite, get out before you crash your portfolio.
My preference is -10%. Why? Because I only need a little more than that (11.1%) on my next trade to get that money back.
But if I just took a -50% loss, for example, I’d need a 100% gain on my next trade or trades to get that money back. That’s a big ask, especially if you just got clobbered for a -50% loss.
Having one less loser, or even just deciding to take smaller losses, will immediately set you apart from the typical mediocre investor.
While setting a goal to have one less loser may not sound exciting, the results can be dramatic.
One More Winner
Now if you can replace that one less loser with one more winner, you'll compound your success even more.
First, stick with the investing style that's right for you. There are many different investing styles out there. The four main fundamental styles are Momentum, Aggressive Growth, Value, and Growth and Income. You can also apply Technical Analysis to any of these styles, and others as well.
But make sure you employ proven techniques to get the most out of each style.
Below are a few of my favorite strategies that have regularly crushed the market year after year.
New Highs: Studies have shown that stocks making new highs have a tendency of making even higher highs. And this strategy proves it. The alignment of positive price action and strong fundamentals creates all the necessary conditions to see these stocks soar to even greater heights. Over the last 23 years (2000 through 2022), using a 1-week rebalance, the average annual return has been 38.7% vs. the S&P’s 6.2%, which is 6.2 x the market.
Small-Cap Growth: Small-caps have historically outperformed the market time and time again. Often these are newer companies in the early part of their growth cycle, which is when they grow the fastest. This strategy combines the aggressive growth of small-caps with our special blend of growth and valuation metrics for explosive returns. Over the last 23 years (2000 through 2022), using a 1-week rebalance, the average annual return has been 46.4%, beating the market by 7.4 x the returns.
Filtered Zacks Rank 5: This strategy leverages the Zacks Rank #1 Strong Buys, and adds two time-tested filters to narrow the list of stocks down to five high probability picks each week. Over the last 23 years (2000 through 2022), using a 1-week rebalance, the average annual return has been 49.5%, which is 7.9 x the market.
The best part about these strategies (aside from the returns) is that all of the testing and hard work has already been done. There’s no guesswork involved. Just point and click and start getting into better stocks on your very next trade.
Beat The Market On Your Next Trade
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You'll quickly see how to get the most out of the system that has more than doubled the market for more than a quarter century. Discover how to identify what kind of trader you are, how to find stocks with the highest probability of success, and how to trade them so you can consistently beat the market regardless of where stock prices are headed. The course also goes over some of our best-performing strategies from a variety of different trading styles, and it helps you create and test your own.
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Thanks and good trading,
Kevin
Zacks Executive VP Kevin Matras is responsible for all our trading and investing services. He developed many of our most powerful market-beating strategies and directs the Zacks Method for Trading: Home Study Course.
¹ The results listed above are not (or may not be) representative of the performance of all strategies developed by Zacks Investment Research.
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