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February, 2013


There is reason to think that in 2013 stock and stock mutual fund investors may have a rough time of it. Everyone loves using a method for superior gains. There are many approaches out there, and not a few are actually quite effective. Hardly anyone, however, enjoys the high speed plummet as a bear market panic destroys profits and replaces them with great splotches of red ink. Who knows exactly how the markets will respond to the latest examples of Washington gridlock and dysfunction? Several other developments could badly spook investors during the coming months. Here is an attempt to limit the downside while preserving much of the upside potential of a winning investment approach.

1. Screen for and invest initially in just 1 to 5 stocks with:
  1. a Value Line 3-5 year projected total return of 19% or greater (a 100% projected return within an average of 4 years).
  2. a 3% or greater annual dividend.
  3. a price to earnings ratio of 12 or below.
  4. double-digit price gains in the past 12 months.
  5. a Value Line safety rank of 3 or below (average or better).

When no stocks meet the criteria, simply avoid any new investments. However, when more than enough candidates are available, select from them the 1-5 which have the then best combination of low debt, low dividend payout ratio, positive net income, return on equity, 3-5 year projected return, and number of shares outstanding being the same as or lower than a year earlier.

2. Review potential buy candidates about every one to four weeks, continue each time to purchase the best candidates (if any) without selling any till have 3-5, and then replace up to one current holding per review with a new stock if:
  1. The one to be sold no longer qualifies under the basic five buy guidelines (#1 above); and
  2. It is currently up the most in price among no longer fully qualifying assets awaiting replacement by a new candidate; and
  3. It also has a net gain in price since purchase of at least 5% or above and an annualized total return (price gain after commission, plus dividends) of 15%. (Note that generally a stock with a 3% annual dividend that must be held, say, for 4 months before it attains a net 5% gain actually has an annualized total return of 19.1%, due to both the short hold period and the addition of the dividend for that third of a year.)

3. Otherwise, merely hold the asset(s). Since these are all stocks which Value Line indicates on a total return basis are likely to double over the next few years and which also have an average or better safety rating, there is little chance of permanent loss from retaining them in one's portfolio till the price is right for sales on one's own terms. (I believe it was Warren Buffett who said that the market price of a stock will almost always reflect its true value at least once in any 5-7 year period. Since the projected return of these assets is 19% a year or greater, holding them till they achieve at least a 15% average annual return, compared with the cost basis, should involve little risk. Thus, one seldom will have any call to sell such stocks at a loss. There will over time be a few that are poorly managed or run into unforeseen profitability challenges and so lose their higher potential before being sold. Yet if the majority of one's investments are gainers, their solid returns should offset the occasional bad apple.)

4. When replacing stocks (per #2 above), limit sales to one per week or even less often, and buy substitutes for them that not only meet all the basic buy criteria but which are, overall, among the best such qualified candidates then available.

5. As one sells assets at a profit and replaces them with new well qualifying candidates, one should keep the per purchase amount roughly the same as initially, socking the profits and dividends away in money market accounts or short-term bond assets. When such extra funds get as high as the initial per stock buy levels, invest this amount in new best qualifying stocks. Repeat this process indefinitely.

6. From time to time one will also have additional funds to invest, perhaps from a promotion, inheritance, winning the lottery, or whatever. Since I am rather conservative, I prefer that one have a significant amount of "rainy day" funds in money market or short-term bond assets, to use for the purchase of great value picks when the markets take serious tumbles. How much to have set aside in this way is an individual decision. A larger percentage ready to hand in case of a major drop in the markets reduces the chance of overall long-term loss, increases the likelihood of picking up significant equity deals on the cheap while others are bailing out of stocks, yet, if left unused for new investments most of the time, also can reduce one's average portfolio performance. Of course, having much less set aside in low risk assets can result in nail-biting volatility in one's total assets when the inevitable happens and stocks turn seriously south. It can then take years to recoup one's losses. If one has substantial other assets or resources that are low-risk, for instance a government pension or several rental houses that are providing more income than their mortgages, taxes, and maintenance costs, this can moderate one's need for additional conservative precautions quite a lot. When one finds that, over and above a prudent investment reserve, he or she has plenty of income available for further stock purchases, it can periodically be used for the purchase of further stocks meeting all the above buy criteria.

Below is a table with my picks among equities currently meeting the basic five buy standards as of 2/18/13. As usual, I suggest that readers do the research, make their own selections, and/or rely on trusted financial consultants before investing.

Goldilocks Investing Top Pics

Company or PartnershipStock
Price to
Kohlberg Kravis Roberts and Company, L.P.KKR$18.036.8%8.2
Seagate TechnologySTX$34.453.6%4.5

7. Meanwhile, assets which, pending sufficient price increases, are not yet replaced will gradually raise the number of securities in one's portfolio, further improving diversification and thus reducing risk more while also adding to one's total portfolio income through dividends.

8. In taxable brokerage accounts, I think it is best to avoid limited partnerships (L.P.) that otherwise meet the criteria, such as KKR, since they can involve us in extra paperwork and headaches during the "tax season." Nonetheless, limited partnerships can be quite profitable additions to this Goldilocks Investing method, so to me they are worth holding or trading in tax-deferred accounts.

9. I personally avoid significantly China-related equities, since their accounting and reporting standards tend to be less stringent than for most stocks.

10. This first approach I am suggesting involves more short-term trades than most investors make and so for this reason may not be best for folks in higher tax brackets or in regular as opposed to tax-deferred accounts. For me, though, its results warrant the added effort and expense.

11. Backtests of approaches similar to this one, yet without the requirements for average or better safety rank or for 3-5 year projected average total returns of 19% or more, have shown significantly market-beating proceeds, yet with lower volatility than for the S&P 500 Index. There are no guarantees, however the Goldilocks plan has a good chance of providing returns averaging 5% or more a year better than the market but with lower than market risk, a probable risk-adjusted annual return in the 15-20% range.

This is a system likely, even if fully invested, to serve one reasonably well in bull and bear markets. I do not recommend one try to forecast when the next market downturn will be or to sell stocks accordingly.

There is a single exception to that: one might take additional steps in the event of an apparently imminent or already proceeding market meltdown of sufficient scope that it threatens the financial system, such as we witnessed in late 2008 through early 2009. Then the investor may be wise to place stop/loss orders on all his or her equities besides those intended to be held indefinitely or for which highly profitable sales in regular brokerage accounts could lead to big tax burdens.

Or one could just sell outright some of one's tradable assets as soon as the severity of the threat becomes evident. Since the market is then likely to go still lower, if it clearly is in a downward spiral, selling assets even at a loss can mean being able later to fund the purchase of many more stock shares at nicely bargain levels.

Otherwise, in my view trying to time the markets via sophisticated technical or other indicators and to short stocks or exchange traded funds to avoid run of the mill bear market growls adds unnecessary complexity and risk to the investor's task. Most of the time, ordinary investors who attempt such precautions get them wrong. Thus, very large or small numbers of short-sellers are contrary indicators. Typically when unusually high numbers of us are selling short, the market is actually about to surge upward. (Watch out, though, when hardly anyone is attempting to short the market or most of its specific stocks!)

Meanwhile, if the first approach above seems like a little too much work and you would like a market-beating, low tax Goldilocks strategy with higher income than long-term government bonds, lower risk than the S & P 500 Index, relatively few trades, that should do reasonably well in both up and down markets, then each month merely buy the best 3% or higher dividend stock you can find which also has a low price to earnings ratio, and a 19% or higher 3-5 year Value Line projected total return, without regard to the asset's most recent 12-month performance, and then hold it essentially "forever" or until you have a portfolio of 40 or more good dividend stocks, after which each month sell from your holdings the one that has the lowest annual dividend yield, replacing it with the then best dividend stock you can find meeting the initial buy characteristics. Typically, such a portfolio offers average annual total returns in the 12-15% range and comparatively does not generate much in the way of capital gains taxes.

Value Line is an investment service I can recommend. The subscription price is relatively high, but this resource may be available in hardcopy and/or online versions through local libraries or brokerages. Though one needs to double-check the stats, since Value Line sometimes calculates price to earnings ratios in odd ways, the internet format includes a screener in which variables such as those for #1 above can be easily used.

I welcome others' feedback on experiments with Goldilocks approaches that may work for them. Perhaps we can get ever closer to an easy to apply technique which, in both up and down markets, is neither so dizzyingly rewarding in upwardly hurtling bull markets as to give us nosebleeds nor so depressingly destroying of our wealth in bad bear markets as to have us wish to leap off tall buildings, but instead is so serenely "just right" that it allows us, even in a house of bears, to sleep calmly regardless of the whims of "Mister Market."


Larry is not a professional. Don't take him seriously!

Actually, the investment article provided here is for general information only and should not be considered as professional advice, a solicitation to buy or sell any security, or the Word of God. Investors are encouraged to do their own research while considering their personal goals and circumstances, or consult their own professional financial advisors, before making investment decisions. Neither Larry nor LARVALBUG will be liable for any losses sustained by any visitor to this site.

(Disclosure statement: Larry and Val have holdings in some of the suggested assets but do not "make a market" in any of them and do not derive any direct benefit from recommending them, except perhaps for a bit of smug self-satisfaction.)

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