Is Stock Picking Impossible This Year?

 | Jul 19, 2013 | 7:00 AM EDT
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One frustration many portfolio managers are voicing -- at least the underperforming ones -- is that stock picking is impossible this year, with the Federal Reserve "manipulating" the markets.  While I do agree that the Fed is trying to steer the market to a pre-ordained outcome (using the wealth effect to drive economic growth and better employment), is it the case that stock picking is "impossible" this year?

Rather than speculate, let's go to the numbers.  I sorted all the large cap stocks (defined as greater than $5 billion market cap) by YTD total return, then looked at a couple key indicators to see what they, well, indicated about the stocks.  Growth managers often look at EPS revisions and value managers look at price-to-earnings multiple, so were these helpful in sorting out stocks to help find this year's winners?

Actually, the answer is..."hmmmm."  As it turns out, if we take the 660 large cap U.S. stocks and divide into "decile groups" -- that is, groups of 66 such that there are 10 groups -- we get an interesting outcome.  In the best performing group, the 2013 EPS estimate was revised down on average by more than 6%!  And this group started the year with an average P/E multiple of 41 times, far higher than all the other groups.  If you wanted to pick a big winner in the first half, you needed to look among the most expensive stocks, and not worry that the earnings were even improving!

Before you underperformers scream "ah ha!" study the rest of the table. Other than the top group, the rest of the universe more or less tracked as you would expect.  The second highest performing group saw its EPS estimate revised up on average, and it started the year with an ordinary multiple of 16 times.

Probably more importantly, the two worst performing groups saw their EPS estimates revised down, and they both started the year with high average multiples of 18 times and 26 times.  One way to outperform is to hit the homeruns, the other way is to avoid the losers. By avoiding high multiples you would not have owned Tesla (TSLA), but you would have also avoided many losers.  Similarly, if estimates were being revised down, you might sell a Vertex Pharma (VRTX), but you would also avoid many, many other losers.

Even when the markets are acting a bit odd, relative to the fundamentals, solid investing precepts can still work over time.

If any of you readers want the full list of names, just email me. At 660, the table is too large to post here!

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