When a year ends, investors are faced with a question: Do I look to the year's winners to use as a guide for the new year's investments? Or do I follow the year's losers, believing they're more likely than not to perform well next year?
In my last column, I wrote about three strategies that were my best performers in 2011 -- a momentum strategy, as well as ones based on the thinking of James P. O'Shaughnessy and Warren Buffett. All of them produced double-digit gains in a year when the S&P 500 was flat. (When I choose stocks, I use strategies I automated that mirror the thinking of Wall Street's great gurus.)
Where there are winners there are also losers, and the three bottom-dwellers for 2011 were the screens based on the writings of Joseph Piotroski, Peter Lynch and Benjamin Graham. Stocks chosen through the Piotroski strategy plummeted 24.4%, while the Lynch and Graham picks sank 21.4% and 19.0%, respectively.
But do not write off these strategies because they had such a bad year. I've been following the Lynch and Graham strategies since July 15, 2003. During that time, when the S&P went up 29.2%, Graham picks rose 169.8% while Lynch saw a 72.5% climb. I've used the Piotroski strategy for my portfolio since Feb. 27, 2004. Since then, the S&P increased 12.7% while the Piotroski strategy went up 45.1%. Sure, 2011 was a terrible year for these screens -- but, over time, they have proven to be winners, and they seem likely to do so again in the future.
Also keep in mind that what goes up one year often goes down the next, and vice versa. In 2010, the dog of 2011, Piotroski, was king of the mountain with a gain of 55.9% vs. the S&P rise of 12.8%. That year's runner-up also placed second in 2011 -- O'Shaughnessy -- which proves that what goes up one year may, in fact, go up the next. Meanwhile, the third-worst performer in 2010 -- the momentum strategy -- landed on top in 2011.
With that in mind, I'll now tell you about some stocks that were recommended by last year's losing strategies -- and which, therefore, could have an even better chance of doing well this year.
Only one stock that gets this strategy's highest grades meets my other criteria, such as minimum market capitalization. That stock is China Yuchai (CYD), which trades the on the NYSE. The company manufactures and sells diesel engines and power generators in China. It also holds an interest in a corporation that owns hotels, and in another that distributes consumer electronics in China.
The Piotroski strategy likes that the company has a positive return on assets of 6.8%, positive cash flow from operations -- of $232.2 million -- as well as a long-term-debt-to assets ratio that has declined in the past year. Also in its favor is an improving current ratio, and an improving gross margin.
Gilead Sciences (GILD) is a pharmaceutical company with an emphasis on HIV-related products, and it gets a nod from the Lynch strategy. This strategy focuses on the P/E/G ratio, which is price-to-earnings relative to growth -- a measure of how much the investor is paying for growth. A P/E/G of 1.0 or less is acceptable, and below 0.5 is a really strong indicator. Gilead is in this most desirable area, sporting a P/E/G of 0.45.
Another Lynch-favored stock is Newmont Mining (NEM), the world's second-largest gold producer. This company's P/E/G is also highly favorable, at 0.30.
Reliance Steel and Aluminum (RS) is the largest metal distributor in North America, distributing more than 100,000 metal products, and it has impressed the Graham strategy. The Graham strategy likes Reliance's strong current ratio of 3.77:1, a measure of the company's liquidity; modest long-term debt; and moderate price-to-earnings ratio of 14.4.
Makita (MKTAY), meanwhile, is a well-known maker of portable electric power tools. It has a very strong current ratio of 4.99:1, almost no debt and a modest P/E ratio of 12.0 -- all of which make it a Graham favorite.
These five companies are all performing well, and they are liked by the strategies that struggled last year. So, while they're are all worth considering on their own merits, these recommendations -- all from strategies that may well be on the rebound this year -- bode even better for them. Don't be surprised if they turn in strong performances in 2012.