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It’s time to revisit our multi-year stock picking experiment. Two years and three stock picks isn’t enough to make a genuine assessment of an investor’s ability, but there are plenty of lessons in it nonetheless.

Two years ago, in an article titled Top stocks for three years, we asked each of our analysts to put forward their best three stocks for the next three years. So, with one year left on the clock, let’s take a look at how things stand.

Share / stock market Game Winner strategies

Whilst several analysts faced a total wipeout on Croesus Mining the biggest individual winner, a 291% return from Tim Searles’s selection, JB Hi-Fi, emphasises an important investing lesson: The most you can ever lose on an ordinary share is 100% while the potential rewards are many times that. It’s what the academics term an ‘asymmetric payoff’ and it’s the reason we try not to beat ourselves up unduly over the occasional loss—you only need a couple of big winners to compensate for several duds.

        

The selections of Tim Searles, who has overtaken Tony Scenna on the leader board, demonstrate this principle perfectly. His 124.8% average return over the two-year period is especially impressive given one of his three selections (Croesus Mining) essentially went broke. Tony Scenna’s average return of 106.3% is also impressive given the conservative nature of his selections. But Brad Newcombe and James Greenhalgh aren’t far behind, both in the ‘nervous nineties’ with 95.8% and 92.3% respectively. At the bottom of the pack comes your Research Director Greg Hoffman with a dismal average return of –37.1%. He suggested last year that perhaps he should stick to picking analysts rather than stocks but we’re content to let his long-term record speak for itself (through our annual audited Performance Reports).

Diggers and dealers - Australia's Gold rush backed...

Overall, the team produced a market-beating average two-year return of 58.6% (the All Ordinaries Accumulation index’s return was 54.3%), increasing our lead over the market to 4.3% from 1.5% last year.

In this issue we asked each team member to report on their progress and also name their current best buy selection. Next issue we’ll prevail on them to explain what they find attractive about their current top pick in more detail.

 Hoffman’s heroes
STOCKS THEN INCOME NOW RETURN
Croesus Mining (CRS) 0.26 0 0 –100%
STW Communications (SGN)  3.08 0.294 2.50 –9.3%
Carter Holt Harvey (CHY)  2.38 0 2.33  –2.1%

Greg Hoffman

Our Research Director was the only analyst to produce more than one stock with a negative return. In fact, he outdid himself by recording negative returns from all three: ‘I was effectively shut out of the race by the early takeover of one of my picks (Carter Holt Harvey) and the demise of another (Croesus Mining),’ explains Greg, ‘my only genuine live entry is STW Communications, which has made heavy weather of it.’

‘So there’s no hope of a “Rumble in the jungle”-type comeback after a few battering rounds against the ropes. Can I get away with the altruistic argument that, as leader of the analytical team, I always intended to run last in this race to save everyone else’s ego the ignominy?’

Best current buy: Platinum Asset Management

 Wayne’s world
STOCKS THEN INCOME NOW RETURN
Wilson Investment Fund (WIL) 0.92 0.11 1.095 31.1%
Over Fifty Group (OFG)  1.97 0.31 2.50 42.6%
Calliden (CIX)  0.35 0 0.57  65.2%

Wayne Jones

Each stock in Wayne’s mixed bag produced a decent return. ‘Interestingly, the stock I am the most happy with over the longer term, Wilson Investment, has been the poorest performer of the three. The best performer, Calliden, continues to make progress in its rehabilitation back to being an insurance underwriter. It’s made a number of acquisitions during the year and hopefully might report a profit this year’.

‘I had little confidence in the management of Over Fifty Group when I picked it two years ago and, unfortunately, they have time and again reinforced my opinion. The share price has gone nowhere over the past year and the company recently announced it had engaged Macquarie Bank to conduct a strategic review of its business and operations. This was followed by court action to gain access to documents by an executive director who had been left out of the process. It sounds like a real bun fight within the company and I hold out no great hope that a takeover, the original reason for putting it on my list, will eventuate while the company is in this state.’

Best current buy: Domino’s Pizza

Trading cfd s _ showing market growth

 

 James’s gems
STOCKS THEN INCOME NOW RETURN
Flight Centre (FLT) 9.46 1.18 25.67 183.8%
Harvey Norman (HVN)  2.93 0.19 6.76 137.2%
Adcorp (AAU)  0.655 0.075 0.29  –44.3%

James Greenhalgh

A respectable fourth on the leader board, James Greenhalgh reports in on his picks: ‘As the supposed small companies analyst, it’s ironic that my larger stocks – Flight Centre and Harvey Norman – have been the winners.

‘Harvey Norman was particularly surprising, contradicting my original comment that it “probably won’t double”. What I do know is that good things happen to quality businesses and Harvey Norman has ended up benefiting from its competitors’ problems. Needless to say, I wouldn’t buy either stock now and, with Flight Centre representing about 30% of my personal portfolio, I’ll probably sell some soon.

‘But, rubbing my nose in my mistake, Adcorp has turned out miserably. I failed to understand the changes going on in its industry and its poor competitive position. Anyway, after the woeful half-year result and halving of the interim dividend, I sold my personal holding. The company has since written off $10m and eliminated the final dividend entirely. I’m stuck with Adcorp in my “Top three” for another year and, while a turnaround might occur, I’m not optimistic. Even so, it’s a good example that one dog doesn’t necessarily mean your whole portfolio has fleas.’

Best current buy: Platinum Asset Management

 Brad’s best
STOCKS THEN INCOME NOW RETURN
Colorado (CDO)  4.27 0.88  6.08 63.0%
Premium Investors (PRV)  0.95 0.17 1.17 40.5%
Flight Centre (FLT)  9.46  1.18 25.67 183.8%

Brad Newcombe

Our banking guru didn’t select a single financial stock two years ago but the situation would change if he were to make his selections this year: ‘My initial stocks were Premium Investors, Colorado and Flight Centre.

‘Coming into year three I’m still happy with Premium, which is a well-run listed investment company. While I don’t expect it to shoot the lights out, it should continue to provide long-term capital growth and increasing dividends.

‘I’ll leave the Flight Centre commentary to others but, at current prices, I wouldn’t be interested in increasing my stake.

‘Colorado worked out well, with a takeover bid providing fast and spectacular returns. Presumably, I’m sitting on cash with the proceeds from this takeover bid. If I had a chance to re-invest now, it would undoubtedly be in RAMS Home Loans, which strikes me as having little downside but plenty of upside from here.’

Best current buy: RAMS Home Loans

In Scenna’s sights
STOCKS THEN INCOME NOW RETURN
Flight Centre (FLT)  9.46 1.18 25.67 183.8%
Telstra (TLS)  3.84 0.62 4.66 37.5%
Australian Wealth (AUW)*  1.51  0.275  2.71  97.7%
*Australian Wealth merged with Select Managed Funds on a 7-for-2 basis. Historical prices have been adjusted accordingly.

Tony Scenna

Last year’s leader and current second place holder, Tony’s returns have been eye-popping: ‘I must say that the performance of all three picks has surprised me because it’s not often you get to enjoy such wonderful returns in such a short period of time.

‘Perhaps the most rewarding aspects have been the returns from Flight Centre and Telstra. Both have had their detractors over the past couple of years (and still do) and the purchases were made when I felt the value was outstanding, even though both were suffering from a whole raft of company-related and industry issues.

‘Finally, no investor should ever think that investing is a free or easy ride. Buying stocks that are under the gun but offer outstanding value requires both confidence and patience.

‘That said, I’m prepared to stick my head out and say that Telstra’s best years are yet to come. No better indicator was needed than the annual general meeting and the media’s focus on remuneration—totally missing the point about what has been achieved to date. How ironic and embarrassing that David Murray, CEO of the Future Fund, should be dictating to others the morals of excessive remuneration payments after presiding over one of the largest payments to a management team as CEO of Commonwealth Bank (to Colonial Funds Management’s Greg Perry and Chris Cuffe).’

Best current buy: Flight Centre 

 Tom’s treats
STOCKS THEN INCOME NOW RETURN
Croesus Mining (CRS) 0.26 0 0 –100%
Roc Oil (ROC)  2.35 0 2.91 24.0%
ARB Corporation (ARP)  2.90 0.24 4.30  57.0%

Tom Elder

Our now very occasional resources analyst is currently in ‘far flung China’, so we’re unable to provide a direct quote on his selections. Knowing his astounding ability to inflict shame and guilt on himself, though, he’d likely be apologising profusely.

The Croesus loss hit his portfolio hard (both this theoretical portfolio and his real-world one) but the performance of his other selections has been respectable, if not startling.

 Tim’s top tips
STOCKS THEN INCOME NOW RETURN
Flight Centre (FLT) 9.46 1.18 25.67 183.8%
JB Hi-Fi (JBH)  3.90 0.186 15.05 291.0%
Croesus Mining (CRS)  0.26 0 0  –100%

Tim Searles

Tim enters the final year of the race in a strong position, with spectacular returns this year: ‘I thought JB Hi-Fi would be doing well to top last year’s return, but it opened the spinnaker and milked some very nice tail winds in 2007. The amazing gain has been the result of a healthy economy and a rampant Aussie dollar.

‘Everyone who bought Flight Centre owes the now departed independent directors a beer or two. If they didn’t stand up to the largest shareholders we would’ve been forced to sell too cheaply. Gareth said so at the time and has been proven correct, probably much quicker than we all thought. Like JB though, it’s no longer a company I’d be buying at current prices.

‘I wouldn’t know how to trade commodities, so I originally picked Croesus to get exposure to the gold price. Unfortunately it didn’t work out (even though the gold price has done well).’

Best current buy: Roc Oil

 Gareth’s greatest
STOCKS THEN INCOME NOW RETURN
ARB Corporation (ARP) 2.90 0.24 4.30 56.6%
Flight Centre (FLT)  9.46 1.18 25.67 183.8%
MMC Contrarian (MMA)  0.945 0.14 0.98  18.5%

Gareth Brown

Gareth, a favourite with regular listeners to our Stock Take podcasts, trounced the index with his three picks: ‘MMC Contrarian has lost its investment genius and achieved poor results. Yet it’s returned almost 9% per year. Although I wish I’d selected a better performer, with Guinness Peat now on board and the stock below underlying post-tax NTA, it looks a safe situation.

‘Two years ago everyone worried about oil prices and a rising Aussie dollar. These factors have only intensified, but ARB Corporation has worked around the issues and gone from strength to strength. Good businesses with owner/managers and cheap stock prices tend to do well. I expect to own this one for many years.

‘Flight Centre has tripled over the past two years but the business has developed a tremendous head of steam since 2005, and it’s far from over. I do get concerned when others start to agree with us (as more investors do today) but we respect this owner/manager team and I think it will prove a mistake to sell this one too soon after picking it up for an absolute song.’

Best current buy: Select Harvests

 Carlisle’s crackers
STOCKS THEN INCOME NOW RETURN
Westfield Group (WDC) 17.02 2.153 20.41 32.6%
ARB Corporation (ARP)  2.90 0.24 4.30 56.6%
Cochlear (COH)  39.25 2.25 72.60  90.7%

James Carlisle

Our regular editor, James Carlisle, is currently working on a book but took time out to report on his impressive selections: ‘I’m very comfortable with my holdings in ARB Corp and Westfield Group. These two high-quality companies are doing all the right things at the moment – Westfield with its emphasis on an exciting development pipeline, and ARB by moving towards smaller vehicles and opening up in Thailand to overcome the local shortage of welders.

‘Sadly I never got around to buying Cochlear and I don’t think I would at these prices. No doubt that kind of attitude is why I’ve never bought it and why the shares might just be good value. The rating might be very high, but that’s what puts people off and few companies have such definable and strong growth prospects. A little patience here should pay off handsomely.’

Best current buy: Platinum Asset Management 

 Steven’s stars
STOCKS THEN INCOME NOW RETURN
Infomedia (IFM) 0.53 0.115 0.54 23.6%
Telstra (TLS)  3.84 0.62 4.66 37.5%
CPI Group (CPI)  0.48 0 0.45  –6.2%

Steven Johnson

Luckily Greg’s returns make our managing director look astute because most of the team left him in their wake: ‘I’m a long way behind but confident I’ll make up some ground over the next 12 months. Infomedia is still plugging away and, by this time next year, the growth profile might be a little more obvious.

CPI Group has been my worst performer and the paper industry conditions don’t look like improving. But the rationalisation of the business itself has been very impressive and they’ve recently won a fairly significant court case. We’ve ceased coverage but I still think I’ll do alright out of this one.

‘There’s still plenty of upside in my best performer, Telstra. We’ve seen a dramatic business transformation over the past two years and financial rewards should soon follow. So I quite like my three stocks but I’m also excited about the other opportunities available at the moment. I’d swap Telstra and CPI for Timbercorp and RAMS were we to repeat the exercise now.’

Best current buy: RAMS HOme loans

 

Investing lessons and principles

The sharemarket is an extremely dynamic environment, as evidenced by Tim Searles’s huge jump from 8th on last year’s leader board to a clear first this year. Anything could happen over the final 12 months of this competition. And while we’re not taking it too seriously it’s a bit of fun and a good opportunity to examine some investing lessons and principles in ‘real time’.

The first of those principles relates to the time frame. Three years isn’t a particularly long time in value investing circles. Markets tend to move through phases that can last years. Only after a number of phases have elapsed can one fully evaluate performance. If, for example, you wanted to look at the quality of our analysts and their picks, the performance report is a better guide than this particular exercise. Running over a period of five and a half years and showing an average annual return of 21.3%, it’s worth a look if you haven’t seen it before.

The second lesson concerns that of diversification. A diversified portfolio, whilst it mitigates the superb returns from, say, Flight Centre, also reduces the impact of a wipeout in Croesus. And that’s crucial. One has to first preserve one’s capital before one can deploy it in attractive situations. So, unless, you are supremely confident and have plenty of time on your side to recover from any losses, it makes sense to spread your risk, and your returns, among a diversified portfolio.

The third lesson follows on from the second. Ask any of these analysts at the beginning of the period what stock they thought would cause them the most problems and most would have difficulty picking what turned out to be the answer. In investing, as in almost everything else, there exists a risk. And sometimes we know neither its extent or its whereabouts. Acknowledging this and looking at what can go wrong, rather than dwelling on what might go right, is a key investing skill.

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