Your Next Great Stock: How to Screen the Market for Tomorrow's Top Performers

Chapter 6. Telling Great Screening Strategies from Not-So-Great Ones

I was a terrible mutual fund salesman, as I've told you. But let me try to talk you into a bad stock-picking strategy just the same.

The Pitch

Have you heard about the XYZ investment strategy? It's simple. Look down a list of stocks in the S&P 500 index—America's 500 largest companies, more or less. Buy ones that start with the letters X, Y, or Z. That's it.

Start thinking about how you're going to spend all those profits. If past performance of the XYZ strategy is any indication of future returns, it's sure to be a success.

Okay, there hasn't been any past performance per se. That's because the strategy is new. We'll have to rely for now on back testing. Back testing involves using a computer and a big database of stock information to tell how a strategy would have done had we been following it over the years. I checked the returns to my strategy in early March 2007. Over the prior year those XYZ stocks—there were nine of them—gained an average of 15 percent. That's 7 percentage points more than the average for all 500 stocks we started with.

I see you're not calling your stockbroker yet to place buy orders. Perhaps you think the one-year results were just luck. Very well, consider this: Over the past three years, my alphabetically disadvantaged stocks gained 48 percent. That's eight percentage points better than the 500 stocks. And over the past five years they gained a stunning 95 percent, trouncing the 500-stock ...