Why two-baggers are bad

Thursday, April 9, 2009 05:02 PM

Why two-baggers are bad
David Berman

If a stock you have steadfastly avoided has doubled in price over the past year, you might feel out to lunch. But according to recent research, now is not the time to go chasing after it in the hope of catching a little momentum.

Steve Foerster, professor of finance at Richard Ivey School of Business at the University of Western Ontario, has taken at look at what he calls “doublers” – stocks that have risen 100 per cent in the previous 12 months – and found that they typically underperform “non-doublers” over the following three to four years. The reason may have to do with the idea that fast-rising stocks tend to move beyond underlying fundamentals and start rising because of momentum and exuberance.

Mr. Foerster looked at the U.S. market – so Peter Gibson, vice chairman at Desjardins Securities, applied the concept to Canadian stocks.

He found that since 1991, investors who jettisoned doublers from a capitalization weighted S&P/TSX composite index would have enjoyed average annual returns of about 14 per cent, versus 12 per cent for the benchmark index. Even better, you would have benefited from lower volatility.

“As a general rule, excluding doubled stocks from a capitalization weighted index tends to produce returns equal to or better than the S&P/TSX composite index with a reasonably consistent performance profile over time,” Mr. Gibson said in a note to clients. “The major exception was during the early stages of the dot-com bubble, and perhaps somewhat disconcertingly, the current period.”

Indeed, avoiding today's doubler stocks means ignoring Potash Corp. of Saskatchewan Inc., Agrium Inc. and Research In Motion Ltd. – which is no easy feat. Curiously, energy stocks are not doublers and nor is oil. Crude oil has risen 95 per cent over the past year, while even high-flying Petrobank Energy & Resources is up 97 per cent – a steep rise, but not quite a double.

http://www.theglobeandmail.com/blogs/markets/why-two-baggers-are-bad/article691891/


Comment: Always fall back on the fundamentals.