Investing 102

Almost 2 years ago I wrote about joining the Motley Fool’s Hidden Gems newsletter.  This was one of my first attempts to learn about investing and to actively try to "beat the street".  Since it’s coming up for renewal and I’ve been looking at a lot of personal finance blogs lately - I decided it was a good time to figure out just how I’m doing.

The newsletter is aimed at your novice investor who wants to learn more about investing and why one should or shouldn’t invest in individual securities.  The focus of the authors is to recommend two small cap stocks per month.  The service does deliver just that each month, though it also re-recommends stocks from time to time (I think something like 3 or 4 times so far).  I generally like the commentary, the active tracking of stock holder issues, executive interviews and the open forums where members discuss, value and recommend to each other.  In addition to the two main picks (which are officially tracked), the service provides a number of unoffiicial watch-list stocks and two tiny gems (micro caps).  Since July of 2003 when the service started, the track record for the main editor’s picks is about a 37% return vs. the guest editor’s picks at 45% (as you can see below):

There are some downsides to the newsletter.  My primary con is that it’s hard to get the recommendation prices.  When the newsletter comes out at 10am on the fourth Thursday of the month the main picks spike immediately - typically 3-10% in one day.  The Tiny Gems (micro caps) spike even more given there lower average volume.  This can make getting in at the ground very difficult.  It’s also plain old frustrating.  Another con is that it takes a while to figure out how best to leverage the news letter.  Instead of going in with no money and trying to start investing in the stocks that are recommended, it’s a better idea to go in with at least a few thousand dollars and diversify heavily the first month or two.  One of the most important lessons I’ve learned is having the patience to wait for a reasonable price and not to check the stock prices day to day - it’s generally nerve racking with volatile small caps and doesn’t lead to good decision making.

One of the best parts of the newsletter is the community feedback.  While it may be Tom Gardner’s words, it truly is supported and added to immensely by the community that comes with it.  From advice on what stocks to buy now to how to properly value opportunities - it’s all there.  Moreover, the community’s feedback is actually heard and incorporated into the product and format of the newsletter. 

So does this warrant a $199/year fee for the Fool folks?  Can average Fools actually earn these sort of returns by using a newsletter like this?  The answer is - I’m not sure.  So let’s look at the numbers:

The reason I’m not quite sure is that I just don’t have enough data and I didn’t follow the newsletter closely enough the first year.  Specifically, I invested in only 2 main picks between May 2004 and December 2004.  I also invested in 2 Tiny Gems (the unofficial microcap picks) which have been my best performers to date (though they really sucked in 2004).  Since the beginning of 2005, I’ve shyed away from the Tiny Gems and started picking one or both of the Hidden Gems to buy per month - diversification has yielded significantly better returns in a harder market environment.  But 1 year doesn’t come close to making a trend.  So why am I hesitating?  Part of it is that over the past 3 years small caps have been on a tear.  In 2003 the Russel 2000 returned 47.25% vs. the S&P’s 28.69%!  It’s unclear if small caps are going to remain the best value in the market or if they’re in for a licking as their boom cycle ends.

In addition to looking at my Hidden Gems portfolio, I also tallied up the score on my Roth IRA.  I have a longer history here, so the numbers are slightly more interesting to look at with respect to trends:

These numbers actually gave me the biggest reason for pausing before renewing my Hidden Gems subscription (which I still haven’t done).  In the two overlapping years, I beat my Hidden Gems portfolio - in 2005 I got nearly double the return from it.  The focus of my Roth IRA has been both large cap value stocks and international opportunities - Brazil, Russia, India & China (BRIC).  Admittedly these international stocks have done extremely well in 2005 (Brazil and Russia nearly doubled) but are just as high risk as the small caps.  In general, when comparing my returns here to the indexes over the last few years - I didn’t do that poorly and squarely beat the S&P each year.

It’s clear to me none of this is close to conclusive and I’m probably going to continue down the small cap path given it’s doing pretty well this year, and I feel like I’ve finally figured out how best to leverage the content of the newsletter and it’d community.  I’m curious to know how do you invest and what has your experience been like?  Are they just a bunch of thieves out to get us?  Can you beat the street?  Most experts say no, I’m not so sure…

technorati tags: finance, hiddengems, stocks