Friday, May 8, 1998

The Daily Workshop Report
by Robert Sheard (TMF Sheard)

LEXINGTON, KY. (May 8, 1998) -- Many of the Workshop models we track include a relative strength component. Plain and simple, the theory is that strong stocks typically remain strong until something significant throws them off course. So-called Momentum Investing often gets a bad rap by value investors because they claim it's not good business sense to buy a stock that's already doubled or tripled. Anything with a P/E above 20 is absurd and a disaster in the offing, they declare.

Studies show this to be specious reasoning, in that stocks with the best returns over the previous six to twelve months often continue atop the return lists. Now don't take this to mean that every high flyer will continue to succeed. We all know stories of stocks that soar overnight and plunge the next day or week. But a stock that has strong enough fundamentals to sustain an outstanding return for six months or a year will often keep doing things right and will be rewarded for it. Relative Strength has turned out to be a very useful tool in identifying next year's winners.

What's too much, though? You'll see a lot of analysts and investors arguing that if a stock's already doubled or tripled, it therefore has to give up something soon; it's time to sell. That's not a solid enough reason in my book. We're not dealing with gravity but with growing businesses in a growing economy. Selling a winner just because it's a winner is a pretty lousy way to make one's sell decisions.

Let's look at an example. Let's say you bought a stock at the end of 1993 that had just lost 52.9% for the year, and you're convinced it's turned around. In 1994, your decision was vindicated with an 81.2% profit. Do you take the money and run because it's gone up so much?

Well, you're brave and convinced the rally's not done and the company is on the right path. So you hang on in 1995 and score an amazing 68.9% victory. Now you're up an awesome 206.0% in two years -- a triple. Surely it's time to sell?

Your neighbor, who bought along with you at the end of 1993, is going to bail, but you stand tough. Lo and behold, in 1996 the roof gets blown off by the stock again, amassing another astonishing gain of 206.9%. In three short years, your $5,000 investment has grown to $46,963. Your neighbor is kicking himself, but he's trying to persuade you that you've been lucky. But now you absolutely must sell. How can you hold a stock that's already gone up 839% in three years?

What? You're going to hold on? Yeah, well, we'll see what happens in 1997, pal. And where's the hedge trimmer you borrowed? You're gonna need it!

(watch the calendar pages flip by.)

In 1997, guess what? No way! Another gain of more than 200%? Impossible. (216.2% to be precise.) In four years, $5,000 has grown into $148,497. Party's over. Everybody� out of the pool!

But yet you persist, determined to hold the stock yet another year. And now we're in May of 1998 and you're telling me it's already doubled again? (Up 108.2% through May 6.)

In four years and one hundred twenty-six days, an investment in this single stock has grown from $5,000 to $309,171 -- a gain of 6,083%.

The stock? If you haven't guessed by now, it's Dell Computer <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: DELL)") else Response.Write("(Nasdaq: DELL)") end if %>. And as of this week's Workshop update, it's the second stock of 1998 to ring the Double Gong. Best Buy Co. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BBY)") else Response.Write("(NYSE: BBY)") end if %> hit a gain of 100% recently but has since backed off a touch.

My point with this glitzy example isn't to say that I, or even anyone I know, picked Dell and enjoyed such phenomenal growth. (If I had, I'd be playing golf at a resort right now.) My real point is that ignoring the power of Relative Strength is something one does at one's own peril. If you're tempted to sell a stock simply because it's made a nice profit, rethink the reasons you bought the stock in the first place. Have they changed? Or has the price simply risen while the strong case for the stock remained in place?

I'm thrilled to disclaim that I'm the proud owner of a position in Dell, held for considerably less time than in this dream scenario, and I admit that my gut reaction going into 1998 was to shy away from a stock that was up 2,870% in the previous four years, but the case for Dell being a good value was still there and with relative strength on its side. Dell was a good choice as it happens.

In short, relative strength is a real force to reckon with and can remain in place for long periods of time for companies that are doing everything right. Don't fall prey to the thinking that "everything that rises must come down." Will Dell, and other similarly strong stocks, rise forever? Of course not. But a massive gain over a couple of years doesn't mean the stock should automatically be excluded as a potential winner again the next year. Fool on!

Check out the latest file updates for the Workshop:
New Rankings | 1998 Returns | New Database

[Robert Sheard is the author of the The Unemotional Investor (Simon & Schuster, 1998) available now at Amazon.com and your local bookseller.]