Fool.com: Mechanical Model Mania (Workshop) August 5, 1998

Mechanical Model Mania

ALEXANDRIA, VA. (August 5, 1998) -- Good evening, everyone. My name is Dave, and I'm a mechanical model-aholic. It's been 4 days since my last attempt to unlock the mysteries of the investing universe with quantitative indicators. Like many of you, I've always been somewhat intrigued by the concept of mechanical model investing, and through the years I've played around with formulas a thousand different times, just looking for that magic key formula that would unlock the treasure chest that is the stock market. Recently, I conducted a job interview with a fellow who is applying for one of our writer/analyst positions (see our Fools Wanted area), and we got into a discussion about mechanical models. He said:

"When I use models, I observe the various influences on a particular stock and then form some sort of common sense theory based on what I've seen. After I form the theory, I work like a dog to disprove it. I want it to be wrong. It's only after I've tried a thousand different ways to prove myself wrong that I start believing that I might be right."

Interesting. As he was saying this, I began thinking back to the end of 1996 when I was playing around with a feature for the Fool called "Relatively Speaking." In the feature, I had a theory that stocks with very strong relative strength were doing well, and, based on this strength, might continue to do well. Not a terribly original theory, I admit, but I wanted to see what would become of it. In order to test the theory out (actually, a theory isn't a theory until it's proven, but I digress), I scoured my Investor's Business Daily for every stock that achieved an RS ranking of 99. Wanting to eliminate penny stocks, I discounted everything that was trading below $5 per share. Finally, I whittled the list down by only including those stocks trading within 10% of their 52-week highs. Below are the 10 stocks, their prices back then, prices now, and total returns:

 
 Name                  Price    Price    Total 
                        Then     Now     Return 
 Centennial Tech.      $31.63   $1.00   -99.96% 
 Clarify Corp.         $48.75   $12.75  -73.84% 
 Flores & Rucks        $49.75   $15.25  -69.34% 
 Clayton Williams      $13.13   $7.63   -41.90% 
 Eagle Hardware        $28.88   $21.50  -25.54% 
 MasTec                $35.64   $23.88  -33.01% 
 Maxwell Tech.         $17.88   $25.25  +40.55% 
 National Tech Team    $21.13   $8.63   -59.17% 
 Pacific Sunware       $18.75   $29.50  +57.33% 
 Technology Solutions  $27.50   $25.50  -07.27%

So much for theories :)

Now, I know that using a sample set of 10 isn't a very scientific way to prove or disprove a theory, but this group really stunk up the joint. The question is, does the fate that befell all of these companies necessarily have to befall all companies that find themselves amongst the strongest of the strong in price performance? It's tough to know for sure. Tomorrow, we'll look at the most recent group of stocks that fit this criteria. Will this be a great list of short sale candidates? I'll bet you that many of the stocks will be Internet related! Tune in tomorrow, RS fans. By the way, if you want to talk about this particular theory, join me in my message board hideaway, "Bogey's Bungalow".

Take care,
David

[Robert Sheard is on vacation this week. He will return on August 10.]

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.]