Portfolio Goes for Growth
The Workshop Portfolio is taking shape under the guidance of the community. We've determined that the portfolio will concentrate on growth stocks and we have defined some of the issues we need to address such as market cap limitation, fundamental growth strategies versus price momentum strategies, and blending strategies for low volatility.
By Ann Coleman (TMF AnnC)
October 26, 2000
The Foolish Workshop discussion board has been very busy since we asked for input on developing the real-money Workshop Portfolio last week. The level of discourse has been high, the suggestions excellent, and the spin-offs to other topics rather less than expected. (Isn't anyone going to post something entirely frivolous?)
Some of the full-blown portfolio ideas that have been proposed on the discussion board have been fantastic. If you want to see them for yourself, check out this thread. (Click the link, then make sure the word Threaded is in black type. If not, click it. Then you can follow the responses without getting side-tracked.)
Some issues that have come up:
Small-cap, small-volume stocks
One of the dangers of any stock-picking "system" is that if it becomes widespread, the system tends to break down. The last thing we want is to set up a situation where too many people are trying to buy too few shares. Whether it is people blindly following the portfolio (bad, investor, bad!) or run-of-the-mill Workshop investors following similar screens, if too many people are trying to buy too many shares, the price can spike.
One way around that is to limit the strategies in our demonstration portfolio to stocks above a certain size. For example: If we all tried to buy some microcap stock that only has a few million shares outstanding, the buying pressure could easily cause one of those situations where the press starts calling the company, and the company just mumbles: "We have no idea why the price spiked." On the other hand, we could all go out and buy $10,000 each of General Electric <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GE)") else Response.Write("(NYSE: GE)") end if %> tomorrow afternoon and it would not effect the price to any great extent, since large institutions routinely trade huge amounts of that stock.
I don't think any of us particularly wants to be buying at the top of a price spike. The official portfolio will be particularly vulnerable to this problem because Motley Fool rules forbid us to trade until after publicly announcing the buys. (That's another issue that will need to be addressed eventually, but most likely we will be making our trades, not as soon as the new rankings come out, but sometime during the following week.)
Copy cats
Another issue that could stand some more discussion is that of people following along. Sigh. You know it will happen. I know it will happen. The Fool has been trying for six years to convince all of our readers that there is nothing magic about our online portfolios. (This year seems doing a better job of that than all our exhortations to "think for yourself" ever did!)
We have to weigh the educational value of a real-money portfolio against the near certainty that there will be people who will follow the portfolio. I won't assume that they are following blindly -- many of the folks who followed the Foolish Four portfolio were very well aware of the arguments about following along and preferred to do it anyway because they thought it was kind of fun. Well, OK. I guess that's their right, and who are we to dictate otherwise? Hopefully, anyone who starts out following with closed eyes will bump into something early on and sit down to do some serious thinking.
I expect that most Workshop investors will be able to beat this portfolio, by the way. Besides the potential handicap of having to wait before trading, individual investors will have more flexibility to select newer strategies as they come along or even get out of one that doesn't seem to be meeting their needs. To set a good example we will have to stick with our chosen strategies for the full year. (The portfolio is committed to Workshop strategies for the foreseeable future, but we can certainly leave the door open to improving the mix next year as new ideas are tested.)
Growth vs. value strategies
There seems to be a consensus on the board that we should be investing the least amount possible in value strategies. I'm not convinced that that is the best course. If it were up to me, I would probably add another value strategy to the mix along with the Foolish Four. I worry about getting whacked upside the head by a serious growth-stock crunch. But I asked for the board's opinion (except on the issue of keeping the Foolish Four) and I'm happy to follow it.
So the next question is: What kind of growth strategies? Some, like the PEG, rely on very fundamental stock-picking criteria like market cap, price-to-earnings-to-growth ratios, and expected earnings. Some, like relative strength, are more geared toward price momentum. Hopefully we will be able to come up with a blend of strategies that don't all behave in the same way. Todd Beaird's article on diversification illustrates this concept using correlation coefficients.
Strategies with high correlation coefficients tend to behave the same way. When one goes up, so does the other and vice versa. We don't want that. We want a mix of strategies that will complement each other. When one is having a bad year, another takes up the slack. At least that's the plan.
Correlation coefficients are pretty cool, and when Todd gets back from his honeymoon I hope he will run some more for us. Another way to test whether a particular blend uses strategies that are complementary is to use Jamie Gritton's backtester, and compare the yearly returns of various strategies over the past 15 years.
Next week we will run some simulations on the backtester to illustrate how this works.
Fool on and prosper!
