Douglas Gerlach
Douglas Gerlach, editor in chief of the Investor Advisory Service newsletter and author of six books, including The Armchair Millionaire. Madison Heights, Michigan. InvestorAdvisoryService.com
Some investors have stock portfolios that soar during bull markets but plunge during bear markets. Other investors have portfolios that hold up relatively well when the going gets rough, but they’re pretty lackluster when the stock market is zooming upward.
But what if you could beat the market no matter which direction it was headed? That’s what investment-newsletter editor Douglas Gerlach has done. He and his team of analysts use a strategy that originally was devised for amateur investment clubs in the 1950s. It is simple enough for the average person to use, yet comprehensive enough to compete with professionals.
Combining the approaches of several legendary investors, including Warren Buffett and John Templeton, the strategy was refined for decades by hundreds of clubs across the country and hundreds of thousands of investors.
Since 1996, the newsletter’s model portfolio has gained an average of 13% annually, compared with 8.5% for the Wilshire 5000 stock index. It was recently named to The Hulbert Financial Digest ‘s Honor Roll of newsletters that have consistently beaten market averages in both up and down markets year after year.
Bottom Line/Personal asked Douglas Gerlach to share his investment secrets…
We don’t worry much about the overall movements of the stock market or economic forecasts. And we don’t seek out sexy, high-profile stocks such as Tesla or Twitter. Those companies may have vast potential, but their fates are very uncertain and the stocks are very volatile.
Instead, we focus our time and energy on identifying high-quality companies to invest in. Once we add a stock to the model portfolio, we keep it there as long as the company continues to perform up to the standards that we consider important. If a business consistently makes money and grows over time, the share price tends to rise more in bull markets than the overall stock market and fall less than the market in bear markets.
The top three fundamental characteristics of great businesses…
Consistent earnings growth. Stock prices bounce around for lots of reasons, but over the long term, earnings growth is the single most important factor justifying rising stock prices. In choosing stocks, we want to see average annual earnings growth of at least 15% over the past five to 10 years for small-sized companies…at least 10% for mid-sized companies…and at least 7% for large companies.
Stable profit margins. A company with stable margins (the percentage of revenue that is realized as profit) that are greater than those of its competitors has a better chance of performing well in economic downturns or when industry-related problems strike.
Long-term competitive advantages. It’s important to make sure that the company has attributes that will help it keep growing in the future and do better than its competitors. For example, the business may have patented technologies, strong brand loyalty from customers or new markets overseas.
Important: We stay fully invested through bull and bear markets because market timing has such a low success rate. This can be challenging because my growth-oriented strategy does not include many shares of defensive, slow-growth companies such as utilities or consumer staples. Consequently, our portfolio is likely to endure losses in bear markets and market corrections, but the losses tend to be less severe than those of the broad market, and the rebound is more pronounced than that of the broad market. For example, in 2008, when the S&P 500 stock index dropped 37%, the newsletter’s portfolio fell just 28%. And over the next five years, it returned 23% annually, on average, compared with 18% for the S&P 500.
We avoid “cheap” stocks—those with a price-to-earnings ratio (P/E) that is considerably below the stock’s average P/E over the past five years. Reason: A cheap stock typically means that something has gone very wrong with the business and/or that investors have lost confidence in it. Besides, it’s tricky to judge whether management has the talent and insights to turn around such a troubled company.
Instead, we prefer companies that are doing well but that have experienced a dip in the stock price because of a temporary business setback or a broad market drop in which worried investors dump holdings indiscriminately. Typically, we like to see a stock’s P/E slightly below, or equal to, its five-year average.
Shares of each of these high-quality businesses have matched or beaten the S&P 500 over the past five years but also have held up better in bear markets such as the one in 2008. Moving forward, each of these companies has a good chance of experiencing strong revenue growth that can drive the stock’s price up by as much as 15% annually over the next five years.
Catamaran Corp. (CTRX) is a major pharmacy benefits manager (PBM) in the US. It handled the processing for, and negotiated discount prices on, more than 350 million prescription drug claims last year for organizations including managed-care firms and health-care plan administrators. The claims that the PBM industry oversees are expected to nearly double by 2020 because of the government expansion of health-care benefits and the rising cost of specialty drugs. Recent share price: $41.25.
IPG Photonics Corp. (IPGP) pioneered the manufacturing of fiber-optic lasers for industrial cutting, drilling and welding in products ranging from
Gillette razors to Volkswagens. Compared with conventional lasers, fiber-optic lasers offer more precision but are far more expensive. IPG’s manufacturing costs have dropped markedly in recent years, and the company is just beginning to penetrate industries such as aerospace manufacturing, telecommunications and medicine. The company owns hundreds of patents on fiber-optic laser design, giving it a major advantage over competitors. Recent share price: $61.64.
Realty Income Corp. (O) is, in my opinion, the best-managed real estate investment trust (REIT) in the US, with impressive occupancy rates and reliable cash flow. It has been able to increase its dividends for the past 19 years in a row. The company owns more than 4,200 properties in 49 states and Puerto Rico that are leased to businesses including FedEx, Walgreens and BJ’s. Its shares recently yielded 5%, making it attractive for investors seeking income. Recent share price: $43.78.
ResMed (RMD) develops and manufactures medical devices to treat sleep apnea and other respiratory problems. The business should see an enormous influx of new customers among baby boomers in the next few years because sleep-disorder breathing tends to worsen dramatically with age and weight gain. ResMed is the technological leader in this health-care niche, with the highest brand-name recognition among physicians. Recent share price: $50.65.
The powerful bull market over the past five years has left the stocks of many terrific businesses too expensive to recommend right now. However, consider tracking the following stocks and buying them when they have big pullbacks…
Aflac (AFL) is best known for its TV ads featuring a duck quacking “Aflac,” but many investors don’t realize that it is one of the world’s largest underwriters of supplemental health, life and cancer insurance, a highly profitable and fast-growing market sector. Recent share price: $62.98. Purchase at $50 per share or below.
Fastenal Company (FAST) distributes maintenance supplies, including a selection of more than a million types of bolts, fasteners, screws and electrical tools, to industrial and construction customers. Fastenal still has plenty of room for growth, with just a 2% share of the highly fragmented $140-billion-a-year market in maintenance supplies. Recent share price: $48.25. Purchase at $37 per share or below.
Fiserv (FISV) is the leading provider of core-processing services, such as electronic fund transfers and loan processing, for thousands of US banks and credit unions. Recent share price: $61. Purchase at $44 per share or below.
O’Reilly Automotive (ORLY) is the second-largest do-it-yourself auto-parts retailer in the US, with more than 4,000 stores. Its business will continue to grow rapidly as owners keep their cars longer. Recent share price: $148.61. Purchase at $120 per share or below.
