Would you be interested in a stock-market adviser who recommended Apple in 2002 at a split-adjusted price of $1.14? Of course you would.
Shares of Apple AAPL, +0.94% neared $195 at Wednesday’s close, representing a more than 39% annualized gain since that level from 16 years ago. Meanwhile, the comparable total return of the S&P 500 AMC, -1.61% is 9.6% annualized.
The veteran adviser is George Putnam, editor of “The Turnaround Letter” investment advisory service. He just celebrated his newsletter’s 32nd birthday. So it’s a big deal that he is beginning his 33rd year at the helm of The Turnaround Letter.
But his well-timed Apple “buy” recommendation isn’t the only reason to pay attention to Putnam’s advice: His service is one of the few that has beaten a stock market index fund over the years. As you can see from the accompanying chart, $100,000 invested in his average portfolio at the beginning of 1988 would now be worth $3.8 million, versus $2.1 million for the Wilshire 5000 index. In annualized terms these gains are equal to 12.7% and 10.6%.
For this column I took the occasion of Putnam’s completing his 32nd year to ask him to reflect on the investment lessons he has either learned, or become more confident in believing, over the past three decades.
‘Selling is a lot harder than buying.’ George Putnam, editor, The Turnaround LetterOf the many lessons that he emailed me about, the first I want to highlight is that “selling is a lot harder than buying.” The reason I want to mention this first has to do with Putnam’s buy recommendation of Apple at $1.14. He sold the stock in July 2004 when it was trading at a split-adjusted price of $2.32, essentially a double from his buy price.
Oops. But Putnam explains himself: “There are a lot of metrics you can use to help identify stocks that are probably cheap. It is much harder to tell when the risk in a stock is beginning to outweigh the return potential.”
Putnam’s focuses on the stocks of companies emerging from a prolonged period of poor performance. His underlying premise is that such stocks are unfairly shunned by investors who can’t look past the companies’ dismal past performance.
In his email, Putnam said that his experience over 32 years has only reinforced his belief in this regard: “While much of the stock market is quite efficient, there are inefficient niches where you can earn outsized returns, and I still believe that turnaround stocks represent such a niche.”
Another investment principle that Putnam says the last 32 years have only reinforced is the twin virtues of patience and discipline. Putnam observes: “No matter how much conviction you have on a stock, it won’t always work out the way you expect. Diversification is the best way to protect against that. Similarly, there are many times where I have been ultimately right but definitely early. You have to have the patience to wait for your analysis to pan out.”
I asked Putnam to reflect on investment lessons he would draw on today that wouldn’t have been on his radar 32 years ago, or at least wouldn’t have beeen emphasized to the same extent. Two key ones that he mentioned are:
1. “Humility is a key element of successful investing. When you make a mistake, you have to acknowledge it, try to learn from it and then move on to the next investment opportunity.”
2. “Virtually all of the stocks of companies in Chapter 11 are bad investments. Bankruptcy stocks may bounce around a lot during the course of their Chapter 11 proceedings, but they almost always end up worthless or nearly worthless. When I started the newsletter, I thought we would be recommending a number of bankruptcy stocks, but I have since learned that if you are thinking about investing in a company in Chapter 11, you should look at the debt, not the stock. Or you should wait until the company comes out of Chapter 11 and then look at the new, post-bankruptcy stock.”
Should you want to try your hand at turnaround investing yourself, Putnam recommends that you look for a stock of companies with the following elements:
“Solid core business. A good brand or franchise. A healthy enough balance sheet to give the company enough time to fix its problems. New management that can bring about change. A large, active investor pushing the company to create shareholder value. A good dividend yield to compensate you while you wait for the turnaround to take hold.”As examples of the kind of stocks that meet Putnam’s criteria, here is a list of his recommended stocks that he added to his model portfolios this year:
AMC Entertainment Holding AMC, -1.61%
Blue Apron Holdings APRN, +5.44%
Hovnanian Enterprises HOV, -3.16%
Midstates Petroleum [ MPO, -1.00%
Newell Brands NWL, -2.12%
If you’re like most investors, you’re unlikely to have even considered stocks such as these. But that’s precisely why the market is not particularly efficient for them and it’s possible to find extraordinary values.
The analogy I often use when speaking about the virtues of Putnam’s approach is to a hypothetical 10-horse race in which we are allowed to bet on any finisher. Imagine that one horse is the overwhelming favorite while the other is expected to come in last. Imagine further that the favorite horse finishes second, while the horse that was expected to come in last instead finishes fifth.
You’d make more money having bet on the horse than came in fifth than the one that came in second — even though the second-place horse was a faster horse.
The point is that you make money when you beat the consensus expectation. You’re betting on relative rather than absolute performance. Since most investors mistakenly believe the opposite, they automatically shun the out-of-favor companies that populate Putnam’s hunting grounds.
For more information, including descriptions of the Hulbert Sentiment Indices, go to The Hulbert Financial Digest or email mark@hulbertratings.com . Create an email alert for Mark Hulbert’s MarketWatch columns here (requires sign-in).
