December 10th, 2008

Revisiting the Early Phase, Low-Priced Stock Strategy

I was somewhat disappointed by the lack of reaction from my loyal readers about the “Perpetual, In-the-Money Call Options“article I wrote on November 15. Why? Because of the relatively benign response. The only comment (skeptical, I suppose) was

A valuable analysis to do would be to take the entire basket of sub $5stocks at a point in time and see the worth of the portfolio after 5 years. Repeat that exercise for $5-10, $10-20, etc. tranches. That will provide you and us with the necessary analytical horsepower to make the investment decisions.

I responded was that the major weakness in back-testing this sort of strategy is

that it includes a bias; some stocks that actually were on the list in 2003 are now off because they actually did go belly-up, or were acquired or got delisted. I just don’t have price data if they’re not listed today.

My hypothesis in the “Perpetual In-the-Money Call” strategy is “put together a speculative basket of some low-priced stocks, put them away and lock them for some time far in the future. Obviously, some will wind up being worth nothing but the % gain on the others would be more than enough to absorb those loses and still generate a very nice profit”. I couldn’t go backwards but can go forward from November 14, the Friday close before that Saturday post to today with these results:

These were the stocks I picked randomly among the 1960 stocks under $5 on that date. The average return for equal $amounts put into each for the past 3 1/2 weeks is 18.4%; the S&P 500 is up 3.0% (unbelievable, considering that the market is up nearly 20% over the past 12 trading days).

But how typical is that sort of return? Perhaps I was lucky or perhaps it wasn’t as random as I thought and there was some sort of subconscious bias working in my selection process. Here are the results for the whole group of 1960 under $5 stocks:

Of the 1960, almost precisely a half at least broke even but 44% had more than 3% beat the S&P 500. The average return for all 1960 was -1.255%

Does this prove that the strategy isn’t viable? I believe these preliminary results are mixed and conflicting. For example, none of the stocks I selected were under $2.00 but 30% of the total were under $2.00 …. and these 588 stocks collectively had an average loss of 7.7%.

It needs more work and I’m not giving up. It is early in this correction and there will be a retest of the lows so it’s not too late.

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