Step 2: Only buy stocks that have a chance to drastically outperform the market
Is it just me, or is “safe stocks” a lot like saying “safe skydiving?” It’s a complete oxymoron, stocks are inherently dangerous, and the only thing that outweighs the risk is reward. So step two to your Rehab Portfolio should be to choose stocks that are either a). drastically undervalued, b). provide tremendous upside, or c). offer both.
In fact, the only safety you should be looking for can be answered in one question—will the company go out of business?
One stock that offers such upside, is Cliffs Natural Resources Inc (NYSE:CLF)
Cliff's has been a perennial grower--with revenue growth of 22% annually over the past five years--but finds itself in the investment dog house. What's funny is that over the past year, while the stock has slumped, revenue has grown even faster. In fact, the company actually made Fortune's list of the fastest growth companies last year.
Analyst’s worries over costs and demand for iron ore have legitimacy. But if you're looking only for stocks that can outperform the market, it's hard to beat one that traded nearly three times higher this year, and it's still growing.
Cliffs Natural Resources Inc (NYSE:CLF) just reported a nice earnings beat, $0.60 vs. expectations of $0.34. Again, there are concerns, cash has decreased and debt has increased while demand has waned. But if this recent quarter was a sign that the ship is stabilizing, there could be tremendous upside amidst a relatively flat market. The stock is still trading just above $20 per share and was at $100 a share not long ago.
The stock has been rebounding recently due to some of the positive factors previously mentioned, but it’s very volatile—so I’d wait for a slight pullback before rushing in.
The most important step to rehab: tuning out the noise
In 2009, after receiving enormous acclaim for “predicting” the crash of 2008 famed economist Nouriel “Dr. Doom” Roubini “predicted” that the bear market would continue for years.
Ditto for 2010, 2011, and 2012. In fact, throughout one of the greatest bull markets in history (2009-2012) this guy was a perma-bear, the only time he’s been bullish on stocks is, well, right now with the market at record highs.
But he didn’t lose speaking opportunities, even as you lost money from taking his advice. The same goes for Jim Cramer and all of the bulls of 2007 and 2008, they’re still solvent even though you may not be.
The point is that listening to these guys is hazardous to your financial health. Not because they don’t know what they’re talking about—they do—but because nobody can “predict” what the market will do next.
In fact, the most important lesson from the crash—and the rally that followed—is to tune out the noise and stay invested. If you would have just contributed, each month to a diversified index fund you would have outperformed the market by a mile. I strongly feel this, along with picking a few stocks that have multi-bagger potential, is the way to go.
But for this to really work, we need to give up the most powerful drug of all: trying to guess what will happen next.
It’s a thrill, but a costly one.
The article Stock Pundits Are Drug Dealers: It's Time for Portfolio Rehab! originally appeared on Fool.com and is written by Adem Tahiri.
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