There are plenty of ways to make money in the stock market but clinging to mainstream thinking is not one of them. Gene Marcial has written a book to help condition your mind to look at the stock market as a market of opportunity.

For seven years as a columnist for the Wall Street Journal and the last twenty-six years as a columnist for BusinessWeek magazine, Gene has watched the stock market gyrate up and down. Not all of his 170 or so yearly stock picks have beat the market, but on average, they have bested the choices of the pros.

With all of his seasoning and experience, here is a journalist who felt compelled to write a book for investors who are not only bewildered, but at times, frustrated by Wall Street. I believe you will find Gene Marcial's 7 Commandments of Stock Investing to be an absorbing and insightful read.

Sheryl Sostarich

When do theserecomendations get listed in the SC / Amazon recommended reading list?

Commandment 1 - Buy Panic

Panic begets loss of logic. And when logic goes, investors rarely find solace by selling their holdings. Time and again, unexpected events roil the markets: a credit crisis, a SARS epidemic, a terrorist attack, an accounting scandal, an earnings miss. The news is rarely as bad as it seems and markets do rebound.

To prepare for the unexpected, Gene Marcial suggests a ready cash reserve ranging from 10 to 20 percent of your portfolio. He advises investors to keep two lists of stocks. One list is your long positions, that you will want to buy more of when they take a temporary hit. The other list is the stocks you own that are showing a paper gain that you wouldn't mind selling to boost your cash reserves. Marcial isn't advocating that you become a speculator. Rather, he is encouraging you to take advantage of mispriced securities during times of unease.

Marcial devotes a short section of Chapter 1 to another form of panic buying, that is, distress investing. These investors seek to buy companies that are trading down due to a significant loss of market share, a lawsuit, or a bankruptcy filing. I do not recommend this strategy for the average investor because the average investor has neither the financial resources nor the insight to be able to reap sizable profits from these situations.

Sheryl Sostarich

Hi Danny,

You asked about book selections. These are listed in the events calendar on the StockCentral website. You will also find a list of books and substitutions under the Book Selections Topic to the After Hours Book Forum. To accommodate those who like to read ahead, I publish my list three months out.

Sheryl Sostarich

Commandment 2 - Concentrate. Diversify Not

Diversification is a lazy man's game. As Warren Buffett aptly said, "We try to avoid buying a little of this or that. Our goal is to buy worthwhile amounts of a few companies to gain maximum returns."

Diversification is touted as a defensive type of investing that protects a portfolio from crashing. The truth is, in a bear market, all sectors go down in varying degrees. In a bull market, diversification produces no better than average results.

Research is essential to choosing a portfolio of winning stocks. Prior to taking a position, you should study the behavioral pattern of a company and learn how it correlates with the market. There is no reason to fill your portfolio with second-rate stocks. If a company has shown a consistent pattern of weathering bad news, it is a company you should build a position in. Look for companies that consistently beat analysts' sales and earnings forecasts. These are ideal candidates for concentration.

We should take our cues from the pros like William Harnisch of Peconic Partners. "To catch the high waves and snare sizable gains, investors need to concentrate in sure winners." Investing in 100 stocks makes it impossible to know all of them well.

Harnisch focuses on a company's fundamentals as well as its chart patterns over a minimum of five years. He monitors the market as well as his individual holdings so he can quickly react to changing market conditions. Harnisch believes in analyzing the balance sheet, the income statement, and other SEC filings. He recommends that investors listen to conference calls to learn as much as they can about a company. In this way, you too can place your bets on companies that are dominant in their industries.

Harnisch doesn't think twice about bailing out [of a position] if the fundamentals weaken, if his price target is met, or if a stock falls below its 200-day moving average price. The essence of concentration is to not dilute your portfolio with a potpourri of stocks. Your goal is to beat the market, not settle for mediocre results.

Sheryl Sostarich

Commandment 3 - Buy the Losers

This is a hard commandment to follow because it goes against our human nature. The question is, how do you tell the difference between a downright loser and a loser that is poised to turn around? Investors have a strong instinct to gravitate towards the big year-to-date [percentage] gainers. This is the last place to look for the future mega winners.

Instead, we should be looking at companies that the institutions are dumping. In many cases, the reason for selling has more to do with a price target and less to do with a company's value. Institutions are driven to be short-term traders to be able show quarterly gains to their clients.

The best place to find potential winners is in the "new lows" list. These are published daily in the Wall Street Journal and Investors Business Daily and weekly in Barron's. A company's earnings miss might be an aberration and the oppoortunity to buy its stock on the cheap. It is up to you to do your due diligence to ascertain the reason for the heavy selling. Is it company specific or industry wide? Was the selling caused by an overreaction to the news or is there something fundamentally wrong?

Some companies have a history of conservatively estimating their earnings so they will surprise to the upside when actual results are released. If you track Apple Corporation on Yahoo finance, you will note a history of positive earnings surprises.

Although I've not run across statistical evidence to prove that companies with high price/ earnings ratios beat the market more often than companies with low price/ earnings ratios, it is a mistake not to pay attention to price/ earnings ratios at all. While a high p/e doesn't necessarily mean that a stock is fully valued, I would rather buy a stock with a low p/e that has room to move up on positive earnings or news announcements.

Gene Marcial talks a great deal about the housing sector in chapter 3. The market didn't distinguish between good and bad companies, the whole sector sold off. Many of these stocks are good candidates for long term holdings in what is now a depressed corner of the stock market. It's up to you to decide which of the homebuilders have sufficient cash and assets to withstand the considerable drop in property values. Buying the losers is all about buying stocks for their fundamental merits and low valuations.

Sheryl Sostarich 

Commandment 4 - Forget Timing

Many market pros advise waiting for the propitious time to buy into the market. "Pay attention to the economic cycle," they say. For some industries, it matters whether the economy is robust or sluggish. Market timers are constantly monitoring interest rates, employment data, wage levels, and commodity prices to gauge which sectors to jump in and out of.

Department stores, railroads, homebuilders, and construction companies fare better in a strong economy. Food, biotech and pharmaceutical companies are deemed defensive plays and do especially well in sluggish economies. The charts, the timers insist, help them adjust their portfolios based on the trend.

University of Pennsylvania professor, Jeremy Siegel, has run the numbers and speaks strongly against market timing. His research revealed that there have only been two years --1995 and 1996 -- since the crash of 1987 when a buy and hold strategy has not beaten the timing strategy. Burton Malkiel has also worked the models back to the beginning of the 20th Century and came to the same conclusion as Siegel. "Past movements in stock prices are not predictive of future movements." Market timing is not only costly, it can cause the less dexterous investor to be out of sync with sudden spikes and swoons.

Legendary Fidelity money manager, Peter Lynch, argues that "if market timing worked so well, full-time market timers would be all over the Forbes list of richest people; there has never been a pure market timer on that list." He urges investors to buy companies with simple business models that they can explain using "a crayon." For superior returns, investors should spend their time studying the fundamentals and place their bets on the standout performers.

Lynch says that "if you look at ten companies, you will find one that is interesting. If you look at twenty companies, you will find two. And don't despair, if you look at ten companies that are all doing poorly, you will find one with some positive news that is not yet factored into the stock price."

Sheryl Sostarich

Thanks Doug, for your comments about diversification. We want to invest in high-quality growth companies. The rate of growth of different industries makes it advantageous to be invested in several industries.

If the last recession taught us anything, it was to not concentrate our portfolios in one or two sectors. While it is true that no sector is completely insulated from an economic slowdown, certain sectors weather a downturn better than others.

And, the truth be told, Warren Buffett doesn't always follow his own rules, even those about diversification. Vahan Janjigian has written a book titled Even Buffett Isn't Perfect. I echo the sentiments of Larry Kudlow, "this is the best book on Buffett in years."

Vahan Janjigian's book examines the myths about how Warren Buffett invests money. I don't want to spoil your read so I'll say no more until we can review this bestseller in the forum.

Sheryl Sostarich

Commandment 5 - Follow the Insider

The insider is king because, more than anyone else, he or she has the most knowledge about how a company is performing. One type of insider trading involves the selling of shares that an officer or director receives from options allocations. The other type of insider trading involves the purchase or sale of shares for an insider's personal account.

We should be the most interested in transactions in the open market that go beyond allocated options. Heavy insider buying can be a signal that insiders believe that a company's shares are undervalued. An investor can find out about these transactions by logging onto financial websites such as Yahoo finance or Reuters or by subscribing to newsletters such as Vickers Weekly Insider Report.

Insider.com monitors insider trading by scoring and filtering the most meaningful transactions. Public filings are required whenever an officer or director accumulates over 5 percent of a company's outstanding shares.

Warren Buffett is one of the most closely watched insiders there is. Buffett has large enough financial resources to take huge ownership positions; he often has a seat on the Board. And you can be sure that he thoroughly researched the railroad industry before buying a 10.9 percent stake in Burlington Northern.

In some instances, a big investor like George Soros or Carl Icahn will buy a block of a company's stock to implore management to make changes to the business strategy. These insiders might also be trying to challenge management by selling their stake to a third party who might want to buy the company outright. Insiders can have a powerful influence on a stock's valuation which is why it's important to pay attention to their trades.

Sheryl Sostarich

Commandment 6 - Don't Fear the Unknown

The stock market hates uncertainty, which is evidenced by the oil embargo of 1973, the Russian debt default of 1988, the technology bubble of 2000 and the terrorist attacks of 2001. Following each of these events, the stock market did reverse its slide and go on to record levels. You need to accept the fact that these corrections are inherent in the stock market.

Investing in foreign markets was generally believed to be off-limits except for the most daring investors. China has become a key emerging market for U.S. investors, representing 12 percent of purchases in 2005 and 22 percent of purchases in 2006.

This doesn't mean that Chinese stocks will rise forever and there won't be periodic corrections, as happened in February 2007. Investment opportunities are waiting to be bought as the huge population of China drives the demand for consumer goods.

While buying individual stocks on a foreign exchange is not recommended, buying mutual funds, exchange traded funds, or American Depositary Shares is highly recommended. Foreign companies who list on the U.S. exchanges are required to meet minimum standards of accounting set by the Securities and Exchange Commission. This makes it considerably easier for investors to study the fundamental characteristics.

Brazil is another developing country that is rich in natural resources. In May 2008, Standard & Poor's and Fitch rating agencies raised Brazilian debt to investment grade status. The move is a signal that Brazil is a safe place for investors to park money and is heralded as "the conquest that the Brazilian people have been waiting for, for many years."

I recommend buying companies in industries that you understand -- meaning communications, food processing, healthcare, banking, oil and gas exploration. Start with small positions and don't overweight your portfolio in single countries. There are many opportunities in high growth countries but you do need to exercise due diligence.

Sheryl Sostarich

Commandment 7 - Always Invest for the Long Term

The strategy of buy and hold doesn't mean buying stocks and forgetting about them. It means buying companies that are standouts in their industries and setting goals of what you expect in terms of returns.

That requires work on your part -- reading the SEC filings, listening to conference calls, and learning the business model. An established company is subject to market risks just as a start-up company is, but that might be an opportunity to add to your position.

Gene Marcial profiles seven companies that he feels should be core holdings for the next seven years. I'll let you read the profiles for yourself. I feel that each individual should come up with his or her own list of stocks that match his or her risk tolerance and investing style. By following the 7 commandments of stock investing, you will be on your way toward being a successful investor.

Sheryl Sostarich

Can you list the seven stocks without listing the profiles?

technology picks is Corning (GLW), a major maker of glass substrates used by the electronics industry. It is also a producer of fiber-optic equipment used by the telecom industry.

... tech picks is Diodes (DIOD), which makes discrete semiconductor products for the communications, computing, industrial, electronics, and automotive markets. 

...industrials  favors Itron (ITRI), the global leader in advanced meter-reading equipment for collecting and analyzing data on electricity, natural gas, and water use in residential, commercial, and industrial locations;
...industrials Joy Global (JOYG), a Milwaukee-based maker of high-productivity mining equipment for the extraction of coal and other minerals and ores;
...industrials Fuel Tech (FTEK), which develops air pollution-control technologies and provides engineering services.


... financial stocks: HSBC Holdings (HBC), part of Britain's HSBC Group that provides a variety of international banking and financial services.
... financial: Old Republic International (ORI), a Chicago-based insurance company that offers property and liability, mortgage guaranty, title, and disability protection.

This dashboard is public and published at: http://www.manifestinvesting.com/dashboard/12559

http://www.businessweek.com/magazine/content/08_19/b4083066458913_page_2.htm

Etana