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Monday, January 22, 2007

My Security Selection Process

One of the topics I’ve been meaning to write about for awhile now is my personal process for selecting stocks to highlight in this blog. Consistent readers know that each post lists our top buy and sell recommended stocks at the bottom, along with the top buy recommended major market, style-box and sector investments. But every now and then I’ll write about a specific security that I find interesting and worthy of further examination. So this post will hopefully offer insight into the strategy I employ and perhaps give other investors ideas for their own strategies.

I consider myself a top-down investor, which means my approach starts with a macro examination of the market, narrowed down to sector and industry, and then to individual security. The macro examination starts with our Long-Term Market Model which combines technical, sentiment and trend analysis. Also included in the model are economic and interest rate indicators, which further help define the current investment environment. The model is currently bearish, which tells me that caution is warranted with regard to investment selection and allocation.

The next step is an examination of the sectors we analyze daily for alpha. Right now, the only buying opportunity we’re seeing is in Financials (IYF), although several sectors such as Real Estate (IYR), Transports (IYT) and Healthcare (IYH) have performed well over the last one week and one month. I can also determine which sectors are under-performing currently, which from the chart below look to be energy and tech related. Often times I look for buy recommended securities within weak sectors as a speculative holding, so I certainly don’t ignore sell recommended sectors. But I normally highlight securities within stronger sectors in the blog.

Once I’ve determined which sectors I like, I then turn to “Today’s Buy Recommendations” from our analytic, which normally produces a list of anywhere from 5 to 200 securities upgraded to “buy” status as of the last market day. Looking at that list this morning, there are 52 stock, mutual funds and ETF’s that were upgraded after Friday’s close.

The next few steps are designed to reduce that list further by removing any issues that were recently sell recommended. I always remove issues that were sell recommended within the last one week, but often time’s I’ll extend the time frame depending on market conditions. By doing so, I’m hopefully removing highly-volatile securities as well as those that are range-bound. Right away that narrows today’s list to 42 securities.

I then reduce the list further based on the AAS Rating Score. Although any positive score is indicative of a bullish trend developing, I prefer values of at least 5.00 in my analysis. Removing all securities without at least a 5.00 AAS Rating Score results in a list of 24 securities, which is still a bit high but workable. Here’s the list:

The last step involves charting the list and looking for those securities that meet certain criteria. Obviously, the criteria is different for everyone, but I personally look for securities with a positive trend off of a recent bottom and have crossed over, or are getting close to crossing over, the 50 and 200-Day Moving Averages. Recent is a subjective term, but for me it means within the last six months. After this step, I’m left with two securities: ADC Telecommunications (ADCT) and Century Aluminum Co. (CENX).

Of course, the analysis could be completely off and these stocks could tank today, which is always a risk when investing. That’s why I pay close attention to the Sell-Limit Values each day, which at the moment are 13.89 for ADCT and 39.13 for CENX. If the closing price falls below the sell-limit value, I sell the security – no questions asked.

I hope this gives you an idea of how I select securities for discussion in the blog. It’s a process that works best for me because it’s disciplined, quantitative and hopefully devoid of human emotion.

Short-Term Technical Indicators

Investor Sentiment

Long-Term Market Model – Bearish since December 8th.

Asset Allocation – AAS Model Portfolios are between 56.25% and 75% long currently.

Beta Exposure and Portable Alpha Generation
Date = Date of AAS “Buy” or “Short/Sell” Recommendation

Top Rated Major Market Derivative – No buy recommended major market investments

Top Rated Style-Box Derivative – No buy recommended style-box investments

Top Rated Sector Derivative – iShares Dow Jones U.S. Financial (IYF 1/16/07)

Today’s Top “Buy” Recommended Stocks

NBTY, Inc. (NTY 12/5/06)

CarMax Inc. (KMX 7/25/06)

Savient Pharmaceuticals Inc. (SVNT 8/9/06)

Martin Marietta Materials, Inc. (MLM 11/6/06)

Volt Information Sciences, Inc. (VOL 11/6/06)

Navistar International Corp. (NAV 9/12/06)

The Goodyear Tire & Rubber Co. (GT 8/23/06)

Brown Shoe Company Inc. (BWS 9/12/06)

Boston Properties Inc. (BXP 1/10/07)

Public Storage Inc. (PSA 12/13/06)

Today’s Top “Sell” Recommended Stocks

Advanced Micro Devices Inc. (AMD 9/27/06)

Brightpoint Inc. (CELL 9/19/06)

Lenox Group Inc. (LNX 12/22/06)

Rogers Corp. (ROG 12/6/06)

Plexus Corp. (PLXS 12/29/07)

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