Stock Picking: How We Select Attractive Stocks

Updated
08.11.2024

We have created a list of over 40 stocks that have historically performed very well. We have strictly focused on the annual return (price increase plus dividend) since the stock listing.

We have created a so-called return triangle for each of these stocks. This allows us to view a stock’s return over longer periods in the past at a glance.

Return Triangle as a Decisive Selection Criterion

Return triangles are very well suited for selecting stocks intended for a long-term “Buy and Hold” strategy.

What you cannot see from the return triangle are economic indicators such as revenue, profit, or price-to-earnings ratio.

Not Watching the Fire, but the Shadows It Casts on the Wall

It may sound heretical, but we consider the analysis of a company in the style of an auditor to be not very productive in the context of stock selection.

For us, the annual return is decisive, and we make a preselection based solely on this. We may subsequently remove one or another company if we view the future of the company itself or the sector as a whole critically.

In the end, we have a list of stocks that have proven to be very reliable in the past.

Risk Minimization through Diversification

We reduce the increased risk compared to ETFs by selecting many (up to about 40 stocks). This way, we have our own small ETF.

Diversification always also reduces returns, as the underperforming stocks drag down the average return.

But we want both. Higher returns than ETFs, but not much more risk. With 40 well-selected stocks, this seems quite achievable.

Forty stocks is a relatively high number of different individual stocks. Investors usually hold only a few stocks as an addition to other forms of investment, and in these few companies, they speculate on explosive growth.

Another common stock strategy aims to buy seemingly cheap, i.e., undervalued stocks, and then patiently hope for significant growth sometime in the future.

We understand our stock selection as a list that has the potential to outperform ETFs. We deliberately do not speculate on three- and four-digit price increases. The companies we select are too large for that.

No Initial Weighting. What About Rebalancing?

We start each position with roughly the same value. Therefore, there is no weighting by market capitalization, as is common with ETFs.

Rebalancing only occurs in that fresh money is distributed to the positions monthly.

With 40 companies, it takes a while to open each position with the first stock purchase.

Fortunate is the one who can start with several tens of thousands of euros right away. Otherwise, you must gradually add one more company over many months.

It’s best to start with stocks that are not at their all-time high on the day of purchase. When all positions are established, then each month, upon receiving income, replenish a few positions with new purchases. Next month, a few more positions, and so on.

Within the positions in question (see next sections), you should replenish those whose price is currently (on that day) weak. We do not recommend waiting days or even weeks for a good time.

Keep Positions at the Same Share of the Total Portfolio Value or the Same Share of the Invested Money?

The question arises whether to replenish positions so that the current market value of each position remains roughly the same or whether it would make more sense to base it on the (accumulated) purchase prices of each position.

Keep Positions at Approximately the Same Market Value

With this option, you would ultimately buy more of the positions that have performed worse: Their share of the current total portfolio value has fallen behind other positions that have performed better.

However, this option creates a dynamic that heavily considers recent price performance, contradicting our long-term strategy.

We do not consider it reasonable to buy more of the underperforming positions, assuming that they would naturally have more growth potential due to poorer past growth.

Keep Positions at Approximately the Same Purchase Cost

We like this option for its lower dynamic and better comparability of individual positions over time.

New investment money is evenly distributed across the individual positions. Instead of the current value, we compare the purchase prices, which can be viewed at any broker at the time of purchase.

In this option, the monetary values of individual positions diverge over time according to their price development, and we do not react to this but continue to stubbornly distribute new funds equally across all positions.

No Cost Average Effect

The “Cost Average Effect,” a theory apparently popular among investors, is eaten up by opportunity costs (missed price gains), and in the end, only unnecessary time expenditure and frustration remain.

A recent internet testimonial: An investor took out a consumer loan at very favorable terms to buy stocks, which is not fundamentally wrong if you know what you are doing.

But now he is holding back the money and plans to invest it spread over about two years to benefit from the Cost Average Effect.

Such a strategy is not advisable due to the opportunity costs of missed price gains.

We recommend investing cash as soon as it becomes available, for example, immediately after receiving income. The only reasonable spreading of deposits is a naturally forced one: Since income is periodic, for example monthly, it can only be invested gradually.

However, doing this willfully, i.e., withholding available cash to wait for a good time, is still just “timing the market,” here “month trading” or “week trading” instead of “day trading.”

In the context of a decades-long investment, trying to always hit the lows of the zigzag line is not advisable considering the time expenditure, emotional stress, and opportunity costs (missed price gains).

The theory that prices are higher at the beginning of the month because many investors receive and invest their income then has also not been proven.

“Natural Cost Average Effect” and “Buy the Dip” Are Given with Our Strategy

As mentioned, a “natural” Cost Average Effect is already given through the necessarily monthly purchases.

Moreover, with each – e.g., monthly – stock purchase, we practice “Buy the Dip.” However, this is not done by holding back available money in the hope of price slumps but – also naturally – by buying more of those positions on the purchase day whose price has recently dropped.

Growth Stocks Instead of Dividend Stocks

Dividend stocks are more popular than they deserve, purely monetarily speaking. Investors report that they find it too boring to only look at the portfolio to see a growing number – their portfolio value.

Moreover, many investors have a pronounced general reluctance to sell stocks, especially those they have held for a long time. Not only do they have to decide which stocks to sell; selling feels unsustainable, like selling cows instead of just the milk.

With dividend stocks, there are dividends and thus tangible results in the form of cash in the account. Small rewards in between instead of just watching pixels on the screen until the “decumulation phase” in retirement.

Dividends also make it easier to use the savings allowance of 1,000 EUR in tax-free capital gains per year.

While with growth stocks you would have to sell one or a few shares and sensibly consider the FIFO principle (First in First out) for tax optimization, this effort is avoided if you already “automatically” reach the 1,000 EUR capital gain with dividends.

However, dividend stocks regularly generate lower total returns (price plus dividend) than growth stocks. Over decades, the difference can be significant.

Moreover, many growth stocks also pay dividends, albeit in relatively small amounts, for example, 1.50 EUR for a position worth 800 EUR. So, the experience of “dividend payout” is also present with a portfolio that exclusively contains growth stocks.

A Lot of USA and Some EU

For stocks, we fully rely on the USA, only a little on Europe, and not at all on Asia or emerging markets in South America or Africa.

The superficially plausible strategy of relying on the supposedly natural growth potential of emerging markets seems not to have worked out in retrospect.

Emerging markets in the portfolio reduce returns. Although they grow from their low level, they do not grow as much as the USA.

It turns out that the large, highly globalized and predominantly US-based world corporations skim off at least some of the growth in underdeveloped regions.

Europe also cannot keep up with the growth of US corporations. This fits quite well into the geopolitical situation, as Europe has not proven to be particularly self-sufficient towards the USA in recent decades.

The dependence and subordination to the USA have rather intensified recently.

Asia, too, is reaching its limits, as China, South Korea, and Japan have significant demographic problems. These countries have made an impressive catch-up race but now have to transition to a society whose population at least does not shrink.

The populations of these countries have been overburdened with decades of strong work and educational pressure and have lost interest in having children even more than people in Western industrialized countries.

Reviving population growth, which seems to naturally decline with increasing prosperity, seems to work best with migration. However, becoming an attractive destination for immigration is not easy. The other method, namely encouraging the population to have children, seems even harder.

We are also hesitant with India due to high corruption, low education level, caste system, discrimination against women, and a fertility rate that has already fallen below the replacement rate of 2.1.

Europe also has problems with shrinking populations and the aging of society that comes with it.

The USA, as the number one immigration country, can maintain its population and can largely choose its immigrants. We consider this to be the USA’s long-term strongest advantage, alongside some other equally important factors:

Healthy population pyramid, immigration country, brain drain from other countries to the USA
World currency dollar, which it can print itself
By far the strongest military, with bases around the world
Cultural hegemony: Hollywood, Way of Life, individualism
Plenty of space for growth: The USA is as large as China, with less than a quarter of the population.
Strong domestic market with purchasing power allows companies to become very large domestically, making later expansion into other countries easier.
Stock and generally capitalism-friendly population, supported by politics, e.g., with the stock-friendly 401k retirement model

We assume that the USA will maintain or even expand its leadership position in the coming decades. China will remain second and, at least as a whole, will not be able to overtake the USA.

Our Stock List

Here is our list of stocks with a historically strong total return. The respective return triangles and a brief assessment of each company will be available in a future article.