Betting against the crowd worked in 2006

By Michael Brush

The results are in, and here's how I did this year: better than the market and a bit better than your average mutual-fund manager.

My 142 picks in 2006 gained 13.8% this year compared with a 12.5% gain in theS&P 500 ($INX) and the 13.6% that all actively managed U.S. stock funds produced, according to Morningstar.

To calculate my results, I looked at how my picks did through Dec. 15. As always, I assumed stocks get sold automatically after a 20% loss to prevent further damage. This year that hurt me because many of those stocks went on to produce decent gains. I also left out three picks from early December because they are too recent to matter (they are down slightly).

My returns weren't as good as last year, when my gain was 2.4 times better than the S&P 500 and 40% better than managers at U.S. stock funds. But this year's results taught me some new lessons and confirmed some old ones worth remembering.

Avoid the crowds

Go against the grain when you can summon the courage. Known as "contrarian investing," this tactic produced some of my best results in 2006. Predictably, the two times I broke this rule and went along with the crowd, I paid dearly.

Before I get into those gory details, here are a couple of success stories. Last May, investors seemed convinced Martha Stewart was still tainted by scandal. Her stock was well below where it traded when she got out of prison in early March 2005. But her company's performance was beginning to hint Martha still had the magic. Sales at Martha Stewart Living Omnimedia (MSO, news, msgs) were galloping ahead by 60% at the time. Company surveys showed fans were as enthusiastic as ever. I went with the numbers over the conventional wisdom and said it made sense to buy the stock.

That column evoked a lot of hate mail from readers who I'm guessing were short (another bullish sign), but we were right. The stock advanced 31%.

More recently, investors freaked out about energy stocks in September during what's called the "shoulder season." That's the time between the summer cooling months and the cold winter months when energy prices predictably lag. A Sept. 20 column said buy that lag, and the energy-services stocks we mentioned are up 22%. I bet the same thing will play out next year.

Likewise, the shares of video-game software producers like Activision (ATVI, news, msgs) predictably fall flat just ahead of big platform upgrades, like the November rollout of PlayStation 3 and the Wii. This time, investors worried that the platforms wouldn't sell because they were too expensive or because of technical snafus. I took the other side of that bet last August. The four video-game software companies from that column are up 44%.

As hard as you try to be a good contrarian, it's still easy to get sucked in by the crowd. Last August I went to a press briefing by market experts at Citigroup (C, news, msgs). What a mistake. There were lots of questions from other journalists about what would happen if oil hit $100 a barrel. I let the idea seduce me. After all, it made sense that the hurricane season, trouble in the Middle East and powerful demand from China could make it happen. A smart money manager, Frank Holmes at the U.S. Global Investors' Global Resources Fund (PSPFX, news, msgs), confirmed the scenario, and I was good to go. Bad mistake. Alas, we never saw $100 oil. The 18 energy names in that column lost 5%, and five of them stopped out after falling 20%.

More embarrassingly, I hopped on the ethanol bandwagon last April after it captured the media spotlight and made the evening news -- which should have been a sign right there. The outcome was predictable. Buying ethanol stocks at the time was a bad mistake. The six stocks I picked were down 2.4% as of Dec. 15.

Sometimes you even need to go contrary to the contrarians. There's a rule of thumb among investors that when new mutual funds pop up to follow a hot sector, the sector is past its prime. I went with this theme in July after Daniel Ahrens launched a casino fund, called the Gaming and Casino Fund (GACFX). I predicted an end to the strength in casino stocks because the sector seemed like it was building too much capacity at a time when an economic slowdown might bite into consumer spending.

Since then, his fund is up 16%. Oops, sorry Dan.

Happily, I did pick three casino stocks to buy in that column: Harrah's Entertainment (HET, news, msgs), Wynn Resorts (WYNN, news, msgs) and Las Vegas Sands (LVS, news, msgs). They advanced an average 31.2%.

Follow the insiders

There's no need to dwell on this one because the logic is obvious: Insiders are worth following because they have the front-row seats on their business.

This tactic helped in a June 21 column in which I suggested buying five stocks that looked safe -- even though the market was falling apart at the time. Those stocks advanced 27.5%, and the column produced my best pick for the year: MasterCard (MA, news, msgs), up 114%.

It pays to own the casino

If you want to make money, it really does pay to own "the house" and get a small cut of every transaction on a regular basis.

I learned this in two ways in 2006. First, a February column highlighted two plays on Macau, the gambling-happy island off China's southeast coast. With the help of Joe Fath, a savvy gaming and lodging analyst at T. Rowe Price Group (TROW, news, msgs), I went with Wynn Resorts and Las Vegas Sands. The stocks advanced 67.3%, my best picks from a single column.

My second best column for picks also focused on the croupier, this time in the form of stock exchanges. Delaware Investments analyst Christopher Bonavico helped steer me toward the futures and options exchanges such as Chicago Mercantile Exchange Holidays (CME, news, msgs), and the outcome was great. Those stocks advanced 66.7%.

Technology IPOs aren't dead

Five initial public offerings in the technology sector are up 9% since I wrote about them just seven weeks ago.

I'll take it as a sign that tech is back, and the sector will produce decent gains in 2007. Just be careful with recent IPOs, as they are normally very volatile.

Don't bet against Buffett

Like Martha, Warren Buffett still has his magic. When he announced last summer that he was giving away most of his stock to charity, it made sense to wonder whether the move signaled a top for the stock, Berkshire Hathaway (BRK.B, news, msgs). Some value managers said no, and they got it right. The stock went on to advance 24%.

Likewise Jim Rogers, author of "Hot Commodities: How Anyone Can Invest Profitably in the World's Best Market," is still making good calls. He helped out on two columns about investing in utilities and the airlines. Both groups of stocks did well. The utilities advanced 24%, and the airlines were up 18%.

Pink is the new red

The pink-sheets exchange, where companies not big enough to make the major exchanges reside, may be cleaning up its act. But it's still a very risky place to put your money. Even with the help of an expert like Robert Robotti of Robotti & Co., who has a solid long-term record, the little-known names that you find in the pink sheets can be trouble.

One stock from my column on pink sheet reform, Southern Energy Homes, advanced 41% before it was bought out. But the other two slipped 19% and 55%.

At the time of publication, Michael Brush owned a short position in the puts of MasterCard (meaning he will benefit if the stock price rises).