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What is the most quoted yet least significant statistic in investing? How about trailing-12-month, or TTM, return?
While there may be other candidates, consider the TTM return's strong qualifications:
- It's purely backward-looking.
- The time frame is too short for statistical significance.
- It requires a lot of context to have real meaning.
So what am I about to do? Throw a boatload of TTM returns at you. But I think you'll find these interesting.
Smarter all the time
If you haven't yet heard of, surfed to or joined our CAPS investing platform, I encourage you to do so. The system simply asks you to predict whether the stocks you select will underperform or outperform the Standard & Poor's 500 Index ($INX) over a time frame of your choosing. In turn, the system rates each stock and each investor who has made at least seven picks. It then incorporates those ratings to make each subsequent rating smarter.The plumbing, however, is not as important as the information that CAPS throws off. Now that it's been a year since we opened CAPS to the investing public, we finally have some findings on the quality of its information.
Stocks in CAPS are rated on a scale of between one and five stars. Because CAPS ratings are based entirely on investor sentiment, we wondered at the outset how good the system's predictive abilities would be.
We have the beginnings of an answer.
| Stock group | TTM return | |
|---|---|---|
Five-star | 27.9% | |
Four-star | 19.3% | |
Three-star | 10.7% | |
8.5% | ||
Two-star | -1.2% | |
One-star | -16.6% | |
Source: CAPS data, Nov. 6, 2006, to Nov. 5, 2007 |
The trailing-12-month returns of these groups correlate precisely with their relative quality according to CAPS. Five-star stocks ran far ahead of the market; one-star stocks trailed it substantially.
| Company | Industry | TTM return |
|---|---|---|
Oil and gas | 173% | |
Steel and iron | 160% | |
Steel and iron | 157% | |
Polymer resins | 155% | |
Industrial equipment | 148% |
A year ago, the CAPS community -- now tens of thousands strong -- correctly foresaw continued strength in China, a steady commodities boom and a number of tiny companies, including ICO (ICOC, news, msgs) and Sun Hydraulics (SNHY, news, msgs), that were poised to be big winners.
There's one slice of CAPS, however, that looks even more profitable than the five-star universe: four-star stocks.
| Company | Industry | TTM Return |
|---|---|---|
Aluminum | 311% | |
Medical equipment | 238% | |
Copper | 168% | |
Shipping | 168% | |
Semiconductors | 165% |
What do these names have in common? It's not China, or commodities or hypergrowth. Instead, these are the returns from newly minted four-star stocks.
More from MSN Money and The Motley Fool
Now this seems counterintuitive, but we've developed a theory.
CAPS weights investor sentiment. So while five-star stocks have clear bullish consensus, stocks transitioning from three to four stars are likely driven by the "smart money." By getting in early, before the crowds, these folks are able to eke out a few extra percentage points of gain.
To wit, our researchers found that a portfolio of stocks purchased as they became four-star stocks and sold when they became 4.5-star stocks returned 41% -- the best returns any CAPS segment has had to offer.
- Top Stocks blog: The latest on what's moving the market
The data history is short, and it can't be back-tested. But it's interesting, intriguing and potentially very profitable. And there's something about those four-star transition stocks (catchy name, right?) that makes sense.
If you'd like to look at today's five-star stocks or some names poised to move up in the ratings, join our CAPS service today. Although the CAPS data may look different next year, it will be that much smarter so long as the community expands.
This article was reported and written by Tim Hanson for The Motley Fool. At the time of publication, he owned none of the stocks mentioned.
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