Strategy

In my 20-plus years in the markets as a broker, analyst, strategist and now columnist and asset manager, I've experienced numerous bull markets (such as we experienced last year) and some very nasty downturns.

Through the ups and downs, I have discovered that the most consistently profitable approach to investing is to hunt down unloved, undervalued stocks -- the market ''dogs,'' if you will -- and then start building positions in them for the long term.

Notice I referred to the stocks, not the companies, as dogs. That's an important distinction and one that helps separate a good portfolio from a flawed one.

For example, a few years back Krispy Kreme Doughnuts (KKD, news, msgs) stock was as tasty as the company's glazed doughnuts, rising to a high of $50 per share. However, overexpansion, dietary changes and poor cash management resulted in the stock falling all the way to single digits by 2005.

Obviously, heading into 2006, Krispy Kreme's stock was a big, old, smelly dog.

Unfortunately, so was the company. Debt was too high, margins were too low, and you couldn’t make a compelling argument for consistent, solid growth. On the plus side, the company was under new management, and it was able to restructure some debt. Nevertheless, this was a broken stock and a broken company -- a candidate for the Dog Pound based solely on performance but not the kind of company I actually would have wanted to own.

Krispy Kreme more than doubled off its lows during the year, but that's not the point. For every dog stock/dog company that rebounds smartly, there will be nine that continue to draw fleas.

Just a temporary downturn

The kinds of companies that we will add to the Dog Pound portfolio are quality, financially sound and generally well-managed firms that have for one reason or another experienced a temporary setback that has resulted in the stock losing favor with investors.

It happens all the time. It wasn't that long ago that McDonald's (MCD, news, msgs) and Walt Disney (DIS, news, msgs) were trading at multiyear lows. Now both companies are back on track and delivering solid gains to shareholders.

Traditionally, buying out-of-favor dogs is not a quick moneymaking strategy. Returns are unlikely to be as gaudy as those achieved by a successful momentum or options strategy. Consequently, it might not be best suited for a six-month contest like Strategy Lab. But the Lab was primarily designed as an educational tool for investors, not a contest, and it is in that spirit that I will run the Dog Pound.

I will apply fundamental analysis to come up with a list of dogs that still have some bite and then introduce technical analysis (charts, moving averages, etc.) to help time the purchase. This latter step is used in order to improve our chances of success over the short term. In other words, we'll look for dogs that are showing signs of life, not those that are dead or dying.