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Guru Investor / John Reese1/28/2008 12:01 AM ET

Don't try to outsmart the market

You can't time the market's gyrations, so I'll stick to my system and put my money to work right away. I'm buying 20 stocks based on computer 'clones' of some of the best investors ever.

Buy $5,000 worth of each of these stocks at the open:

Strategy Lab is MSN Money's stock-picking challenge. To learn more about the game -- and the contenders -- click here.

Just in case anyone was worried that this round of Strategy Lab would be boring, the markets, the Federal Reserve and now the president and Congress have converged over the past couple of weeks to set the stage for what will likely be a very interesting few months.

All of the recent activity hasn't changed my strategy, however. I'll be sticking with a purely quantitative, fully invested approach that buys and sells stocks based on my Guru Strategy computer models, each of which is based on the published strategy of a different Wall Street great.

Send in the clones

To start the contest, I am distributing all of my funds equally into the 20 stocks that currently pass the particular guru-based approach I'm employing for Strategy Lab. This may be a surprise to some given the market’s choppiness and uncertainty, but I don’t subscribe to trying to time the market. Maintaining a cash position has a cost to it -- it’s called opportunity cost -- and I want to put my funds to work immediately even though there are still a lot of questions about where the markets are headed in 2008.

This approach I am using to create the portfolio takes five of my guru models -- those that I base on the published quantitative strategies of Warren Buffett, Benjamin Graham, David Dreman, Martin Zweig, and James O'Shaughnessy -- and selects the four highest-scoring stocks from each. I picked this five strategy combination because I wanted to combine value and growth methods together so that I will be well-positioned no matter what style is favored the most over the next six months. I have found that this blended approach can improve risk-adjusted performance and limit the risk of one specific strategy falling out of favor.

I'll maintain a disciplined approach throughout the six-month contest. My portfolio will be rebalanced every 28 days, ensuring that only the four highest-rated stocks from each of the five strategies are being held, and also making sure that the stocks are equally weighted within the portfolio. I won't deviate from these models, or from the 28-day rebalancing pattern, which I've found produces superior long-term results.

The five strategies I'll be using are based on books written by or about each of the highly successful investors I listed above. Please note that my models involve my best interpretation of these gurus' strategies, and are not endorsed by the gurus themselves.

Here's a look at each of these five strategies:

1. Patient investor

Perhaps the most famous -- and greatest -- investor of all time, Buffett's Berkshire Hathaway (BRK.A, news, msgs) averaged a 24% annual return over a 32-year period. Buffett is known for his patient, highly selective, long-term investment style. The strategy I base on his approach looks back as far as 10 years into a company's past, examining such factors as earnings consistency, return on equity, and debt.

2. Strategy: Value investor

Widely recognized as the father of securities analysis, Benjamin Graham argued for investing in stocks that were significantly undervalued relative to their intrinsic worth, which he measured principally by future earnings potential. Defensive investors who followed his advice, he said, would enjoy an invaluable "margin of safety." Graham's defensive investor strategy is considered by many to be the ultimate value strategy and has stood the test of time more than perhaps any strategy ever created. My Graham-inspired strategy looks for deep value stocks that trade at low P/E and price/book ratios, while at the same time maintaining strong balance sheets.

3. Strategy: Contrarian investor

Dreman is a contrarian. He focused on the least popular stocks -- those that have been shunned because they're in a troubled industry or because of investor apathy, and found stocks within that group that have strong underlying financials. His Kemper-Dreman High Return Fund was one of the best-performing mutual funds ever. At the time he published Contrarian Investment Strategies, the fund had been ranked number one in more time periods than any of the 3,175 funds in Lipper Analytical Service's database. My strategy based on his book looks for large, fundamentally sound companies (good earnings growth, good return on equity, low debt-to-equity ratio) that are out of favor due to public apathy, delirium or naiveté. Such companies can be recognized by their low price relative to their earnings, cash flow, book value or dividends.

4. Strategy: Conservative growth investor

During the 15 years that it was monitored, Zweig's stock newsletter returned an average of 15.9% per year and was ranked number one based on risk-adjusted returns by Hulbert Financial Digest, a publication that tracks the records of investment newsletters. Zweig looks for growth stocks and his methodology is highly selective. He likes firms whose earnings aren't only increasing, but also accelerating, and he also likes earnings increases to be fueled by an underlying increase in sales.

5. Strategy: Cornerstone growth investor

O'Shaughnessy's book -- in which he detailed what he learned from back-testing 44 years worth of the stock market -- made a couple of surprising findings, including that P/E ratios aren't the best criteria for selecting stocks. He developed two models, one targeting larger value-oriented stocks and the other targeting growth stocks. His back-tested results averaged 22 percent per year over those 44 years. For this contest, I'll be using his growth strategy, which produced the highest absolute returns in his study.

Wherever the market and economy head in the coming months, I'll stick strictly to these models, each of which has outperformed the S&P 500 since its inception. I believe strongly that the best way to beat the market is to develop a long-term strategy and stick to it -- a concept that each of the gurus I've studied has preached. As we move forward, I hope to not only highlight winning stocks, but also to pass on to you some of the knowledge I've gained from learning how these investing legends developed some of the best stock-picking track records of all-time.

If you have any questions about my strategy, feel free to drop me an e-mail.

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John ReeseGuru Investor John Reese

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