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  1. 1. The Quillian & Taylor Private Investment Co. James M. Quillian, PO Box 131 Eden, Texas 76837 325-869-5255 Quillan & Taylor Stock Market Research Investing Long Term Using the Quillian Model Copyright © 2003 by James M. Quillian, Securities Analyst, Portfolio Manager When the stock market bubble burst a few years back, individual investors lost millions of dollars. Long-term investors were especially hurt. As the decline began investors all across the country could be heard repeating the mantra “I am a long term investor. I am not concerned when the market goes down” These words were often spoken as a means of appearing to take the high ground, as if people doing the selling were being reckless. Most investment losses can be avoided by thinking though a common flaw in the in the investment reasoning process. More often than not investors believe, because stock averages continue rising over time, that most stocks also rise over time. Decade after decade stock averages have indeed continued to make new highs. The total value corporate capitalization, or stock, also continues to rise. However, most individual stocks eventually go down and never recover. Figuring this out doesn’t take a lot of analysis. Right now a stock screener on a popular web site turns up 4709 stocks that are trading below $5.00 per share. The same screener turns up 1241 stocks trading between $5.00 and $10.00, and 2074 between $10.00 and $20.00. 3153 stocks trade at over & 20.00 per share. The majority of stocks did not start out trading at such low prices. They all traded much higher at one time. Only a few low priced stocks will ever recover. During the debacle the multitudes of investors unwittingly held on to their stocks believing they were going to be rescued by the long term. The long term for the majority of stocks always has been and always will be something resembling a graveyard. An investor who anticipates ahead of time that less than half of all stock purchases turn out to be profitable if held indefinitely is in a better position to put together a successful investment program than someone who does not know what to expect. Most serious stock market losses occur not because of a lack of
  2. 2. financial sophistication but because of simple errors in judgment. Quillian & Taylor suggests building a portfolio using the Quillian Model. The Quillian Model as described below provides individual investors with a logical framework of expectations. The Quillian Model • Only buy stocks in up-trends or in recognizable positive technical patterns. Think long term but understand what actually happens over the long term. For the example, consider long term to be ten years. According to the Quillian Model: • If 20 stocks, all in up trends, are picked at the beginning a long term period. (10 Years) • 5 will continue moving up at the same rate for the entire period. • 9 will eventually falter and move sideways or slowly down or up. • 6 will reverse direction and end up losing money. Secondly, • Over time, portfolio value increases, will be the result of a minority of the stocks that make up the portfolio. • Portfolio performance is greatly enhanced if money is appropriately rotated out of poorly performing stocks and into ones that are steadily advancing. The Quillian Model is not a guarantee that the future will unfold in a certain way but instead a reasonable expectation that is based on observations of stock market history. The exact numbers might be different from those in the example but the principle always applies. Over time, the majority of investment ideas turn out to be bad. The successes of a few stocks, however, end up more than making up for losses incurred in the others. Portfolio performance is greatly enhanced if the stocks that begin to falter are eliminated and replaced with new stocks that are already in up-trends. The Quillian Model is not a ridged prescription of any kind but as a logical expectation. In order to be truly successful, any long-term investment program must be adjusted in accordance with the simple principal described in the Quillian Model. Stocks are good long-term investments but one must realize that a minority of stock picks turn out to be profitable in the end. Buy and hold is the best strategy but only when over time non-performing stocks are replaced.
  3. 3. Investors are invariably hurt when they expect from the stock market more than the stock market is capable of delivering. The Quillian Model provides portfolio managers with a reasonable table of expectations. Often the performance of stock averages is sited as evidence that stocks are a good long-term investment. What is never mentioned is that the stocks that make up the averages are constantly being changed. Looking at a 50 year chart of the Dow Jones industrials makes an impressive case for a buy and hold strategy. But what kind of performance would the Dow Jones Industrials have had if none of the Dow stocks of the 1930 list had been replaced? Three stocks have been rotated out of the list just since 1997. Look in the table below and observe how the composition of the Dow Jones Industrials has changed over time. Composition of the Dow Jones Industrials at Selected Time Periods 1930 1956 1976 1997 2003 Allied Chemical Allied Chemical Allied Chemical Allied Signal 3M American Can American Can Aluminum Co of A Alum Co. of America Alcoa American Smelting American Smelting American Can American Express Altria Group Bethlehem Steel American Tel. & Tel. American Tel. & Tel. AT&T Corporation American Express Borden American Tobacco American Tobacco B Boeing Company AT&T Chrysler Bethlehem Steel Bethlehem Steel Caterpillar Boeing Eastman Kodak Co. Chrysler Chrysler Chevron Caterpillar General Electric Corn Products Ref Du Pont Coca-Cola Citigroup General Foods Du Pont Eastman Kodak Du Pont Coca-Cola General Motors Eastman Kodak Esmark Eastman Kodak DuPont Goodyear General Electric Exxon Exxon Eastman Kodak Hudson Motor General Foods General Electric Procter & Gamble Exxon Mobil International Harv General Motors General Foods General Electric General Electric International Nickel Goodyear General Motors General Motors General Motors Johns-Manvile International Harv Goodyear Goodyear Hewlett-Packard Liggett & Myers International Nickel Harvester Hewlett-Packard Home Depot Mack Trucks International Paper Inco IBM Honeywell National Cash Reg Johns-Manville International Paper International Paper Intel Paramount Publix National Distillers Johns-Manville J.P. Morgan IBM RCA National Steel 3M 3M International Paper Sears Roebuck Procter & Gamble Owens-Illinois McDonald’s J.P. Morgan Chase Standard Oil of Ca. Sears Roebuck Procter & Gamble Merck & Company Johnson & Johnson Texas Company Standard Oil (NJ) Sears Roebuck 3M McDonald’s Texas Gulf Sulphur Standard Oil of Ca. Standard Oil of Ca. Philip Morris Merck & Company U.S. Steel Texas Company Texaco Sears Roebuck Microsoft Union Carbide U.S. Steel U.S. Steel Travelers Group Procter & Gamble United Air Transport Union Carbide Union Carbide Union Carbide SBC Communications
  4. 4. Westinghouse United Aircraft United Technologies United Technologies United Technologies Woolworth Westinghouse Westinghouse Wal-Mart Wal-Mart Standard Oil (NJ Woolworth Woolworth Walt Disney Walt Disney Here are a few more helpful tips: Give up naive ideas about risk. Many investors automatically assume that sticking with low P. E. stocks or stocks of large well established companies, reduces risk. High dividends are often seen as indications of safety. No such ideas hold water when empirical evidence is examined. Understand the limitations of fundamental analysis. New investors often delude themselves into thinking they know something special about a stock that the rest of the world will eventually catch on, and the stock will go up. That kind of reasoning only works on rare occasions. The speed with which information spreads through the investment community is almost beyond comprehension. Novice investors also typically believe that insiders and professionals have superior information. They have an advantage only occasionally and in isolated circumstances. The financial realm unfolds faster than even the brightest mind can decipher information. Fundamental analysis is valuable for answering basic questions concerning the financial stability of a company, and understanding the broad scenario in which a company operates. Fundamental analysis can successfully be used to eliminate stocks from consideration. For example, if a stock is in a strong up-trend but is in horrible financial condition, it might make sense to choose another stock instead. Fundamental Analysis will do little to indicate the future direction of a stock price.