Why Mr. Underdog Stock Picker Underperforms

Michael is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

My friend, Mr. Underdog Stock Picker, is not doing so well these days. He has spent much of his life rooting for underdogs of all kinds -- but often gets burned. He invests in stocks below $5.00, hoping to catch a big ride back up, but his picks usually don't work out. Why?  

I believe underdog stocks tend to underperform the market. I remember when Bear Stearns fell to $4.00 per share. Mr Underdog Stock Picker thought it was a good opportunity to invest in the stock on the cheap, so he picked up 1,000 shares. As debate gained speed over whether or not Bear Sterns would survive, the stock fell to $2 per share, and he decided to take his licks and sell out at a loss.

After newspaper stocks tanked in 2009, my friend decided there was an opportunity in McClatchy Company (NYSE: MNI) and Lee Enterprises (NYSE: LEE). Both stocks fell below $5.00. He bought both of them but hasn’t made much profit yet. Both companies continue to struggle to make money after losing readers and advertisers to competitors on the Internet. Both MNI and LEE have been trading below $5 per share for most the past four years. Meanwhile the S&P 500 has doubled since March 2009.

I believe earnings drive stock prices. There is a reason why a stock is trading below $5.00. Its prospects for earnings growth are slim or risky, sometimes the best its shareholders can hope for is a buyout or merger. Bearn Stearns in 2008 was purchased for $10.00 per share by JP Morgan Chase & Co. (NYSE: JPM).

Mr. Underdog Stock Picker calls me every time there is a big run in Boston Beer (NYSE: SAM) because he knows I own shares in the stock. SAM recently went up $10 in one day to finish at $157.72 per share. SAM is a solid company with a clean balance sheet, it has grown sales and earnings nearly every year since its inception. I started buying SAM at $58, I bought more at $95 per share, and continued buying it at $107 and $110. 

In “Reminiscences of a Stock Operator” by Edwin Lefevre, the hero of the book, Jesse Livermore, says that “when a stock crosses 100 or 200 or 300 for the first time, the price does not stop at the even figure but goes a good deal higher, so that if you buy it as soon as it crosses the line it is almost certain to show you a profit. Timid people don’t like to buy a stock at a new high record. But I had the history of such movements to guide me.”

Union Pacific (NYSE: UNP) is another good example of a stock going over $100 a share and quickly rising to $133.00 per share. I started buying it in 2009 at $48 per share, adding more shares at $88, $93 and $110.

Livermore hated stocks with no patterns, no real movement. LEE and MNI have been stuck at their current low prices for a long time. I sold my LEE in 2011 and bought more SAM.

As Livermore says, “Buy rising stocks and sell falling stocks.”

Michael R. Hooper owns shares of Boston Beer (NYSE: SAM) and Union Pacific (NYSE: UNP). He has no positions in any other stocks mentioned in this article. Michael R. Hooper is a freelance writer based in Topeka, KS

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