The 52-Week Low Formula

A Contrarian Strategy that Lowers Risk, Beats the Market, and Overcomes Human Emotion

Luke L. Wiley

• Publisher: Wiley
• Year: 2014
• Print ISBN: 9781118853474
• eBook ISBN: 9781118853573
• Edition: 1
• Topic: Business
• Subtopic: Investimenti e titoli
• Index: Business

A new but timeless strategy and mindset that should greatly help investors lower downside risk while achieving market outperformance

In The 52-Week Low Formula: A Contrarian Strategy that Lowers Risk, Beats the Market, and Overcomes Human Emotion, wealth manager Luke L. Wiley, CFP examines the principles behind selecting the outstanding companies and great investment opportunities that are being overlooked.

Along the way, Wiley offers a melding of the strategies used by such investment giants as Warren Buffett, Howard Marks, Michael Porter, Seth Klarman, and Pat Dorsey. His proven formula helps investors get the upper hand by identifying solid companies that are poised for growth but have fallen out of the spotlight.

• Shows you how to investigate companies and identify opportunities
• Includes detailed discussions of competitive advantage, purchase value, return on invested capital, and debt levels
• Presents several case studies to examine companies that have overcome obstacles by trading around their 52-week lows

The 52-Week Low Formula is a must-read for investors and financial advisors who want to break through conventional strategies and avoid common mistakes.

Chapter 1
The 52-Week Formula

Invert, always invert.

—Carl Gustav Jacob Jacobi

Inversion. Such a simple concept. If you have a problem to solve, consider all the solutions that won’t work and, in so doing, the correct answer reveals itself. When I first came across the preceding quote from nineteenth-century German mathematician Carl Gustav Jacob Jacobi, it resonated. This way of thinking—in reverse—seemed to speak to the way I made decisions. Want to lose weight? Think of all the things that will make you fat and do the reverse. Want to be a better father? Think of the things that would turn your kids away. And Jacobi’s maxim seemed most appropriate to my career in finance, particularly as it relates to investing’s golden rule:

1. Buy low, sell high.

It’s the cardinal rule of investing and, often, the most overused, underfollowed principle in the world of finance. Too often, investors do just the opposite—they buy a hot stock hoping it will get hotter and end up riding the downward slope toward a loss. These people are driven by the idea of a quick return, a profit that appeals to their sense of winning but defies logic and overwhelms their discipline.

If they aren’t chasing stocks bound to lose, they invest in what they know: the path of least resistance. They rely on instinct, intuition, a familiar path, or wishful thinking, rather than doing the necessary work. And, as we’ve seen in books like Unthinking and Thinking, Fast and Slow, cognitive ease can be a powerful force.

This willingness to go with the status quo is the approach of System 1 thinking, as defined by Nobel-Prize winning economist Daniel Kahneman.¹ It’s reactive, instinctive, and prone to following the path of least resistance. It’s the kind of thinking that doesn’t seek opportunities to challenge. System 2 thinking, however, takes little for granted. It is a challenging way of thinking because it requires consideration and a willingness to go against the grain, especially when the grain is going in the wrong direction. That’s not to say it is purely contrary, but rather, it is devoted to purpose and making the best decisions possible—not simply the easiest decisions.

Psychologists refer to this phenomenon of two ways of thinking as the dual process theory. It means that something—a behavior, a response, a cognition—can happen in two separate and distinct ways: System 1 and System 2. Both are valid, but understanding the difference between them is important, especially in the context of an investment strategy like the 52-Week Low.

System 1 thinking is responsive and immediate. It’s the kind of thinking Malcolm Gladwell covers in great detail in his bestselling book Blink. In System 1, we take small bits of information and extrapolate rapidly. We make quick decisions based upon limited data. System 1 thinking is what tells you that you shouldn’t walk down a dark alley; it’s the way you respond in a heated conversation. It’s not purely emotional, but it is emotive. When in the process of System 1 thinking, your mind is responding, firing a specific kind on neuron that makes unconscious connections. It is thinking without thinking. It’s the thing that tells you to sell when you see the stock ticker on the bottom of your television screen flash negative news about a company you own. System 1 thinking is not considered thinking; rather, it is the extremely rapid thinking that keeps you safe, keeps you moving and dictates the process of getting routine things done (shaving, brushing your teeth, etc.) without having to consider every step in the process.

System 2 is just the opposite. System 2 thinking requires you to seek out input, to consider data and extrapolate consequences. Where System 1 is spontaneous, System 2 is more academic. System 2 thinking is how we process context and overcome cognitive biases to make informed decisions. A System 2 thinker—and we are all capable of both kinds of thinking—considers the costs and benefits of walking down that alley. In System 2, we don’t respond in the heated conversation, but walk away to consider what we really want to say. We see the stock ticker at the bottom of the screen as another source of data or as an impetus to seek more information. System 2 thinking is how we make plans to change our routines and project the long-term benefit of something.

The 52-Week Low is heavily System 2. The strategy is based on formulating long-term decisions based on many consistent data points. System 1 is recognizing an opportunity to make a quick buck, while System 2—and the 52-Week Low—is about making good decisions to build wealth.

System 1 investing follows preset rules, discourages critical thought, and makes it easy for investors to follow preset paths. It takes minimal effort to buy a mutual fund with the notion that the more acronyms a money manager has behind his name (CFA, MBA, PhD), the better the results. Not exactly. These mutual funds are relatively familiar and don’t require a lot of thought, in their mind, so they go that route even when the evidence doesn’t support it. Many individuals and investors don’t take the time to do their homework or challenge their belief system. Instead, they read surface-level articles and follow their emotions and often end up buying into something that is already at or around its high. For all of us, it is much more comfortable emotionally to invest in a mutual fund, index fund, or stock that looks healthy and is favored by Wall Street. We all have this bias in some form, called the conformity bias, and it is one that can severely impact your financial health. Three quarters of all mutual funds underperform their respective benchmarks over a 10-year period, and yet behavior doesn’t change.²

It didn’t take me that long to figure out that something was wrong. Maybe not wrong, but certainly not right. I was in my 20s, a young financial adviser working for a big company, attracting new clients and making the kinds of recommendations I was supposed to make—mutual funds of every shape and size. But it felt off. I was doing my job and doing it well. My clients seemed content, but I knew there was a better way. What really opened my eyes was when the stock of the world’s largest consumer products company, Procter & Gamble, dropped, and six Wall Street analysts downgraded the stock on March 7, 2000, after the stock had dropped approximately 50 percent. A funny thing happened. One of my clients called me after P&G had fallen off the proverbial cliff and said they would like to buy some shares. I remember telling them that six analysts had downgraded the stock, including the firm I was working for at the time. The client persisted and said, “Buy it.” So I bought it thinking they were going to regret it, and instead their investment made a considerable amount of money as the stock rose in value.

What I realized is that most analysts will upgrade a stock after it has become common knowledge that the antibiotics have worked and the stock has recovered, and will downgrade a stock after it has become common knowledge the company is ill and the recent stock performance is underwhelming.

Where do you have the most risk as an investor? Buying a business that everyone already likes, where enthusiasm is high among investors and Wall Street analysts, and that is trading around its 52-Week High? Or buying a business that no one really likes, where enthusiasm is low among investors and Wall Street analysts, and that is trading around its 52-Week Low?

Hint: A company that has had really good recent performance has not made you any money. It h...

Table of contents

• Cover
• Contents
• Title
• Copyright
• Dedication
• Introduction
• Foreword
• Acknowledgments
• Chapter 1: The 52-Week Formula
• Chapter 2: Herding and the Bandwagon Effect
• Chapter 3: Filter 1: Competitive Advantage
• Chapter 4: Five Common Mistakes Investors Make
• Chapter 5: Filter 2: Free Cash Flow Yield
• Chapter 6: The Power of Fear and Decision Fatigue
• Chapter 7: Filter 3: Return on Invested Capital
• Chapter 8: This Time Is Never Different
• Chapter 9: Filter 4: Long-Term Debt to Free Cash Flow Ratio
• Chapter 10: The Sunk-Cost Bias and Pride and Regret
• Chapter 11: Filter 5: The 52-Week Low Formula and My Journey Trying to Disprove It
• Chapter 12: The Importance of Embracing a Trailing 12-Month Return of −25 Percent
• Chapter 13: The Problem with Selective Perception and Confirmation Basis
• Chapter 14: Putting It All Together
• Afterword
• About the Companion Website
• About the Author
• Index
• End User License Agreement