A Strategy That's Built To Last

Professors of finance and others in the growing class of people who are smarter than I am, had driven me nearly to submission with their insistence that trying to beat the market is a sucker's bet. Then I heard about a bravura show of stockpicking by one of Wall Street's oldest names, Lehman Brothers. Its annual choice of "10 Uncommon Values" just ended its first 50 years way ahead of the Standard & Poor's 500-stock index. By Lehman's count, it beat the market by an annual average of 7.5 percentage points.

Mirage? Miracle? Or is it "a freak of nature?" as the firm's director of global equity research, Joseph Amato jokes. "It's very impressive," says Vanguard Group Senior Chairman John Bogle, a hawk on this stuff. "But I'd wonder if it's real." Lehman's account doesn't subtract costs, such as taxes and fees, that eat into returns, Bogle notes. Nor does it add dividends, which could narrow its lead.

True, all true, and if anyone offers you one of the unit trusts or other investments based on Lehman's picks, look hard at the fees: If you have less than $100,000, expect to pay 2.75% the first year and another 1.75% each following year as the portfolio turns over. That's not cheap.

Yet Lehman's picks since 1949 beat the S&P in 37 of the 50 years. Often, they did so by a lot, while the underperforming years were more muted (chart). The market would have lost you money 14 years over the span; Lehman would have left you in the red 11 times.

All this tells me Lehman is on to something. Exactly what it's doing right is harder to pin down, if only because any record of how Lehman made most of its 500 picks is locked away in a warehouse in New Jersey. Lately, the method has been passed along by oral tradition and operates this way: Each May, Lehman's domestic stock analysts begin filing past an investment policy committee. They pitch the single stock they think will rise most in the 12 months starting July 1. By mid-June, the committee begins to vote on the 10 best. The firm unveils its list before the market opens on July 1.

LOTS OF LIQUIDITY. Sure, there are some details. Lehman checks that its picks trade with lots of liquidity, for one. But pretty much, that's it. No diversification by industry. No conscious contrarianism. No tilt toward growth or value, cyclical or consumer stocks. No heroic calls on rates, growth or currencies. No computer algorithms to render an "optimal" portfolio. None of the stuff, in short, that so many active investors seem never to get enough of. "Just good, old-fashioned stockpicking, completely unencumbered by any macro overview," says Jeffrey Applegate, Lehman's chief investment strategist and the committee's chairman.

What should you make of this? Maybe just that simplicity is a virtue. "Picking stocks is not a simple thing," Bogle says. "But going about it with simplicity involves less statistics, numbers, and such, of which we probably have enough."

That's not all we might learn from Lehman, so let's zoom in. What does Lehman do first? It taps industry experts for ideas, leaning hard on their concrete knowledge of company fundamentals. Next, it asks them to focus on their best ideas--and the ones likely to work soon. Time helps lots of investments bear out, but there's a risk: The further you look, the less sure you are of what you see.

A Strategy That's Built to Last

Lehman instead exploits time on the front end, devoting two months to pick stocks it holds one year. Apply that formula to a stock you expect to hold three years, and you'd spend six months deciding. Sometimes I hate waiting six hours, never mind six months, but this sounds like a good way to limit errors.

And for the final cut? Lehman picks by consensus after a full debate. You may not be able to convene a committee. But if you aim to beat the market, try asking someone to poke holes in your investment idea before your next trade.

For my review of the list of Lehman's 10 Uncommon Values for the coming year, go to or to AOL, keyword: BW Daily.

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