Here’s a worthwhile tip on methods to beat the market: Keep it easy. This looks as if dumb guidance in an investing world stuffed with erudite portfolio managers who attempt to dazzle investors with complex strategies as a part of their marketing.

But here’s proof that easy is healthier. The Hennessy Cornerstone Mid Cap 30 Fund HFMDX — which has a method so easy that even I can follow it — has topped its fund category and index by eight percentage points annualized over the past three and five years, based on Morningstar Direct. It also outperforms nicely over 10 years — by 4 percentage points annualized. 

That’s remarkable in a world where most mutual-fund and hedge-fund managers consistently lag the market yr in and yr out — including lots of the ones with essentially the most complicated strategies. 

To get these returns, Hennessy portfolio manager Ryan Kelley uses a basic seven-part screen. He focuses on midcaps, tossing out anything with a price-to-sales ratio above 1.5, and targets names with earnings and price momentum. He eliminates non-U.S. stocks and stocks under $5 a share because they could be less liquid. He ranks what’s left by stock performance and keeps the highest 30. Then he lets the portfolio ride for a yr and rebalances again every October. 

The gating aspects within the screen are based on back testing that found what works over the course of a market cycle. “The method is like a large funnel,” Kelley says. “We search for reasonably valued corporations with growth in earnings which have turned off the underside. We now have been running it the very same way since day one.” 

In a recent interview, Kelley explained the five core investing lessons in his strategy that we are able to all use. 

1. Drift

Legendary investors like Martin Zweig stand out for performance through the use of a momentum strategy — which mainly says whatever is working will proceed to work. Briefly, momentum begets momentum. “Don’t fight the tape,” was how Zweig put it. 

Kelley captures momentum in 3 ways. First, his screen looks for positive stock-price momentum over past three to 6 months. “We don’t need to buy stocks which are still falling since it is difficult to discover stocks right before they turn,” Kelley says.

He then captures price momentum again with the last step of his process. It ranks finalists by one-year stock-price performance, and goes with the highest names. “We’re OK with missing the primary a part of a move up because normally positive price movements last more than six months.” Six months to one-year price momentum has essentially the most predictive value. 

He also finds momentum by singling out corporations where earnings are improving, or losses narrowing. “This is very important because in the event that they are growing earnings, they’re doing something right,” Kelley says. 

2. Let your winners run

A number of investors spend far an excessive amount of time fascinated with methods to tweak their portfolios every week based on headlines and perceived trends. A standard mistake is to take profits too early. “The tendency after a 100% move is to say ‘This has been an important holding and I’m out,’” Kelley says. He avoids this by rebalancing only yearly. That helps him let portfolio winners run — partly by taking the emotion (greed) out of investing. 

3. Favor value

Kelley’s price-to-sales cap of 1.5 is Draconian. It means his fund won’t be invested now in popular “Magnificent Seven” stocks. But there’s upside on this. “Value lets you sleep higher at night because there’s less volatility,” says Kelley. And you would possibly not be missing out on much, depending on if you get out and in. Kelley points out the Magnificent Seven had an important 2023, but were down 42% in 2022. When you put the 2 years together, they were up just 8%. 

The hard cutoff of 1.5 times sales brings one other advantage. It gives Kelley’s portfolio a contrarian bent by populating his portfolio with stocks in sectors which are unloved by the gang. The system finds sectors which are out of favor which have began to turn and still have long runway due to favorable changes within the economy or the sector, says Kelley. 

He goes with price to sales versus p/e or price to book, because revenue is least more likely to be messed with by accounting adjustments — one other good lesson from his system.

As of the top of 2023, the Cornerstone MidCap portfolio was chubby consumer discretionary (20% of holdings), energy (22%) and industrials (35%). 

In consumer discretionary, as of essentially the most recent reporting date, the fund owned Gap
GPS,
-1.40%
and Abercrombie & Fitch
ANF,
+0.92%,
that are already up lots since his screen found them back in October. It also owns Guess
GES,
+3.86%
and Cinemark Holdings
CNK,
-0.06%.
 

In energy the portfolio included Par Pacific Holdings
PARR,
-1.12%,
California Resources
CRC,
-0.02%,
PBF Energy
PBF,
-5.68%,
Liberty Energy
LBRT,
+1.74%,
Consol Energy
CEIX,
-1.83%
) and Plains GP Holdings
PAGP,
+1.26%.
  

Amongst industrials, it owned Flowserve
FLS,
-0.19%,
Emcor Group
EME,
+0.23%,
MSC Industrial Direct
MSM,
-0.10%,
Fluor
FLR,
-1.61%,
Applied Industrial Technologies
AIT,
+0.11%,
Parsons
PSN,
+0.71%
and Oshkosh
OSK,
-2.70%.
 

4. Go along with midcaps

This implies corporations with market valuation of $1 billion to $10 billion. Smaller corporations like these are more likely to be misunderstood because they’ve less (or no) analyst coverage. But in the event you go too small, you increase volatility. That could make you do dumb things by stirring up emotions. Midcaps are also more more likely to perform well. “Over the past 20 years midcaps have outperformed large-caps and small-caps 60% of the time,” Kelley says. 

5. Stay optimistic

Over time I’ve noticed that individuals out there with the most effective records are sometimes optimistic — like Warren Buffett, or Ed Yardeni of Yardeni Research. “People accuse me of being a permabull, and I say ‘thanks very much,’” Yardeni quips. He’s referring to the indisputable fact that over time, the U.S. stock market tends to go up. 

Kelley attributes his fund’s outperformance partly to his own optimistic outlook. The important thing here is that in the event you are optimistic, you usually tend to stay invested and never bail out near market bottoms when sentiment is dire — a typical mistake. 

“Investing will not be about timing and getting out and in of the market at the correct time,” says Kelley. “Because inevitably you can be unsuitable on considered one of those big up days.” 

Michael Brush is a columnist for MarketWatch. On the time of publication, he owned META, GOOGL, AAPL, MSFT and NVDA. Brush has suggested META, GOOGL, AAPL, MSFT, NVDA, GPS, ANF and PAGP in his stock newsletter, Brush Up on Stocks. Follow him on X @mbrushstocks

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