The Birth of an Investment Strategy

How the heck do I decide what to buy? That is a question that scares most average investors from making their own investment decisions. Some go around this issue by investing in index funds (highly recommended), others utilize investment advisors to make investment decisions (not as highly recommended).

You may be wondering just how one goes about making an investment decision. I recently thought up an investment strategy on my own, and figured it would be worth it to document my thought process behind the strategy in case it proved helpful to other trying to come up with a plan for identifying their own strategies to buy stocks. 

Back in October 2020 I had about $100,000 that I knew I would eventually use to invest in real estate. The money had come from doing a cash-out refinance on my first investment property, which I proudly discuss on this blog post (it’s a worthy read). I had to find a place to safekeep the money. Option one was .05% at my local savings bank, and option two was 1% at an online savings bank. I hated both of those options. 

I’ve been dabbling in the market since I was 16 years old, so I decided to look for opportunities in the stock market. My goal was to protect my capital, but obviously get a better return than the 1% an online savings account could get me. Here are the steps I took in arriving at my own investment strategy:

Step 1: Looked at Historic Sector Returns

I found the below chart at novelinvestor.com, which ranks the market returns since 2007 for each sector on the S&P 500. In analyzing this chart, I noticed that the energy sector had been the worst performing sector in 5 of the prior 7 years, including a massive drop in 2020 due to the COVID-19 pandemic. Knowing that economic activity and oil prices were likely to recover once the pandemic was controlled, I saw a potential opportunity in this sector.

Step 2: Looked at Potential Market Correlations

After I identified the energy sector as a target, I looked for a correlation between oil prices and the performance of oil stocks. As you can see from the below chart, oil prices have been struggling since 2014, which correlates with the poor sector performance starting that same year. 2016 was one of the few years in which oil prices had a large year over year rise, and the sector was the best performing sector in 2016.

Step 3: Identify Companies to Buy

After establishing that i wanted to target the energy sector, and coming up with the hypothesis that a recovery in oil prices would likely result in a recovery in the price of oil stocks, I was left with the difficult job of identifying which companies within that sector I was going to purchase. 

Searching for stocks can be as easy as going to Google and typing in the type of stocks you are looking for. Personally, I like going to Yahoo Finance and looking at their stock screeners. When screening for companies in the energy sector, we get a list of stocks that look like this. From there, it is a matter of finding stocks that meet criteria that you find are important. Those criteria for me where:

• Steep discount from February 2020 prices

• Strong dividend yield

• Stable stock price history

• Stable past earnings

• Strong correlation between stock price vs. oil price

I wanted to invest $50K total in this strategy, and ended up identifying 9 companies that fit my criteria. The list consisted of solid stocks that had an average annual dividend yield of 10.56%. I would at least be able to capitalize on the great yield from the portfolio, but if everything worked out well, I would see capital appreciation as well. I purchased all of the stocks around 10/16/2020. The companies and purchase prices were as follows:

Results:

After purchasing the stocks, news of vaccines boosted the price of oil futures in November, 2020, which in turn boosted the price of my holdings (the correlation of oil prices to my portfolio actually worked). Not only did I earn $1,285 in dividends between November and January, all companies saw fantastic gains ranging from 10% to 84% capital gain returns. 

Fast forward to January 26, 2021 and I had to capitalize on these gains and close my positions due to two real estate properties I am hoping to buy going under contract (as mentioned earlier, real estate is my primary jam, a blog post about those properties will follow!). 

The results of this strategy were incredible. My initial $50,000 investment ballooned to $70,543, or a 41% return in just 102 days. In case you were wondering, this is an annualized return of 147%! I attribute this incredible growth in the stock prices within the portfolio to the correlation between the overall portfolio and oil prices, which climbed from $40.88/barrel on 10/16/20 to $52.61/barrel on 10/26/21, a 28.70% hike. 

I would like to say that I only closed these positions because of me needing the funds to purchase real estate. I still think these companies will continue climbing hire, as most of them are still at a 40% discount from their February levels. As economic activity continues improving from the implementation of COVID-19 vaccines, the price of oil should continue rising as should the price of the stocks here. As always, though, please do your own diligence as this is my own personal opinion and I am not a certified (or qualified) investment adviser!