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NOT ALL DOGS GO TO HEAVEN

Sometimes simple is best. Sometimes it isn't. Knowing the difference is important for investors. Buy the dogs of the Dow, the 1 or 2 worst performing stocks among the Dow's 30 components and historically you have good odds for a comeback in the succeeding year. This strategy of "worst to first" has an impressive history based on research done by Dow Theory Forecasts Chuck Carlson www.dowtheory.com, or try another perspective at www.dogsofthedow.com

However, there have been many years that this worst to first anomaly has not worked, and I think it's usually due to difficulties specific to an entire industry. For example, if telecom, real estate, or chip makers are having challenges sector wide, it is unlikely that a Dow component company in that sector will go unscathed.

Because I think several industry specific recessions are likely in 2006, our new Fallen Angels candidates do not include a Dow 30 member company at this time. Instead, I've chosen two very unpopular S&P 500 components that appear to be substantially undervalued. We'll take a closer look at these selections, but first some brief thoughts about timing.

WHO LET THE DOGS OUT?

Why do one year's worst performers have a tendency to do so well the following year? I think it's about human nature and self preservation. If you are running one of the largest and most influential public companies in the world, and your stock has lost more money for shareholders than most of the others...you have a problem. Your board of directors and all the other owners (shareholders) will blame you for their losses.

Eventually, they will all conspire to remove you and find someone else who can make them some money. This kind of pressure can force a CEO to take action in an effort to get out of last place. CEO's will often do everything in their power to enhance shareholder value after a difficult year of sagging stock prices.

It makes sense to buy the laggards when they're down and out, so long as they're profitable, have lots of cash, and demonstrate a willingness to do whatever it might take to improve their share price.

EVERYTHING MOVES IN CYCLES

Chaos Theory, quantum mechanics, and other esoteric sciences are interesting, but simply stated, the markets move in fairly predictable cycles. I've seen evidence that stocks and entire index's have a tendency to go up after 4 down days, and to go down after 4 up days. If you look at most stock chart patterns, you will see a rhythm which resembles a wave. These wave cycles can be lucrative to trade, if you are both lucky and smart.

Since our goal is to buy for as low as possible, and to sell at or near the top of a cycle, it's best if you have the CEO and his or her management team working towards your mutual objectives when you buy a stock. That's what I generally like about Fallen Angel's. If we pick them carefully, and management is interested in the same thing we are, it can be very rewarding. But what about selling these stocks after they turn around?

When management feels their equity is overvalued, they usually sell shares in the open market. This activity is fairly transparent, and you can follow insider activity at www.sec.gov or even on Yahoo Finance. Because I believe that over time, a company's underlying value and it's share price will converge, I like getting stocks when they sell at big discounts to their intrinsic value. It's at these depressed levels that insiders tend to be buyers, not sellers.

THESE DOGS HAVE FLEAS (FOR NOW)

Consider Ford (symbol F). The automaker is going hybrid, it's shares are almost half of where they were earlier this year, and you get paid a 4.90% dividend yield while your waiting.

Consider Aegon (symbol AEG). This international insurance company is now trading at a third of it's former share price and pays you a 4.80% dividend yield while you wait. With all the weather related disasters that insurance providers have had to cover this year, it's very likely that they will have no problem raising their premiums. If history is any guide, it's going to mean rising share prices for insurance stocks next year.

Enjoy the holidays, and good luck!
Gabriel
gwisdom@amminvest.com

The opinions expressed are those of Gabriel Wisdom and do not necessarily reflect the opinions of American Money Management LLC (AMM), an SEC registered investment advisor www.amminvest.com. Clients, Mr. Wisdom, and employees of AMM may buy or sell investments mentioned without prior notice. Prices are as of the close on 12-12-05. This Bulletin should not be considered investment advise. The opinions expressed do not constitute a recommendation to buy or sell securities. Investing involves risks, and you should consult your own investment advisor, attorney, or accountant before investing in anything.

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