The Sorting Hat
Harry Potter books were new and very, very popular in my house when my children were younger. These books, and the movies that followed, continue to entertain youth and adults. One of the memorable “characters” in these books is “The Sorting Hat”. At the start of each new school year, new students are forced to don the Sorting Hat which determines which of the four houses each new student is assigned. The hat has quite a pedigree and possesses magical powers. Yet, despite its wisdom the hat sometimes has difficulty making decisions, also known as a “hatstall”. There is a parallel to the Sorting Hat in the investment arena, in my opinion.
The ratings system for stocks at Raymond James sorts companies into four categories – Strong Buy (SB1), Outperform (MO2), Market Perform (MP3), and Underperform (MU4). Other firms have similar ratings systems which guide investors and portfolio managers, sometimes well and other times not so well. The trick to utilizing these sorting terms is clearly defining your own objectives for your investments. The wise investor knows when to follow certain advice and when to ignore it. Experience is the best teacher in this regard.
Personally, as I help clients manage portfolios, I have developed my own Sorting Hat. Truth be told, markets like the one we have experienced over the past six months force me to reevaluate my stock and bond positions in light of the market action. The extreme moves in both directions in the markets make it easier to determine certain company characteristics. For example, did a company drop less than the market when the market went lower? Did a company fail to rise when the market rebounded? Did a company lag or advance faster than its peer group? These are some of the questions I find it important to ask. For advisors like me, volatile markets afford a good opportunity to reassess, reaffirm or reject investments.
My “sorting hat” has four categories. “Buy More” is for companies that I believe remain undervalued and acted appropriately in a portfolio, protecting capital during the decline or advancing more quickly than other choices during an advance. “Solid Hold” means a company has performed as expected, and I believe is neither undervalued nor overvalued. “Source of Funds” translates into an investment that has NOT delivered as expected, either losing more than peers or failing to rise during a rally. Something is wrong, whether I know it or not. And my fourth category is like a hatstall, “Needs More Observation”. Simple definitions. Hard decisions.
So the next time you hear an investment analyst or market commentator on television making some recommendation, I want you to remember the Sorting Hat and I want you to be sure you know your own objectives for your portfolio. Call me should you have questions.
There is no assurance that any investment strategy will be successful. Investing involves risk including the possible loss of capital.
Ralph McDevitt
