The Moron Portfolio: shares to avoid as an investor

Some of you may have read about my Moron Portfolio, a diversified portfolio of stocks that is recommended by any adviser operating under the first rule of investment advice, which is "Don't get sued".

The process for picking the stocks in the Moron Portfolio is simple. Print off the ASX 100 in market cap order and, starting at the top, work your way down the list crossing out any stocks you don't understand and picking any stocks that you can't be sued for recommending.

You do this not by picking the best stocks but by picking the biggest stocks with the biggest brand names so that when ASIC puts you in the dock and asks you whether you had a reasonable basis for your recommendation all you have to reply is that "It's BHP" or "It's QBE, m'lud".

It's a lot easier when the stock code is the brand name. How else could QBE have found its way into so many portfolios?

Of course, the issue with the Moron Portfolio is not that it underperforms; on the contrary it will almost always perform smack in line with the market. The issue is that it will never outperform because it includes all the rubbish stocks as well as the good stocks.

The other issue is that it tends to include all the biggest stocks, so by definition it includes the mature stocks, in which case its growth is limited.

The other issue is that if you really wanted to achieve a Moron Portfolio (read average) return there are myriad products on the market these days, from managed funds to listed investment companies and exchange traded funds, that will achieve exactly that return but without the need for an adviser in the loop charging alpha-sized fees for a beta-style return.

These days you don't need to pay for an average return; it is available everywhere.

So how do you improve the Moron Portfolio return? Let me get you started.

The first step to outperformance is avoiding the weeds, not picking the flowers. In other words, stop buying rubbish stocks for the wrong reasons.

These include:

• Because they are big.
• Because they are a brand name.
• For the sake of diversification, because you don't hold anything in that sector.
• Because they have a high yield.
• Because their price-earnings ratio is relatively low.
• Because they have underperformed.

On the big-brand name front, it is simply not good enough to hold BHP Billiton and Rio Tinto simply because they are BHP and Rio. You need to apply more brain.

On the diversification front it is not good enough to hold or buy BHP and Rio just because you don't hold anything in the resources sector. Diversification for diversification's sake is not safer, it's riskier.

Then there are stocks that have a high yield. Generally speaking stocks have a high yield for the wrong reasons - because they are mature, low-growth stocks that people don't like.

I know some of you simply won't accept this but ask any American: equities are about growth, not income.

If you want income buy a bond. If the yield in fixed interest is too low, tough. Sure, some investors have come to equities for income but, even with the banks (which have just fallen 15% in a month), yield is a distraction from the share price performance, which is far more volatile and important.

Stocks that have a low PE ratio are also a trap. Why would a stock have a low PE? I'll tell you: because people don't like them and they won't pay up for their earnings. It is a fact that if you want a list of the best stocks in the market, sort the ASX 200 in PE ratio order and look at the 20 most "expensive".

Barring a couple of disaster stocks whose earnings forecasts have not been updated, these are the most popular stocks - and for a reason. At the same time, the 20 stocks with the lowest PEs are the least popular stocks in the market, usually for a reason.

And, unless you know something nobody else knows, you shouldn't be buying them.

Then there are the stocks that have underperformed. Despite the natural urge to buy something that's gone down, when it comes to stocks, the golden rule is to respect the trend, not go against it. Avoid stocks that are trending down.

Did any of the Moron Portfolio investors in the past five years ever stop and wonder why they held BHP, Rio, Woodside, QBE, Origin, Newcrest, Santos, Fortescue Metals and Orica?

Because they were big-brand names, perhaps, or were on low PEs or high yields or had underperformed? Or maybe they just needed a resources weighting for diversification purposes. They are down 17%, 13%, 18%, 30%, 12%, 56%, 31%, 36% and 17% in five years.

Sorry, but it's just not that hard to do better.

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