Table of Contents
Title Page
Copyright Page
CHAPTER 1 - The Road from Broadway to Wall Street
CHAPTER 2 - The Paradox: Diversification and Superlatives
CHAPTER 3 - The Bell Curve: Stock Market Superlatives
CHAPTER 4 - The Inefficient Market: Reallocate into Superlatives
CHAPTER 5 - Nature’s S-Curve: Buying Stock Sweet Spots
CHAPTER 6 - Reevaluating Risk: Volatility Is Not Risk
CHAPTER 7 - The Search for Superlatives
CHAPTER 8 - The InterBoomer Generation
CHAPTER 9 - Implications of Market Interference
CHAPTER 10 - Free Earnings: A New Metric
CHAPTER 11 - The Magnet System: Putting It All Together
CHAPTER 12 - Selected Articles and Interviews
APPENDIX - Testing the Magnet Approach: The Investment Performance of the Superlatives

More Praise for
The Magnet Method of Investing
“Investors have long been sold diversification as the Holy Grail. Jordan Kimmel pushes investors to see a different light. He knows the big money is often made in just a few moves. Investors should embrace his big-picture wisdom.”
—Michael W. Covel Author, Trend Following and The Complete TurtleTrader
“Whether you are a novice or an experienced investor, you owe it to yourself to absorb how the MAGNET method takes a unique look into the brightest minds on Wall Street—and highlights why they ignore the call to widely diversify.”
—Doug Trenary Author, The SuccessMind
“If you are simply seeking average returns, do not bother with The MAGNET Method of Investing—invest in a low cost index fund. However, if you want to learn the secret to generating exceptional returns, this book is a must-read. Inside, Jordan Kimmel reveals his MAGNET method for finding the truly exceptional stocks in the stock market.”
—Nicholas Maturo CEO, Global Investor Services, Inc.
“A clear and entertaining manual on how to profit from sensible risk-taking in the market without blowing up.”
—Aaron Brown Author, The Poker Face of Wall Street, and Risk Manager, AQR Capital Management (formerly of Morgan Stanley)

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The Almanac Investor series features books by the industry’s brightest minds: money managers, traders, and investors who have continued to succeed in the face of the market’s ever-changing environment.
For a list of available titles in the Almanac Investor series, the Wiley Trading series, or the Wiley Finance series, please visit our web site at www.WileyFinance.com.


To all those investors who desire above-average returns and who are willing to go the extra mile to generate them.
To my wife and boys, who have been so patient with me while I took time away from them while I worked on this book.

Since the early 1990s, economists Eugene F. Fama and Kenneth R. French have reported in several papers in the Journal of Finance that stocks with low price-to-earnings ratios, low price-to-book ratios, and low market values generate the best returns over time. The venerable Value Line Investment Survey has shown that since 1965 its number-one-ranked stocks have beaten “the Dow by more than 20 to 1.” Why diversify your portfolio when it is well-known by Wall Street pros and leading academics that a small number of stocks account for the biggest gains? Why would you diversify and not seek out the top performers?
Overemphasis on diversification, asset allocation, and the use of modern portfolio theory have severely limited the creation of wealth in our portfolios. It is only after many years of following the failed strategies of asset allocation and systematic diversification, which have yielded unacceptably mediocre returns, that institutions and the public at large are now open to a more logical and robust methodology of seeking out, identifying, and concentrating capital in the truely superlative companies.
Future top-performing stocks are like needles in a haystack. Find them by turning your portfolio into a magnet for pulling in these hidden gems. The name of the game is isolating these future runaways, focusing your efforts on really getting to know and understand them, and then concentrating your capital on these hidden values at the right time.
Money manager Jordan L. Kimmel’s Magnet® Stock Selection Process (MSSP) has been unearthing these top-performing stocks since 1997. Mr. Kimmel and his clients have reaped the gains by owning shares of these stocks before they became the darlings of Wall Street. Jordan has been asked by the financial networks to appear hundreds of times over the last ten years for a reason: He continues to unearth undervalued, overlooked stocks on the brink of the big upmoves.
Dogmatic asset allocation and overdiversification have put a drain on savings rates, wealth creation, society, and capitalism. Instead, embracing the concept of superlative stock selection increases individual savings, creates wealth, helps society, and strengthens capitalism. Mr. Kimmel’s proven Magnet System zeros in on these future stock champs in their sweet spots before they take off during the companies’ greatest growth phase.
The Magnet Method of Investing demystifies modern portfolio theory, efficient market theory, asset allocation, and diversification, and it details what characteristics the best stocks have in common before they produce their oversized returns for investors. In the following pages Jordan Kimmel dissects his process from conception to birth to wealth creation and capital acceleration.
Jordan Kimmel’s unique mind and experiences synthesize the economics of the free market with an organic conception of the nature of all things and the power of Internet access to information that is unconstrained by time, language barriers, and space, creating a perspective of stock picking and the efficient allocation of capital that results in transformational change in investment returns.
The free market channels funds to the best ideas, solutions, and innovations. Relentless, willy-nilly asset allocation and overdiversification do the exact opposite. One’s capital is spread out so broadly and evenly that large losses are mitigated over the long term, but the investment is relegated to perpetual mediocre and often inferior returns. In these pages Jordan takes aim at the asset allocation and diversification models that investors have been scared into following, proving the case that superior concentrated stock investing that benefits all investors will help alleviate many of the world’s problems.
Editor-in-Chief, Stock Trader’s Almanac
Nyack, New York
June 2009

Modern portfolio theory does not work. It has interfered with the flow of capital to superlative companies and has severely limited the creation of wealth in our nation. This is due to the misdirected importance placed on diversification.
Harry M. Markowitz introduced the concept of modern portfolio theory in 1952. At the time, the financial markets were comprised of two alternative investments: stocks and bonds. Since then, several significant trends have altered the course of investing. Now institutions, along with individuals, have the opportunity to invest in various products that were simply not available back in 1952. These products include hedge funds, commodities, real estate, and insurance products. Various investment tools have also emerged, including options, hedging strategies, and numerous leveraging devices that can control large sectors of the market with limited capital.
While Dr. Markowitz’s theories shed light on the subject of diversification, the overall strategy within modern portfolio theory was still flawed. It consisted primarily of selling performing issues and reinvesting in underperforming issues. The outcome has been capital support for mediocre performers and lack of capital support for superlative performers. Clearly, reinvesting in laggards is not the most efficient use of a portfolio’s capital. When looked at from this vantage point, the practice of modern portfolio theory has done more damage than good.
In addition, the implementation of modern portfolio theory’s capital allocation practices and so-called reversion to the mean interfere with the growth of the free market. Diversification and asset allocation strategies have hindered the invisible hand of Adam Smith and the flow of capital to its most efficient use. They have had a direct and negative impact on investors’ wealth creation capabilities and on America’s role in the emerging Internet-based global economy. Mediocre companies do not—and often cannot—provide stable employment or dependable benefits for their workers, not to mention the other benefits that come with high performance.
When I wrote my first book, Magnet Investing, in 1999, stock market investing was starting to engulf Main Street and the Internet was still in its infancy. The mutual fund business was growing, and participation in pension and 401k accounts was bringing a greater percentage of the public into the market. It was a far cry from just 20 years earlier when most individuals did not invest in stocks. I saw a future unfolding wherein access to information about public companies would empower investors to make better decisions. This information was available to anyone who wanted it, not just to Wall Street insiders. In essence, the Internet would place the individual investor on a level playing field with Wall Street professionals by providing access to detailed information about public companies and a mechanism with which to invest in them.
My goal in writing my first book was to demystify the market and to enlighten readers on how to isolate, trade, and profit from exceptional stocks before they became the darlings of Wall Street. But tremendous losses in the aftermath of the dot.com bubble and the market crash in the technology sector left individuals with deep investment scars. The losses generated in the bear market from 2000 to 2002 created a large problem that individual and institutional investors still face. Those who suffered from overexposure to the tech bubble found salvation in increased stock diversification (modern portfolio theory). But by harboring the false sense of security of limiting risk through the ownership of a multitude of stocks and asset classes, investment returns become restricted, often not keeping pace with the market, inflation, taxes, and fees.
The mentality is even more restrictive at the federal level. The U.S. government wastes billions on pork barrel spending and endless bureaucracy while the stewards of the land struggle to figure out how to fund Social Security, Medicare, and our massive international involvement. Federal funds are invested only in low-yielding Treasuries and other U.S. government debt securities. This money is not put to work in new and growing industries here in the United States or abroad; yet other countries are deploying state-owned sovereign wealth funds to make massive equity investments in individual companies and projects all over the globe. The intent of these foreign funds is to use time to absorb the short-term volatility associated with the ownership of stocks, while reaping the long-term rewards, and they are doing it with equity positions alone and without leverage. If invested well, these funds will enable other countries to build wealth and eventually to play a larger role in world politics. It is a shame that the United States seems to have lost its risk-taking appetite at exactly the wrong time. Only the state of Alaska has such a fund established to redistribute some of the oil revenue from the Trans-Alaska Pipeline. This is not to suggest that the U.S. Treasury should be involved in buying and selling shares of start-up tech stocks. But if Asian and Middle Eastern nations have no qualms about buying stakes in Citigroup, Merrill Lynch, or Visa International, why shouldn’t the United States? Or how about following the lead of T. Boone Pickens in taking an equity stake in solar and wind power projects.
Several times over the last 20 years there have been suggestions to begin investing a portion of the country’s capital into the stock market. Each time there was a backlash against the idea with suggestions that we could not afford to risk our nation’s savings. Interestingly, it took the financial meltdown of 2008 for the government to change its course of action. Although it will probably turn out that the government actions were taken at a time when valuations were artificially low due to a liquidity crisis and will pay off with fair returns, the policy was to “save distressed institutions” rather than to invest in and support the healthiest companies.
We currently live in a country of immense wealth but hear that our own Social Security system is broke. How is this possible? It is true because we continue to attempt to fund our long-term financial future with short-term financial investments like U.S. Treasuries. If only a portion of the country’s assets were placed in the stock market (using superior selection and portfolio management), I believe that we would develop a surplus within short order and that our country’s future would be secure. This remains true for our country’s foundations, institutions, and citizens alike.
America now faces a crossroad that will determine its future role in the world of global relations. It can either use its expertise—the implementation of the free market—to solidify its position as the most powerful economic engine in the world, or it can further its use of asset allocation strategies, interfering with the flow of capital to superlative companies, much to the detriment of the free market.
In this book I draw direct correlations between the outcomes of the efficient flow of capital and the future of America as a world power. The recognition that the efficient allocation of capital to superlative companies expands the collaborative methods of business management is a nearly universal and central component in the productivity of these superlative companies. Collaborative forms of management eventually lead to collaborative forms of government, a more stable society, and ultimately higher standards of living. The efficient allocation of capital within a global free market can even greatly reduce the terrible human and economic cost of terrorism, because more people would have something to lose by destroying themselves and others.
The markets today are far bigger and more global than just ten years ago when Magnet Investing was first published. In writing this second book, I think of one of my favorite financial authors, Gerald Loeb, who wrote a book relatively early in his career and another toward the end. Although some of the same themes were covered in both books, having lived through a few market cycles and having gained so much experience trading the market, the author was wiser in his second book. The last 25 years that I have spent studying and investing have been remarkable. This experience has made me a better investor, trader, and money manager, and this latest book is the culmination of this knowledge. It is intended to create profits for readers, but it also help change the destructive investing behavior we see today.
The past 30 years have seen fantastic developments in almost every field. It is time for the investment world to reap the benefits that we have seen transform and improve the rest of our world. Despite the negative slant of news in the general media, in many ways the world is a better place for most. People are living longer and eating better. We have harnessed technology to give us more leisure time. Why should you be satisfied to generate the same returns using the same tired diversification strategies that started pushing for mediocrity over 50 years ago and got us into this mess in the first place?
The adverse effects of overdiversification and asset allocation have macro- and microeconomic, political, and even social implications. Compared to failed strategies, my Magnet System of investing isolates and identifies superlative stocks during the early stages of their most powerful growth phase. By debunking the myths associated with diversification and asset allocation, I hope to guide today’s investors and their capital down the path of the superlatives.
As I was writing this book in 2008 and 2009, the markets around the world experienced a vicious bear market that helped to highlight and prove many of the points I made throughout the book. The very core of the theories of diversification and asset allocation were shaken and disproved. We saw supposedly noncorrelated assets become very correlated indeed. There was nowhere to hide as stocks, bonds, and commodities alike were hit hard, both domestically and internationally. We will see, when the dust finally clears, that a liquidity crisis developed as a result of a global margin call experienced by the largest financial institutions that had drunk their own poison. Their reliance on their own models led them to overleverage themselves, attempting to generate higher returns. It was because they were so overdiversified that they felt safe and ignored other risks. It was because of the overreliance on their models that excessive leverage was used, making the use of stop-losses impossible.
If I can teach investors how to redefine risk and show them how higher returns come with fewer, well selected companies, I will rest easier, knowing that our government will not have to support a nation of citizens who cannot care for themselves. More foundations will be set up similar to the Robert Wood Johnson Foundation, which continues to accomplish great things for humanity. This foundation is in this position because their entire fortune was allowed to remain solely in Johnson & Johnson stock. Bill Gates certainly would not be doing his great charitable work had he diversified away his Microsoft stock early on.
My goal is to help secure our country’s future by replacing models and strategies that continue to come up short, and to employ The Magnet Stock Selection Process, and other effective investment strategies to replace these ineffective models.
In the pages ahead, I share the results of my own research over the past 25 years and, through personal interviews, the philosophies of some of the greatest investors of all time. And so, in this book, I challenge you to discard the notion of modern portfolio theory and explore the possibility of achieving higher returns with fewer stocks.
Magnet Investment Group
Randolph, New Jersey
June 2009

A special thanks to the Magnet team for all their efforts—not only on this book but in the many ways they have continued to support our great working environment over the years. Jeff Anderson and Jason Nolan—this book could not have been completed without your dedication and insights.
And, of course, thanks to the great efforts of the Wiley team and Jeff Hirsch for pulling together a loose manuscript to make this book something I am extremely proud of.
Jen MacDonald and Lynn Lustberg, your guidance and professionalism were invaluable over the course of the project.
Over the years, I have reached out to the top investors and portfolio managers of the era. Several of them have been partly responsible for my success. Among them, they manage several billion dollers in assets with their own investment style and insight. I am honored that so many of them took the time to spend with me during an extermely difficult market environment. I am grateful for their contributions.
J. K.

Throughout history investors have searched for new ways to achieve investment success. Lasting success has rarely been found by following the crowd or the latest investment fad. In fact, doing so has usually ended with disastrous consequences: the Tulip mania of 1637, the South Sea Bubble of 1720, the Internet bubble of 2000, and, most recently, the real estate bust and credit markets crash. It is reasonable to conclude that simply following the latest fad can lead to failure and has the potential for significant losses.
Investment success can be achieved only through the judicious application of a well-grounded discipline built on a solid foundation of fundamental principals and understanding of market behavior. The Magnet Stock Selection System (MSSS) is such a discipline.
Jordan Kimmel, inventor of The Magnet® Stock Selection Process, has transcended being an avid student of investment principles to a leading proponent of the art and science of investing. His knowledge and keen insight into the investment process have been gained in the trenches and on the front lines in the battle for investment survival and success.
The Magnet Stock Selection Process has evolved from those experiences. It uses conventional technical and fundamental factors within a theoretically sound framework and a clear set of practical rules to select a limited number of stocks expected to outperform broad market averages such as the Standard and Poor’s(S&P) 500 and Russell 2000 indexes.
The system’s underlying theory states that stocks are likely to outperform the general market if they have large and rapidly growing sales, are reasonably priced according to metrics (such as their price-to-earnings multiples and earnings growth), have above-average relative strength, and are undervalued.
The strategy underlying the model states that investors consistently underestimate the expected returns of stocks with strong fundamentals, technical patterns, and risk and growth characteristics. Thus purchasing a basket of such stocks over time will lead to outperformance with lower risk.
We evaluated the system by performing extensive back-testing and found that it produced superior returns relative to the S&P 500 and Russell 2000 by substantial margins over a nearly 20-year history. Our study back-tested the strategy using portfolios of varied sizes—20, 25, and 30 stocks—and found that each of the Magnet portfolios produced greater returns than both the S&P 500 and Russell 2000 by substantial margins.
The results held up in the long and short term, as well as in the traditional long run only. In addition, although these Magnet portfolios have greater volatility than either index, their volatility is lower than typical 30 stock portfolios, and their risk-adjusted returns are superior to both the S&P and the Russell 2000. Moreover, the Magnet portfolios have lower maximum drawdowns from market peak to trough and shorter drawdown recovery periods.
We have back-tested many strategies over the years. On the basis of the empirical evidence, we find the Magnet strategy appears to be theoretically sound; its selection criteria and rules offer significant promise for outperforming the S&P 500 and Russell 2000. These back-tests have produced some of the highest unleveraged returns of any strategy tested to date. These results are consistent with those obtained by other researchers and reflect methodologies used by a number of “best-of-breed” money managers in major U.S. institutions.
The system’s back-test results challenge a popularly held view that passively holding a diversified portfolio with a large number of securities is the best strategy. They indicate that holding a portfolio based on the Magnet system, using a small number of carefully chosen securities can produce superior risk-adjusted performance.
The Magnet investment strategy uses a disciplined two-step process for ranking approximately 8,000 stocks for which earnings estimates are available. Stock selection criteria and heuristic rules are used to rank stocks in descending order according to their potentially superior expected returns for monthly capital appreciation.
The first step in the Magnet process is to rank NYSE-, Euronext-, and NASDAQ-traded stocks by expected returns based on the fundamental, valuation, and technical criteria that research has shown are shared by stocks that have performed well historically. Among the fundamental criteria considered are those related to sales and earnings, favoring companies with superior growth over others with average or below-average growth. The valuation criteria consider a company’s market value relative to its sales and earnings, favoring companies that appear to be undervalued at current prices. The technical criteria consider a company’s stock price momentum relative to others, favoring those with the greatest momentum.
The second step screens out selected stocks according to a set of rules. Among these rules is one that limits sector exposure to 25 percent of the portfolio to ensure adequate industry diversification, thereby avoiding the potential for catastrophic losses in any one sector. Another rule places stop-loss limits on holdings to limit downside losses at 20 percent and partially pares back positions on stocks that have appreciated 40 percent to lock in a portion of the gain. In addition, each stock must be sufficiently liquid to have a minimum daily trading volume of 35,000 shares.
Once a portfolio is selected, it is monitored daily to ensure that each holding remains eligible. If a stock violates one of the rules, it is removed from the portfolio, and the next highest ranking stock meeting all of the criteria is chosen.
The Magnet strategy is on the forefront of portfolio selection processes that choose stocks based on valuation rather than market capitalization. Active portfolio selection processes are currently gaining acceptance among former advocates of passive or indexed investment strategies. In the last decade, many indexes on which market capitalization strategies were built have been modified. They have dropped market capitalization-weighting schemes in favor of float weighting, formally recognizing that that not all of a company’s shares outstanding are available for trading.
Some of the more sophisticated index creators now use fundamental metrics to break the dubious linkage between market capitalization and intrinsic value in their search for performance. For example, Research Affiliates, a Pasadena-based firm, created a series of indexes called “Fundamental Indexes” which use factors such as sales, dividends, cash flow, and number of employees rather than market cap. In a similar vein, WisdomTree, a New York City- based firm, created a series of indexes using earnings and dividends rather than market cap. Also, First Trust AlphaDEX funds are based on enhanced indexes that employ proprietary rules based on a fundamental stock selection process.
For investors, the Magnet investment strategy is important not because of its advanced theoretical nature, but rather because of its performance. Despite holding only 20, 25, and 30 stocks, Magnet portfolios are adequately diversified by virtue of its rules limiting sector exposure. A significant gain in any one of its holdings beyond the sector limit requires that the position be trimmed to bring it back into line.
Magnet portfolios have consistently higher returns than the S&P 500 and the Russell 2000 indexes. The higher returns are occasioned by somewhat greater volatility, but the portfolios’ return-to-risk trade-offs are clearly superior to the “indexes”. They are also superior in what is perhaps the most relevant risk measure to investors: their maximum drawdown. The strategy’s maximum drawdown from market peak to trough is less than the indexes‘, due in part to the use of stop-loss limits. And, more significantly, the strategy’s higher returns result in shorter drawdown recovery periods.
The important lessons to be learned from the Magnet strategy could not be made available at a more opportune time. Investment survival and future investment success will rely on having a sound discipline with strong fundamental, valuation, and technical underpinnings. Such a discipline consistently applied should help investors during the impending worldwide economic slowdown and global stock market malaise.
New Millennium
Advisors, LLC
HedgeMetrics, Inc.

The Road from Broadway to Wall Street
If you are ready to give up everything else—to study the whole history and background of the market and all the principal companies whose stocks are on the board as carefully as a medical student studies anatomy—if you can do all that, and, in addition, you have the cool nerves of a great gambler, the sixth sense of a clairvoyant, and the courage of a lion, you have a ghost of a chance.
Whatever method you use to pick stocks, your ultimate success or failure will depend on your ability to ignore the worries of the world long enough to allow your investments to succeed. It isn’t the head but the stomach that determines the fate of the stockpicker.
For as long as I can remember, I have had a deep understanding of the engine of the free market. Surely it had something to do with growing up in New York City with my bedroom window overlooking Broadway. I am also sure that my interest in business operations came from having two parents who operated a retail store right below our apartment building. At the dinner table, the discussion often revolved around how the store was doing, as well as how their competitors were fairing. As the youngest of four children, I did not participate much in the conversation, but I listened intently. I saw stores opening and closing throughout the neighborhood and often thought about what made them successes or failures.
All four of my grandparents lived in New York City as well. We spent a lot of time visiting with my mother’s parents, who lived in the same neighborhood as us. Those grandparents were fairly well off, enough so that my grandfather was able to retire at a fairly young age. I can remember often being in his living room as he watched his favorite financial show. He would jot down prices of his stocks throughout the day and would make note of any tidbits of information about those companies that he found interesting.
My father’s grandparents, however, were not as well off. The contrast between my two sets of grandparents was very clear. Though I did not love either set of grandparents more or less, the fact that my grandfather who kept track of his stocks was the one who visited us with a trunk full of toys was not lost on me. I identified at an early age that the stock market was a vehicle that could lead to wealth generation. I was determined to understand how it worked.


The discussion of the stock market was commonplace in my childhood home. Though my parents were not very successful in the stock market when I was young, they did eventually have a major investment success that allowed them to live more comfortably in later years. One night while enjoying my family dinner—a hamburger to be exact—I asked whether Heinz was a company that you could invest in. Excited by my early interest in investing, my parents answered yes and encouraged me to dig further. Using my accumulated savings, I became an investor for the first time at age 8—the proud owner of 35 shares of Heinz. I think I enjoyed my hamburgers even more being a Heinz shareholder and followed the stock in the newspaper. A few years later, my shares of Heinz had risen substantially in price, and my opportunist older brother bought my shares from me at a discount to the current market price. I was hooked from that time forward and continued to invest in both stocks and, by high school, in stock options.
In eighth grade, I tested for and was accepted into the Bronx High School of Science. The school was considered one of the best in the country. Despite not being the most conscientious student, I used my natural affinity for math and science to bolster my grades and graduate. The hour-and-half journey each day to Bronx Science, along with working after school, may have had something to do with helping me to develop the work ethic I carry with me today. At Bronx Science, I was exposed to the scientific method as well as other method of critical thinking, which have clearly helped me throughout life.
As my time at the Bronx High School of Science was coming to a close, I knew that my choices for college were limited. First of all, I was going to be paying for college myself and the thought of a private college overwhelmed me. Second, I knew that I could not pass a college-level foreign language course and that eliminated another set of opportunities. As it turns out, the State University of New York (SUNY) system provides an excellent education at a very affordable level for in-state residents. SUNY at Stony Brook offered an accelerated five-year degree that included both a bachelor of arts and a master of science, which I completed. The program focused on using both statistical and quantitative analysis to find solutions to various problems and applications.


One concept in particular that I became very in tune with during my time at SUNY was that of the bell curve, or Gaussian distribution. Karl Friedrich Gauss was a German mathematician and astronomer known for his contributions to algebra, differential geometry, probability theory, and number theory. Among other things, he was the creator of the Gaussian distribution, or the bell curve as we will refer to it going forward. By definition, the bell curve (also known as a normal distribution) plots all of its values in a symmetrical fashion where most of the results are situated around the probability’s mean, with a small group of outliers at either end of the curve. In layman’s terms, this means that the majority of items in any set of data will be at or near average, whereas a select few will be above average or below average. This idea can be applied to nearly anything: athletes, automobiles, air quality, or, of course, stocks.
The obviousness of the bell curve in its simplicity and its wide applications had a profound effect on me. It was very clear that, in nature, there would be some outliers on both the winning and losing side, and all else would fall basically in the middle. Through the use of the bell curve and a statistical approach adapted to identify superlative, or in other terms highest-quality, companies, I began to develop what we now know as The Magnet® Stock Selection Process (MSSP). Interestingly, years later one of the cofounders of the Urban Policy Science Department at SUNY Stony Brook would become my director of research at the Magnet Investment Group.
After college and graduate school (having earned both degrees simultaneously), I began working for Mayor Edward Koch at New York’s Office of Management and Budget. Within two years, I was responsible for forecasting over $500 million in revenues from various city agencies. I was on track to becoming the youngest commissioner in New York City’s history. Although I was enjoying my time in city government, I knew my true calling was in the financial markets. The Municipal Building was just a few blocks north of Wall Street, and I felt myself pulled down to The Street. I continued to invest in stocks and was a student of the market, trying to learn as much as I could.
It was not until I was 25 that I entered Wall Street and my financial career began. I started as a municipal bond salesman, but I was using my savings to continue investing in the stock market and to further develop my Magnet theories. I took the opportunity to meet as many portfolio managers, newsletter writers, and authors as I could and invited them all to lunch or dinner. I asked, “What is the number one book that you would recommend?” “What sets you apart from the rest?” What was startling to me then—and even today—is how money managers and mutual funds have pigeonholed themselves into specific boxes: growth, value, or momentum investors. It was after years of listening to these varied approaches to investing that I realized I could develop a quantitative method to incorporate the best aspects of several different top-performing money managers and construct my own process that included the best of various styles. It was over several more years of working with more than 70 college interns from five different universities that The Magnet Stock Selection Process was developed.
Since the beginning of my investment career, I had been interested in developing a model that would try to analyze public companies to give me an advantage investing in the stock market. Several distinctly different models had been created that fell into three broad categories: value, growth, and momentum. In addition, a more passive approach was being pushed on Wall Street, and it was called the efficient market theory. As opposed to the other methodologies, the efficient market theory assumed that all relevant information about a company was already in the public domain and therefore the sum of all buyers and sellers created the correct, or “efficient,” price. In analyzing price movement, however, I found it clear that the market was far from efficient. There was simply too much price movement within individual companies for the market to be truly efficient.
This observation of nonefficient price movement is supported by an idea known as chaos theory, whose proponents believe that price is the very last thing to change for a stock, bond, or other security. Though in this context the theory is adapted for analysis of the stock market, the ideas of chaos theory were originally pioneered by a meteorologist at Massachusetts Institute of Technology (MIT) named Edward Lorenz, who attempted to use computers to predict weather patterns. He kept a continuous simulation running on his computer that would output 24 hours’ worth of his simulation for every minute it ran, as a line of text on a roll of paper. He intended to draw correlations between seemingly insignificant changes in weather conditions to predict likely occurrences in the future. James Gleick described it well in his book, Chaos: Making a New Science:
Line by line, the winds and temperatures in Lorenz’s printouts seemed to behave in a recognizable earthly way. They matched his cherished intuition about the weather, his sense that it repeated itself, displaying familiar patterns over time, pressure rising and falling, the airstream swinging north and south (Gleick, p. 15).
Applying chaos theory to the fundamentals of stock selection made perfect sense to me. I began to gather all the data I could get my hands on about public companies and set out on my quest to develop a model that would identify stocks on the brink of a massive growth spurt. Through the use of applications borrowed from chaos theory and factor analysis (as opposed to raw data mining), my theories on what makes a good company were transformed into The Magnet Stock Selection Process. At this time, I was asked to be a member of the Quantitative Work Alliance for Applied Finance, Education, and Wisdom in New York City. This is a group composed of some of the top quantitative thinkers from around the country. They hold meetings to debate cutting-edge theories and openly collaborate with one another. Shortly after my initial presentation to the group, more interest gathered in the Magnet system. Two of the largest asset managers in the world offered to do a study to see whether they would hire us to select stocks for them. Both of them offered us contracts. Our approach was closely examined by a few other institutions, and, despite its controversial and unique methodology, we received some lucrative contracts that took us to the next level.
I continued to read every investment book that was recommended to me by the professionals that I sought out and encountered. I was particularly interested in books written by those who had considerable success in the stock market. I began to embrace several aspects of the different schools of investing. Although the various proponents of growth, value, and momentum styles of investing adamantly rejected each other’s approach, I saw merit in the different approaches, and it made sense to me to try to combine them somehow. I began to build a model that incorporated the best attributes of the best investors that had come before me. Within a few years, Magnet was offered contracts to select stocks for two of the biggest institutions on Wall Street: John Nuveen & Co. and Van Kampen Funds Inc.
At the time that I was under contract with John Nuveen & Co., I came across a book called The Predictors