Before this column comes across as a shameless bashing of banking analyst Meredith Whitney (and I hope that's not how it comes across), let me give praise where praise is due.
Whitney's a brilliant analyst. She was the first to point out that Citigroup (NYSE: C ) would need to cut its dividend in 2007. She's still rightfully critical of the company today -- Citi has "an enormous portfolio of mortgages it services but does not hold," according to CNBC. It amounts to $500 billion worth. And the company hasn't even set aside $1 billion of reserves against these.
Whitney then correctly predicted looming losses and writedowns at other banking giants like Bank of America (NYSE: BAC ) , which also still publicly struggles with the portfolio of mortgages it acquired when it bought Countrywide.
These brazen predictions propelled Whitney to the forefront of the financial media, and she became an authority on financial stocks. One report led to a one-day U.S. stock market loss of $369 billion!
But often the authority must be questioned. Which is what I'm doing today.
You see, since she left Oppenheimer to launch her own firm, Whitney's track record has been mixed. According to Bloomberg Businessweek, "about two-thirds of her picks have fared worse than market indexes." Peter Lynch famously quipped, "You're never going to be right nine times out of ten," but his definition of a good investor was being 60% correct -- not only 40% right.
Below, I'll offer my explanation of why Whitney's struggling while a team of top Motley Fool analysts is succeeding (two-thirds of their picks are beating the market). But first let's take a look at some notoriously faulty calls.
Two big mistakes
On May 4, 2010, Whitney advised buying Visa (NYSE: V ) , declaring it her "single best buy." The stock had just hit an all-time high, so it was a risky gamble.
It didn't pay off. A week later, the Senate voted to limit debit card fees, and Visa -- along with other credit card issuers -- took a hit. The stock's still down 12% since then, and its near-term performance will largely depend on the strength of holiday spending.
Going back further, you'll find another noteworthy blunder on the opposite side of a trade. On April 1, 2009, Whitney advised selling Capital One Financial (NYSE: COF ) , believing the "core earnings power is negligible" and that it could need to sell assets to stay afloat.
But again, that was a mistake. Customers are spending more on their Capital One cards, its banking business is seeing huge growth in its auto segment, and delinquency rates are falling. Shares have nearly tripled since then, and continue to rise.
This is similar to many of her other calls. Bloomberg Businessweek calculates, "She was right seven times and wrong 12 when compared with the S&P 500 Financials Index."
Again, no one's investing track record is flawless. There are too many variables to be right all the time. But this 40% success rate isn't something you'd expect from one of today's top analysts.
Why is her track record so full of mistakes?
Whitney's record is disappointing because of her lack of diversification. She focuses exclusively on financials. True, she's an expert on banks, but stocks in the same industry often move in sync. This is especially true of the banking industry, in which new obstacles seem to arise every quarter. This might seem like it'd be easy to make bearish calls.
The problem, though, is that once people realized that not every bank was going bankrupt, bank stocks rallied (the Financial Select Sector SPDR ETF (NYSE: XLF ) , which owns shares of the major banks, is up nearly 150% off the market's bottom), leaving Whitney's bearish calls out in the cold.
Avoid this and success will follow
This brings me back to the team of analysts I mentioned above, which I'll share is the Million Dollar Portfolio team, headed up by former hedge fund manager Ron Gross.
They've successfully implemented safeguards so that they don't fall prey to Whitney's mistakes -- policies you can implement in your own investing strategy.
One of these safeguards is they advise that you look at a portfolio as a whole. It's why their portfolio is spread fairly evenly among market caps, and across sectors -- the greatest exposure being to software, telecommunications, and insurance companies. The companies are also a mix of slow growth, aggressive growth, and even distressed bets. And although the bulk of the portfolio is invested in U.S.-based companies, they have significant exposure to Asia.
However, this doesn't mean they're afraid to be overweight in a sector they're convinced is promising. As Ron Gross recently explained, "if we believe energy prices are going to rise over time (which we do), then we want to make sure we have enough cash allocated to top-notch oil and gas companies. And if we think the American consumer will curtail spending over the next several years (which we do), we want to make sure we're not too heavily tilted toward consumer discretionary stocks."
We're about to open up the doors to Million Dollar Portfolio for the last time in 2010. To find out more about how you can benefit from the team's research -- and follow along with their real-money buys and sells -- enter your email address in the box below. We'll share with you "Motley Fool Top Picks & Perspectives 2011," a new free report with real stock recommendations and portfolio guidance for the year ahead. Again, just drop your email address below.