The perfect stock-picking formula?

ASX reporting season comes to a close, the Dow hits a high, and has The Motley Fool uncovered the perfect stock-picking formula?

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ASX reporting season comes to a close, the Dow hits a high, and has The Motley Fool uncovered the perfect stock-picking formula?

U.S. stocks rose overnight Thursday, sending the Dow Jones Industrial Average to the highest level since May 2008.

"The recovery is starting to pick up speed," said Tom Wirth of Chemung Canal Trust on Bloomberg. "There was so much fear about what was happening in Europe that people couldn't see through all of that."

Australia: A recovery-free zone
I'm not sure if Mr Wirth is referring to the U.S economic recovery or the U.S. stock market recovery, but one thing is for sure…there 'aint no recoveries here in Australia.

You can either laugh or cry.

Laugh because Australia still hasn't had a recession in over two decades. Laugh because our unemployment rate is a touch over 5 per cent, well below that of America and Europe. And laugh because of the strength of the Aussie dollar, making a holiday to London or Los Angeles feel dirt cheap.

Or you can cry because our sharemarket, the S&P/ASX 200 index, trades around the same level as it did in early 2005. Cry because our market has only recovered 40 per cent from its March 2009 lows. And cry because of our dire political situation.

Be thankful for what you've got
The bottom line – you can't have it both ways. You can't recover if you haven't been sick. You can't have low interest rates if you are in the middle of a mining boom. And you can't have a rising sharemarket if the largest companies in the country are struggling to grow.

ASX reporting season is coming to a close. If I was to summarise the results of large cap companies like BHP Billiton (ASX: BHP), Rio Tinto (ASX: RIO), Westpac Banking Corporation (ASX: WBC) and Wesfarmers (ASX: WES), in a word I'd say "yawn".

Still, what do you expect when commodity prices are off their recent highs, the Aussie dollar trades at near record prices, house prices continue to steadily fall, and consumers are keeping their wallets in their pockets and purses in their handbag?

The Goldilocks economy
But believe it or not, amidst all these perceived headwinds, the Reserve Bank of Australia (RBA) said economic growth was likely to be close to its average over the next few years.

Looks like we might be able to kiss good-bye any interest rate cut in March…not that I'm changing my mind nor making any predictions.

Futures markets are now pricing in a less than 30 per cent chance of a 25 basis points interest rate cut in March. We've come a long way since Australia Day, where two interest rate cuts looked odds-on.

Who'd be a gambler? The only good odds-on bet is one on Black Caviar, although the odds are, baring an early retirement, even that winning streak will come to an end one day.

Average economic growth is good. Not too hot, not too cold, but just right. And just right too for us optimists. We'll leave all the worrying to politicians and pessimists. Onwards and upwards, Fools.

Don't try this futile exercise…
And here's something else we'll largely leave to others… trying to second-guess where markets might move next.

Market timing is a futile exercise. We'll leave the guess work to the chartists. We'll just focus on trying to buy good companies at great prices.

The press, and other newsletter services, tend to focus on results coming out of the top 50 ASX companies.

The perfect stock-picking formula
We keep an eye on them too, as large-cap companies should form the core of any portfolio. Telstra (ASX: TLS), with its 8.5 per cent dividend yield, is one such example of a core stock.

But we spend most of our time looking around for smaller companies. For investors, such companies generally have four positive things going for them…

1) Unloved

2) Overlooked

3) Undervalued

4) Growing

Add it all together, and you could have the perfect formula for successful stock-picking.

It's a formula that has already seen our Investment Analyst Dean Morel bring Maverick Drilling & Exploration (ASX: MAD) to the attention of the investing public.

Today, Maverick is seemingly the toast of the town, its shares trading above 80 cents. Gains of 200 per cent, or even more, is what can happen when a growth company goes from over-looked to over-loved.

Investing legends use the formula too
And it's a formula which largely saw the UK's investing legend Anthony Bolton deliver the Fidelity Special Situations Fund a 20 per cent annual return over a 25-year period. recently interviewed Anthony Bolton. Coming out of retirement because he saw China as "the investment opportunity of the decade" Bolton's new Fidelity China Special Situations fund has materially under-performed the benchmark.

But Bolton, although disappointed, remains confident of turning things around.

His formula? In his own words…

"What hurt me last year was being in small and medium stocks — which were 60-70 per cent of the portfolio…

Smaller companies are more risky, but those are the stocks that are going to make you a lot of money. They're also the stocks that are going to be less efficiently priced, and which have less broker coverage.

Obviously, I've been wrong to date, but I strongly believe that the bears will be proved wrong…"

It's music to our Foolish ears.

Charlie Aitken of Bell Potter recently called this a "real stock picker's market".

Unloved. Overlooked. Undervalued. Growing.

Could this be the perfect formula? It's certainly working for us Fools.

Attention: If you are looking for ASX investing ideas, look no further than "The Motley Fool's Top Stock for 2012." In this free report, Investment Analyst Dean Morel names his top pick for 2012…and beyond. Click here now to find out the name of this small but growing telecommunications company. But hurry – the report is free for only a limited period of time.

Of the companies mentioned above, Motley Fool General Manager Bruce Jackson has an interest in BHP, TLS, WES, MAD and WBC. The Motley Fool's purpose is to educate, amuse and enrich investors. This article contains general investment advice only (under AFSL 400691). Click here to be enlightened by The Motley Fool's disclosure policy.

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