Much has been said about buying last year's worst performers for their "cheap valuation", but history shows you might be better off sticking with the winners instead.
This is great news for the Afterpay Ltd (ASX: APT) share price and Fortescue Metals Group Limited (ASX: FMG) share price – and I'll explain in a moment.
Buying the top performers would run contrary to our tendency to buy low and sell high. After all, the best performing ASX stocks of 2020 are trading on very stretched valuations.
ASX dogs with surprising bite
But buying last year's dogs is fraught with risks, as I have written about before. It might not feel that way to those who used this strategy in 2019 though.
High-profile Bell Potter trader Richard Coppleson found that buying the bottom 20 stocks of 2019 delivered returns of around 7.2% on average in 2020.
This is miles ahead of the circa 1.5% loss on the S&P/ASX 200 Index (Index:^AXJO) for last year.
From zero to hero
The Pilbara Minerals Ltd (ASX: PLS) share price contributed the most to the gains with a 212% surge in 2020 after losing more than half of its value the year before.
Other big contributors included the Costa Group Holdings Ltd (ASX: CGC) share price and Orocobre Limited (ASX: ORE) share price. Both of these 2019 underachievers rebounded by around 60% each in 2020.
Bargain hunters who indiscriminately buy members of the annus horribilis club would be further embolden by the 20.9% gain generated by this strategy over the past eight years.
Buying the worst ASX stocks vs. buying the best
This is the return you would have reaped if you bought the 20 worst ASX annual performers and sold them 12 months later starting from 2012 to 2019.
However, Coppleson pointed out that the data is skewed by the 70% plus return made in 2015 and 2016. These appear to be unusual one-off type events. If the two years were excluded, the returns drop to 3.6%. That's what Coppleson believes this strategy should be generating.
This is because ASX stocks that suffer a bad year typically need more time to turn around its fortunes, he added.
Sticking with the ASX outperformers
In his opinion, a better strategy is to buy the top 20 stocks of any given year instead. These top performers generated an average annual return of 42.1% from 2012 to 2019.
Investors using this strategy would have generated a positive return in every one of those years, except for 2018 when the return was zero.
If history repeats, 2020's best performing ASX stocks are likely to outperform again in 2021, at least on a collective basis.
Perhaps price shouldn't be the biggest determiner for bargain hunters.
