Why 'Year's Best' Stocks May Flop in 2011

Investors should read year-end stories with a big grain of salt, because top-performing stocks one year are often mediocre performers the next.
By InvestorPlace ,

By Jeff Reeves of InvestorPlace

NEW YORK (

InvestorPlace

) -- Investors love trends, charts and numbers. We have to -- because if somehow we can plot a trend from a mess of candle graphs and historical data, we can convince ourselves our portfolio will be profitable in the months ahead.

Right now investors are being overloaded with a myriad of year-end recaps highlighting the

best stocks

and sectors from the last 12 months, but make sure you read all of these stories with a grain of salt. They tend to offer little insight on the future performance stock market, and acting on them can do more harm to your portfolio than good.

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At the end of 2009, investors were thrilled with the way the stock market had bounced back from the March lows and was humming into a new year. The typical "year in review" story in December 2009 would have highlighted these stocks as some of the

Dow's

top five performers:

The average gain of this group is 68% -- better than three times the broader Dow's 23% gain on the year. Even the "worst" of this group doubled the index's returns.

So how have the best of 2009 fared this year? In a word ... badly.

  • American Express, +16% in 2010
  • Microsoft, -8% in 2010
  • IBM, +13% in 2010
  • 3M, +5% in 2010
  • Alcoa, -11% in 2010

With the Dow Jones Industrial Average up about +10%, only two of these top-five picks have outperformed the market. When you take the average return of the five stocks, you squeak out a +3% gain -- barely better than the anemic return of a CD.

To add insult to injury, two were among the five worst-performing Dow stocks of 2010. Microsoft and Alcoa came in No. 26 and No. 27, respectively, out of the 30 names in the index.

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Worst Stocks of 2009 So-So in 2010

Now that we've soundly proven that past performance doesn't mean future returns for the coming year, what about the worst performers?

A look at the numbers shows that being one of the dogs of the Dow one year means you're ripe for a rebound. Take a look at the worst five components of 2009:

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That's pretty ugly, with an average return of -1% despite a surging market that added 23% to the Dow Jones industrials.

Now look at how the same stocks performed year-to-date in 2010:

  • Verizon Communications, +9% in 2010
  • Procter & Gamble, +7% in 2010
  • General Electric, +20% in 2010
  • Wal-Mart Stores, +3% in 2010
  • ExxonMobil, +9% in 2010

Aside from from GE, most tracked or underperformed the Dow's +10% gain on the year, but the average return of the group is pretty darn close to the broader index.

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What Predicted the Best Stocks of 2010?

The short answer is "nothing."

Consider

McDonald's

(MCD) - Get Report

, which has gained almost 28% in 2010, almost four times the broader market. In 2009, however, it gained a mere 4% compared with a 22% gain for the Dow Jones.

Of course, some high-flying stocks did post another strong year. One of the best performers in the Dow of 2010 is

DuPont

(DD) - Get Report

, with a 50% return year to date. That comes after the stock nearly doubled the market's return in 2009 -- specifically, a 41% gain vs. 22% for the Dow Jones Industrial Average.

Perhaps most muddling is that most of the top performers this year were middle-of-the-road picks last year, including 2010's top-performing stock:

Caterpillar

(CAT) - Get Report

. CAT is up 62% year to date after only moderately outperforming the market in 2009 with 33% returns.

What does all this add up to? Unfortunately, not much. The clearest lesson drawn is an obvious one: Markets are cyclical and blue-chip stocks that had their moment in the sun one year rarely remain top performers in the next.

Or to beat a tired, old drum, past performance does not indicate future returns.

As you peruse the copious offerings of year-end stories out there, keep in mind that these stories are simply a lighthearted look in the rearview mirror and nothing more. They may be fun to read, but your best bet for a profitable 2011 is to focus on the future.

(Figures are calculated as of the close on Dec. 10.)

As of this writing, Reeves did not own a position in any of the stocks named here.

--Written by Jeff Reeves of InvestorPlace.com.

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This commentary comes from an independent investor or market observer as part of TheStreet guest contributor program. The views expressed are those of the author and do not necessarily represent the views of TheStreet or its management.

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