The Pinnacle Portfolio System

Beating the market isn’t easy. In fact, it’s extremely difficult to do.

But beating the market is possible. I know… I’ve done it.

The key is to use an investment approach that shifts the odds in your favor – a method that allows you to avoid “bad risks” and embrace “good risks.”

Obviously, these twin objectives are easier said than done.

But I’ve identified three keys that have proven to beat the market. I call this trifecta my “winning formula.” You’ll read more about each key below, and you’ll also learn how they fit together to serve as the foundation of Fry’s Pinnacle Portfolio.

If you can master my winning formula, you’ll be well on your way to market-beating returns.

3 Keys to Outperforming the Market

Winning big begins by losing small.

Warren Buffett said it best when he declared, “Rule No. 1: Never lose money. Rule No. 2: Don’t forget rule No. 1.”

Return of capital is much more important that return on capital.

Over the long term, simply not losing can build tremendous wealth. But a “safety first” approach to investing doesn’t mean avoiding all risks… just the bad ones.

“Safety first” means having the discipline and patience to say no to bad risks while still having the courage and conviction to say yes to good risks. (If you’re wondering how to decipher between good and bad, don’t worry – I’ll get to that below.)

After saying yes, it’s essential you diversify and manage your good risks as well as possible in order to maximize their returns.

That’s the winning formula…

• Discipline
• Decisiveness
• Diversification.

Let’s dive into each one of these…

Discipline: Saying No to Bad Risks

A disciplined investor is a patient investor. Patience is the single most essential trait for investing successfully.

To outperform the market, an investor must maintain the discipline of saying no to bad risks… and do that as often as necessary until good risks come along.

That sort of discipline isn’t easy. It’s hard to say no to high-flying stocks when everyone else seems to be saying yes. It’s like leaving a cocktail party when the drinks are flowing and all the attendees are feeling jolly.

But just like the old expression “No good decision is ever made after 2 a.m.,” no good investments are ever made after a stock becomes richly priced and loses momentum.

You need the confidence and restraint to say no… and to wait patiently for better opportunities.

But what’s a bad risk, and how do you spot one? A bad risk is also called an “asymmetrical risk.”

It’s a proposition where the potential upside is much smaller than the potential downside. Here’s an example (albeit an extreme one) to illustrate the concept…

Let’s say you decided to ride over Niagara Falls in a barrel for a $20 prize. If everything works out perfectly, you win $20. If not, you probably perish.

Here’s another example…

You decide to run red lights to get to Disneyland 10 minutes early. If everything works out just right, you make it to the “Happiest Place on Earth” 10 minutes earlier than expected. If it doesn’t, you may get in a horrible accident.

These examples of asymmetrical risk are so obvious that they seem ridiculous.

But many asymmetrical risks are less obvious – like jaywalking in broad daylight…

In all likelihood, the jaywalker will cross the street without incident. But if the jaywalker happens to encounter a distracted driver texting a joke to a friend, something bad can happen… something very bad.

In the financial markets, many asymmetrical risks seem as benign as jaywalking. They’re not always obvious. That’s why so many investors take asymmetrical risks every day… and never even know it until harm comes their way.

But disciplined investors understand the dangers of these risks. Disciplined investors begin their analysis by asking, “What can go wrong?” rather than “What can go right?”

They also understand that investing is optional and they must be selective.

That’s the exact approach we take in Fry’s Pinnacle Portfolio. We don’t kiss a lot of frogs to find a prince… we toss frogs aside until we find a prince.

This is the kind of discipline required to succeed in the markets… and like all disciplines, it is learned behavior.

As you follow my Pinnacle System, you’ll learn greater investment discipline and will become more comfortable saying no to bad risks.

We cannot afford to take risks that might work but that are likely to cause serious harm if they don’t. The math of lost capital is daunting. If you suffer a 50% loss, you need to double your money just to recoup your losses.

Rather than saying no to bad risks, many investors grow impatient. They justify buying richly valued stocks by comparing them to stocks that are even more richly valued. But that logic is very dangerous…

It’s no different from sleeping 30 feet away from a pride of lions because other campers are sleeping only 20 feet away.

It’s quite possible that you’ll wake up every morning still 30 feet away from the lions, just like the morning before. But a less favorable outcome is also possible, if not probable. Net-net, this would not be an ideal self-preservation strategy.

Avoiding bad risks is the essential first step toward outperforming the market.

With my Pinnacle System chart patterns, the “bad risks” often lie in the red “Sell Zone.” These stocks are very richly valued… and are losing momentum.

Sure, some of the stocks might regain their momentum and move up to even higher valuations. But that’s a bad bet. And if you lose that bet, the downside risk is very large.

When richly valued stocks finally start to fall, they usually fall a long way.

The richly valued stocks in the red zone are not the ones we want to buy. They’re the ones we want to avoid.

The stocks we want to own have the opposite traits. They are undervalued and gaining momentum. These are the “good risks” that deserve a yes from disciplined investors.

Decisiveness: Saying Yes to Good Risks

You cannot outperform the market by simply “buying the market.”

In other words, you cannot just buy an S&P 500 index fund or a cluster of big-name U.S. stocks and expect your investment to perform any differently than the broad U.S. market.

If you want to outperform the market, you must take calculated, thoughtful risks… and say no to all the others.

You may have to wait a long time for truly superior investment opportunities to come along. But that’s okay. They are worth the wait.

Warren Buffett didn’t become one of the world’s richest individuals by making lots of mediocre investments. He waited for the very best opportunities… and then pounced on them.

To emphasize how patiently he awaits opportunity, Buffett once remarked, “Lethargy bordering on sloth remains the cornerstone of our investment style.”

In my Pinnacle System, the stocks worth waiting for are the ones that lie in the green “Buy Zone.” These are the stocks that offer asymmetrical reward – rather than asymmetrical risk.

They are in the early stages of their profit life cycles. They are gaining momentum and starting to climb from their low valuations.

It is well-known that low-valuation stocks outperform high-valuation stocks over long periods of time. This tendency is the fundamental basis of “value investing.”

There are literally dozens of academic studies from all over the world that demonstrate the power and superiority of value investing. Here’s one of the most well-known examples…

In 1992, Tweedy, Browne Company published a fascinating report titled “What Has Worked in Investing: Studies of Investment Approaches and Characteristics Associated With Exceptional Returns.”

The report presented the findings of various academic studies that examined the connection between the starting valuation of a stock and the subsequent investment results.

And in short, the report concluded that “time and time again… contrarian, value-based strategies not only succeed, but succeed consistently.”

Here is just one example from the Tweedy, Browne report…

In a Morgan Stanley research report dated April 8, 1991, Barton M. Biggs – then a managing director at Morgan Stanley – described a study that examined the returns from investing in non-U.S. and U.S. stocks trading at low price-to-book values.

In the study, all stocks in the Morgan Stanley Capital International database were ranked according to their price-to-book values and sorted into deciles each year from 1981 through 1990 – a total of 10 years.

Approximately 80% of the companies in the database were non-U.S. companies. Returns for each price-to-book value group were compared to the return for the Morgan Stanley Capital International global equity index. The investment returns were equally weighted and expressed in U.S. dollars.

Here’s why it matters… The report found that $1 million invested in the highest price-to-book value companies would have increased to $3.65 million by the end of 1990. That’s not bad.

But $1 million invested in the lowest price-to-book value category would have increased to more than double that amount – $7.95 million.

Decile	Compound Annualized Return	Return in Excess of Market Index
1 (Lowest price to book valuation)	23.0%	5.1%
2	18.8%	0.9%
3	18.6%	0.7%
4	18.4%	0.5%
5	16.2%	-1.8%
6	19.3%	1.4%
7	18.2%	0.3%
8	16.3%	-1.6%
9	15.7%	-2.2%
10 (Highest price to book valuation)	13.8%	-4.1%

The academic analyses cited in the Tweedy, Browne report are not merely studies. They’re observations of real-life tendencies that repeat themselves over and over again in financial markets.

But as great as value investing strategies have worked in the past, they could have worked even better if investors had considered a stock’s momentum.

“Momentum” is a term you have probably heard before in the context of investing, but maybe you aren’t clear on what it means…

When most investors talk about a stock’s momentum, they are talking about a stock’s trend, either to the upside or the downside.

So a stock with “good” or “strong” momentum is a stock that is in an established upward trend. A stock with “bad” or “poor” momentum is one that is in an established downward trend.

The drawback of most value-based investment strategies is they fail to monitor and optimize momentum trends.

My Pinnacle System is different. It marries value investing with momentum investing for an approach that’s much more powerful than just a sum of the two strategies.

For any stock, my system analyzes more than 8,000 data points to determine where it is in its profit cycle. And by marrying value and momentum, my system identifies the ideal moments to “buy low.” It signals the low-valued stocks that are gaining momentum – the kinds of stocks that deserve a yes from investors.

When we identify these opportunities, it is essential to buy with conviction. That means…

1. Taking a position that is large enough to produce a personally meaningful reward. If you’ve got a real winner, you don’t want to make $100 with it – you want to make an amount that will impact your net worth in a meaningful way.
2. Taking a position that is small enough that you are able to give it time to work without stressing out about it. Small positions in excellent stocks can become big positions in a hurry. That’s a much better “problem” to have than establishing a position that’s too big for comfort and then feeling like you need to trim it down if it falls even a little bit.

Diversification: Spreading Your Money Around

To some folks, diversification seems defeatist or lazy. It seems like playing defense – or like a kind of surrender…

And that’s exactly correct!

Diversification is a defensive strategy and a surrender to the unknown. We diversify our portfolios because we cannot know exactly what the future holds nor can we know the exact time frame over which our investments will excel.

Berkshire Hathaway, for example, was an excellent company in December 2007, when its market value was $230 billion. It was also an excellent company one year later when its market value had plummeted to nearly $100 billion – or less than half of what it had been one year earlier.

Who knew that this excellent company would lose half its market value in 12 months?

But that’s what happened. In late 2008, investors were panicking about the financial crisis. And as they panicked, they dumped stocks, including Berkshire Hathaway. Meanwhile, the price of the 30-year Treasury bonds soared more than 50% during the 2008 financial crisis, the price of silver jumped 70%, and the price of crude oil doubled.

That’s why we diversify. By doing so, we reduce the risk of catastrophic loss while improving the odds of compounding profits over time.

Diversifying across various financial markets and asset classes has worked wonders for generations… and it is certain to work wonders in the future. That’s why it’s part of my Pinnacle System.

The basic elements of portfolio diversification include U.S. stocks, bonds and cash. And an intelligent mix of these three assets can deliver higher risk-adjusted returns than a portfolio that holds only U.S. stocks.

But a broader mix of assets that also includes exposure to foreign stocks and commodities can produce an even better result. That’s why my Pinnacle System recommends trades on every major asset class in the world, not just on U.S.-based asset classes.

However, there is a second kind of diversification that’s unique to my Pinnacle System. It is what I call “trade structure diversification.”

This type of diversification provides a second layer of protection by dampening a portfolio’s overall risk profile and volatility. It means that our investments take different forms.

With Pinnacle, for example, we diversify by using stocks, exchange-traded funds and options. The risk profile of each investment determines the structure of the trade.

For example, in the very early stages of a stock’s life cycle, when it is in the green “Buy Zone,” it is prone to high volatility. It is likely to bounce around for a bit and “retest” its recent low before moving decisively higher.

Owning the stock directly in this circumstance can be nerve-wracking. So instead, we may buy a long-dated call option, making short-term volatility of little concern. With the long-dated call, we know our risk is limited while our potential reward remains limitless.

ETFs can provide a different sort of trade structure diversification. Buying a sector ETF instead of an individual stock or option can reduce the volatility and risk of a particular position.

So by combining stock positions with options and ETFs, we gain a second layer of diversification. This layer not only dampens overall portfolio volatility and risk, but also creates the stability that allows our winning investments to realize their full potential.

Bottom line: If you want to outperform the market – as we’ll do in Fry’s Pinnacle Portfolio – begin by remembering the three D’s…

• Discipline
• Decisiveness
• Diversification.

We’ll use this approach in the short term to achieve our “10x in 12 months” goal on the six biggest opportunities on my radar right now. These trades are detailed in your report “Beat the Street With America’s Top Trader.”

But we’ll also apply this approach to rack up steady returns over the long term in both the Investors and Speculators parts of our portfolio.

As I think you’ll quickly find out, my Pinnacle System puts you in the right stocks at the right time to score big winners.

And that’s it. Now it’s time to turn this strategy into profits. With your subscription to Fry’s Pinnacle Portfolio, you have access to my very best research findings.