<THE FOOLISH FOUR>

Foolish Four Report
by Robert Sheard

LEXINGTON, KY. (Jan. 5, 1998) -- Let me venture once more into the fray and try to eliminate some of the confusion plaguing the Dow Area today. As I see it there are three main sources for the current confusion.

First, last week the Gardners announced that they're adopting a modified variation of the Dow Dividend Approach for the Foolish Four model we follow in this area. In the past, the Foolish Four approach automatically skipped the cheapest of the Dow High Yield Ten stocks and bought the next four stocks on the low-price Beating the Dow list, doubling the weight of the #2 stock.

For the new 1998 model, however, the Foolish Four model is following what we've been calling the Unemotional Value approach. This approach simply buys the four lowest-priced Beating the Dow stocks with one exception. When the lowest-priced stock also carries the highest dividend yield in the group, we skip that stock and buy numbers 2 through 5 on the BTD list. It doesn't happen all that often, but when it has happened historically, it's been a fairly dependable signal of a stock in real financial trouble.

Why the switch? Since 1961, the beginning of our Dow database, the old Foolish Four model has returned 17.4% a year. The new Foolish Four has returned 18.1% over the same period. But just as important, the new Foolish Four (the Unemotional Value approach) has accomplished this without taking on the added risk of putting 40% of your portfolio into a single stock. Higher historical returns with less per-stock risk? You bet the switch makes sense.

I'll be working as quickly as possible this week to revise and update the many references to the Foolish Four method in our forum so that they're consistent with this new method. Please bear with us while we tidy up.

The second source of confusion comes from a mistake in the 12/31 rankings I made and didn't catch until the morning of January 2. When I calculated the yields for the 30 Dow stocks on Wednesday, I failed to notice that both DuPont <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: DD)") else Response.Write("(NYSE: DD)") end if %> and Union Carbide <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: UK)") else Response.Write("(NYSE: UK)") end if %> had yields of 2.10%. Many months ago on our message board, we had a good discussion of whether to carry out the yield calculations as far as they can go to break such ties or to accept a rounded-off number at some point.

The consensus agreement from that discussion was that we should round off the yield to two places beyond the decimal and leave it at that. When stocks were tied for the tenth and final spot (as Union Carbide and DuPont were at the close on Wednesday), the procedure would be to give preference to the stock with the lower stock price. That should have been Union Carbide. But alas, I missed the tie and mistakenly listed DuPont on Wednesday evening as one of the new Foolish Four choices. I regret the oversight, of course, but in the interest of consistency I explained in my January 2 column that the correct rankings should have included Union Carbide, and so that's what we'll indeed track throughout 1998.

If you bought DuPont, should you switch? Absolutely not. The rankings are at best an imprecise art, and by the end of the trading on January 2, in fact, DuPont was right back among the current Foolish Four again. Regardless of when you buy your four stocks, the rankings will continue to fluctuate and you should simply hold what you have for the duration of the year.

The third source of confusion, and the one that took me the most by surprise, surrounds the prices we list as our opening prices for this year. It's important to remember that the Foolish Four portfolio is not a real-money portfolio; it never has been. It's a paper model that we track only as an example of how one calculates the rankings each year and then sticks with the same group of stocks throughout the full annual cycle. And in fact, the head Fools have agreed to remove the Foolish Four portfolio from the Hall of Portfolios, where all of the other entries ARE real-money portfolios, to clear up some of this confusion. In the future, the Foolish Four portfolio reports and numbers will only be located within our Fool's School area. Any such hypothetical model, however, has to start at an arbitrary point. The point we selected was the final prices at the end of the previous trading year. This makes back-testing easy; it makes tracking against major indices easy; and it's as good as any other arbitrary price.

This year that arbitrary starting point caused a big discrepancy between theory and reality because the stock market gapped up at the opening bell on Friday and no one buying on January 2 would have been able to get the prices available at the close on 12/31. Let me point out that had the market dropped instead of risen, the same would have been true in reverse.

In e-mails and message folders since Friday I've been called a liar and a fraud for this practice as if I've somehow manipulated the numbers to make them look better and am somehow responsible for the poor prices investors got who bought on January 2. Nothing could be further from the truth, and frankly, the viciousness of the accusations are appalling. I have no vested interest one way or the other in what numbers are counted as "official" prices. I'm simply following the pattern we established quite some time ago for tracking annual hypothetical models. You are free to follow along or ignore this model portfolio as you choose, of course.

The most disturbing truth to come out of this confusion is that we, as Fools, have far more work ahead of us than I imagined in teaching the idea of personal and individual responsibility for one's investments. If you're following our rankings blindly, without bothering to verify the numbers the one day a year you trade, you're not doing your job as your own portfolio manager. Everyone is fallible, as I proved in overlooking the tied dividend yields Wednesday, but it's your money and your responsibility to make and live by your investment decisions, regardless of what you read here in The Motley Fool or anywhere else. Our goal is to help you learn to manage your portfolio yourself, not to manage it for you from a distance, anonymously and for free. When my mistake was brought to my attention about overlooking Union Carbide, I explained what had happened in my next column and my opening prices are consistent with other annual models we've tracked. To accuse me of deception in this matter is simply untrue and undeserved. I won't accept that responsibility.

Feel free to disagree with the way our model is tracked. I recognize the validity of a lot of different viewpoints on this and to remove the apparent discrepancy with our opening prices and the dates we "acquired" the stocks, I'll revise the dates for each to read 12/31/97 instead of 1/2/98. But if your disagreement with our procedure is reduced to the lowest common denominator -- adolescent name-calling -- don't expect Foolish readers who are here to share what they discover and learn from each other to pay you any attention. Life's too short for that kind of silliness.

Regardless of what you hold or what your attitude is towards our models, I wish you a prosperous new year. Let's move on to something more useful.

TODAY'S NUMBERS

Stock Change Last -------------------- UK -1 3/8 42.63 IP + 15/16 46.13 MO + 5/8 45.88 EK - 15/16 62.94

Day Month Year FOOL-4 -0.29% 2.88% 2.88% DJIA +0.18% 0.89% 0.89% S&P 500 +0.21% 0.69% 0.69% NASDAQ +0.80% 1.51% 1.51% Rec'd # Security In At Now Change 12/31/97 289 Int'l Pape 43.13 46.13 6.96% 12/31/97 206 Eastman Ko 60.56 62.94 3.92% 12/31/97 276 Philip Mor 45.25 45.88 1.38% 12/31/97 291 Union Carb 42.94 42.63 -0.73% Rec'd # Security In At Value Change 12/31/97 289 Int'l Pape 12463.13 13330.13 $867.00 12/31/97 206 Eastman Ko 12475.88 12965.13 $489.25 12/31/97 276 Philip Mor 12489.00 12661.50 $172.50 12/31/97 291 Union Carb 12494.81 12403.88 -$90.94 CASH $77.19 TOTAL $51437.82