<THE FOOLISH FOUR>

Which and why
by Ann Coleman
(TMF AnnC)

Alexandria, VA. (September 14, 1998) -- Although we focus on the Foolish Four strategy in this area, there are other ways to take advantage of the Dow Dividend Approach. Our Dow Dividend Approach/Foolish Four message board is a hive of activity, with Fools constantly testing new strategies to identify which Dow companies are likely to outperform the market in the next year or two. Some of them are quite promising.

In this area we confine our comments to three strategies: The High Yield Approach (also known as the Dogs of the Dow), the Foolish Four, and the RP variation. Back in April Robert Sheard discussed the mechanics of each system in Nuts and Bolts, Part I and Part 2, so we don't need to get into that in depth (just click the links for a quick refresher), but let's look at some things you should consider when choosing between the three. Today we will look at the High Yield 10 approach.

The High Yield 10 approach is easy, stable, and has been backtested an impressive 69 years. In How to Retire Rich, James O'Shaughnessey reports that this ridiculously simple strategy of buying the 10 highest yielding Dow stocks each year has beaten the Standard & Poor's 500 Index in every decade and in all but two rolling 10-year periods since 1929.

Note on Rolling Returns: There are 6 full decades between 1929 and 1997, but there are 49 rolling 10-year periods: '29-'38, '30-'39, '31-'40, etc., all the way through '88-'97. Using rolling 10-year periods is a much more informative way to look at the data. In this case it tells you that no matter when someone started the strategy, they had a pretty good chance of beating the S&P 500. (Actually, How to Retire Rich only published returns through 1996, but our data confirms that the '88-'97 period went to the Dogs.)

Our data also shows that the High Yield 10 beat the S&P in 28 of the last 33 rolling 5-year periods and in every rolling 15- and 20-year year period we studied (our data goes back to 1961).

What else is good about the High Yield 10 strategy? Well, its returns are relatively stable compared to most other investment strategies. To illustrate stability we need to talk about the dreaded standard deviation. DON'T LEAVE! I will try to make this as painless as possible. Standard deviation is a measure of variability -- the larger the standard deviation, the more the results being studied varied. Here's a quick (and very simple) example: Suppose you had invested $10,000 each in two different stocks and three years later, they were both worth $20,000 -- but in the meantime, they had had very different histories. 

 
                  Stock A    Stock B 
 End of Year 1    $13,000    $15,000 
 End of Year 2    $16,000    $ 8,000 
 End of Year 3    $20,000    $20,000

If a very astute and learned statistician were to calculate the Standard Deviation for each of these two stocks over this time period, he would announce gravely that Stock A had a lower Standard Deviation. Standard deviation measures the variability of a set of numbers. Think of it as the Insomnia Index.

You may already be guessing that the High Yield 10 has a nice, low standard deviation, but it's even better than that. The HY10 has the lowest SD of any strategy we've studied and actually has a lower standard deviation than the S&P. Yes, it has beaten the market AND caused investors fewer sleepless nights.

So that's what's good about it.

What's not so good?

The negatives: 1) The returns, while quite respectable compared with the S&P, are lower than Foolish Four. 2) Because it is a 10-stock system, the trading costs are higher.

Investors with at least $10,000 to invest and a high Insomnia Susceptibility Quotient would probably be happier with the more stable returns of the High Yield 10 Approach. If this super-safe strategy appeals to you, though, do consider using one of the less expensive brokerages. If your trading costs exceed 2%, you could lose much of the advantage that this system has over an index fund.

Stay tuned. Wednesday we will look at Risk and The Foolish Four.

Fool on and prosper!

Current Dow Order | 1998 Dow Returns

What Happened to Robert Sheard?

09/14/98 Close
Stock  Change   Last 
 -------------------- 
 UK   +  11/16  38.94 
 IP   +  11/16  42.38 
 MO   +   3/4   43.94 
 EK   +2  5/16  80.31 
  
 
 
                    Day   Month    Year 
         FOOL-4   +2.08%   4.64%   6.01% 
         DJIA     +1.92%   5.39%   0.47% 
         S&P 500  +2.05%   7.54%   6.11% 
         NASDAQ   +1.47%  11.11%   6.07% 
  
     Rec'd   #  Security     In At       Now    Change 
  
  12/31/97  206 Eastman Ko    60.56     80.31    32.61% 
  12/31/97  289 Int'l Pape    43.13     42.38    -1.74% 
  12/31/97  276 Philip Mor    45.25     43.94    -2.90% 
  12/31/97  291 Union Carb    42.94     38.94    -9.32% 
  
  
     Rec'd   #  Security     In At     Value    Change 
  
  12/31/97  206 Eastman Ko 12475.88  16544.38  $4068.50 
  12/31/97  289 Int'l Pape 12463.13  12246.38  -$216.75 
  12/31/97  276 Philip Mor 12489.00  12126.75  -$362.25 
  12/31/97  291 Union Carb 12494.81  11330.81 -$1164.00 
  
  
                              CASH    $754.73 
                             TOTAL  $53003.04