<THE FOOLISH FOUR>

Too Many Fools?
by Chris Rugaber
(TMF RFK)

Alexandria, VA (October 29, 1998) -- Today I want to look at a perennial question here in Foolish Four-land: what if so many people start to follow the Dow Dividend Approach, in one form or another, that it no longer "works?" This is not just a Foolish question. Various financial analysts raise it all the time, most recently in an article provocatively entitled Neutering the Dogs of the Dow at Quicken.com.

Let's clarify the question. On our message boards, for example, Fools have speculated that if hundreds of thousands, or even millions, of people buy some variation of the Dogs of the Dow during the December-January period, it will drive up the price of the higher yielding stocks to artificial levels. Then, if you bought at a higher price, won't that ultimately reduce your gains?

Of course, the way to determine whether the approach "works" or not is to continue to track its returns over time. In the shorter term, we can look at prices and trading volumes to see if they tell us anything.

One approach is to examine some basic price and volume charts to at least determine if this is worthy of further investigation. Using this year's Foolish Four virtual portfolio, "purchased" on December 31, 1997, we can use the charting function here at the Fool Quotes & Data area and check trading volumes and price fluctuations for each stock. I also looked at a twenty-day moving average line to see how daily prices diverged from the general trend.

This rudimentary form of analysis demonstrates that there were some small, short-term price increases around January 1, 1998 for three of the four Dow stocks we are following in the Foolish Four portfolio this year. If you click on the following links you can see that the daily prices spiked up above the 20 day moving average line for a few days, then fell back. To put this in perspective, though, the full Dow showed that same little spike.

Eastman Kodak <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: EK)") else Response.Write("(NYSE: EK)") end if %> Philip Morris <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MO)") else Response.Write("(NYSE: MO)") end if %> and International Paper <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: IP)") else Response.Write("(NYSE: IP)") end if %> all rose slightly right around the beginning of the year, but the rises hardly stand out compared to the normal ups and downs. Perhaps more important for us, mid- to late December showed no unusual price rises. In fact, these three stocks were either flat or dropping during that period. The other Foolish Four stock, Union Carbide <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: UK)") else Response.Write("(NYSE: UK)") end if %>, was flat at the first of the year. Furthermore, trading volumes didn't fluctuate more than normal for any of the Fool Four stocks; unsurprisingly, most of them saw much greater fluctuations around earnings reports.

Clearly, this exercise is limited in value, but it does show that there were no extraordinary spikes in price or trading volume in the most recent late December to early January period. The argument that the Dow Dividend Approach causes these stocks to artificially inflate in price through a sudden surge in demand is far from proven.

There are some other, obvious reasons why the popularity of the Dow Dividend Approach is unlikely to be an insurmountable problem. First, those who follow it use different variations or start at different times. Here in Fooldom, for example, the Fool Portfolio, the Cash-King Portfolio, and the Fool Four Portfolio itself all have different Fool Four stocks purchased at different times.

Another reason is that individual investors still aren't driving the market in most cases. Michael O'Higgins, in his book Beating the Dow, writes that money management professionals "account for three-quarters of all trading activity and determine which way the Dow and other major indexes move." If this is the case, then individual investors are unlikely to have much effect.

Things may have changed since O'Higgins wrote his book in 1991, however. A number of brokerages have formed unit investment trusts (UITs -- kind of like a mutual fund, but different) that buy the Dogs of the Dow, so now some institutional investors are following a version of the Dow Dividend Approach. Most Dow UITs hold a High Yield 5 or 10 stock portfolio. It should be more productive to investigate how these trusts may impact the Dow strategies. How much of the Dow stocks do individual investors own? How much money is in these UITs? What kind of investing protocol do these UITs follow? We'll look at these and other questions next week.

Current Dow Order | 1998 Dow Returns

10/29/98 Close
Stock  Change   Last 
 -------------------- 
 UK   -   1/16  38.00 
 IP   -   3/16  44.31 
 MO   +   3/16  51.81 
 EK   +1  7/16  75.94 
 
 
                    Day   Month    Year 
         FOOL-4   +0.51%  -1.54%   9.12% 
         DJIA     +1.47%   8.32%   7.42% 
         S&P 500  +1.66%   6.77%  11.90% 
         NASDAQ   +1.14%   3.74%  11.90% 
  
     Rec'd   #  Security     In At       Now    Change 
  
  12/31/97  206 Eastman Ko    60.56     75.94    25.39% 
  12/31/97  276 Philip Mor    45.25     51.81    14.50% 
  12/31/97  289 Int'l Pape    43.13     44.31     2.75% 
  12/31/97  291 Union Carb    42.94     38.00   -11.50% 
  
  
     Rec'd   #  Security     In At     Value    Change 
  
  12/31/97  206 Eastman Ko 12475.88  15643.13  $3167.25 
  12/31/97  276 Philip Mor 12489.00  14300.25  $1811.25 
  12/31/97  289 Int'l Pape 12463.13  12806.31   $343.19 
  12/31/97  291 Union Carb 12494.81  11058.00 -$1436.81 
  
  
                              CASH    $754.73 
                             TOTAL  $54562.42