Tuesday, April 14, 1998

The Daily Workshop Report
by Robert Sheard (TMF Sheard)

LEXINGTON, KY. (April 14, 1998) -- Yesterday I wrote about the Unemotional Growth strategy and its near-40% annual returns since 1987. But we all know that volatility can be a wicked deterrent to using the most aggressive of approaches. So today, I'll devote this space to a much more sedate growth approach, but one that nevertheless blows away the Standard & Poor's 500 over the last dozen years -- the Keystone Growth Approach.

For newer readers, let me summarize the model. Starting with the Value Line Investment Survey (I use their electronic version to get the required information easily), I narrow the field down to the top 400 stocks, using their timeliness ranking. From that group, I eliminate foreign companies and identify the thirty largest stocks (based on market cap). Those are the Keystone 30. To choose from among them, I rank the thirty stocks in descending order based on their total returns over the previous six months. It's really fairly simple -- I'm using a proven ranking system (Value Line) and focusing on the largest stocks for stability. But choosing those with the best relative price strength affords us a very strong yet stable portfolio of market leaders to be held for a full year.

So far this year, the top five group is starting a little bit slowly, up 12.7% versus the S&P 500 Index's gain of 13.8% (all returns quoted here are year-to-date through April 8). But the rest of the Keystone 30 configurations are starting to put a little bit of distance between themselves and the S&P 500.

S&P 500 Index  13.8% 
 Keystone 5     12.7% 
 Keystone 10    17.0% 
 Keystone 15    16.6% 
 Keystone 20    15.5% 
 Keystone 25    15.8% 
 Keystone 30    17.7% 
 

Looking just at these groupings, it might seem counter-intuitive to focus on the top five or ten stocks; after all, so far in 1998, holding all thirty has produced a better profit than holding the top five. But in short tests, all sorts of distortions are possible. To get a better picture, let's look at the annualized returns for each of the groups and the S&P 500 from January 1, 1986 through April 8, 1998:

S&P 500 Index  17.8% 
  
 Keystone 5     29.0% 
 Keystone 10    25.8% 
 Keystone 15    24.4% 
 Keystone 20    23.3% 
 Keystone 25    21.5% 
 Keystone 30    21.0% 
 

As you can tell from the annualized returns, the higher-ranked stocks consistently perform the best over the long run, even if that's not always the case in shorter periods. A $10,000 stake in the S&P 500 Index in 1986 would now be worth $75,000. But invested in the five-stock Keystone Growth portfolio, the same $10,000 would have grown to $228,700 -- over three times as much as in the S&P 500 Index.

And as I've written on many occasions, my favorite perk with this approach is that it's been so stable throughout the whole twelve years, even though we've had some quick ups and downs. In fact, it held up even better than the Foolish Four approach in the last recession (in 1990). The following table lists the annual returns for the five-stock approach and the S&P 500, year by year:

Year     Key 5       S&P 
 1986      22.0%     18.5% 
 1987       8.1%      5.2% 
 1988       8.5%     16.8% 
 1989      59.2%     31.5% 
 1990      -0.3%     -3.2% 
 1991      71.8%     30.6% 
 1992      12.4%      7.8% 
 1993      36.3%     10.1% 
 1994       9.0%      1.6% 
 1995      43.8%     37.5% 
 1996      38.2%     23.3% 
 1997      56.6%     33.2% 
 1998      12.7%     13.8% 
 

If you add money regularly, you might want to consider what a number of readers are using -- a "Dozens" approach where one buys the highest-ranked stock each month that's not already in one's portfolio, holding each stock for a full year. The theory behind the Keystone Dozen is to gain the diversity of a twelve-stock portfolio, but always choosing from very high in the rankings by spreading out one's purchases across a full year. The hope is to get the returns typical of a much more concentrated portfolio with far less risk. (Plus, capital gains are still capped using a one-year holding cycle for each stock and commissions are limited to a maximum of 24 trades per year.)

If you're considering a large-cap growth strategy to complement your Foolish Four stocks, Keystone Growth may be one to kick the tires of. Fool on!

Check out the latest file updates for the Workshop:
New Rankings | 1998 Returns | New Database

[Robert Sheard is the author of the forthcoming book, The Unemotional Investor, due out from Simon & Schuster on May 12. To pre-order your copy, please visit Amazon.com, where it's available at a discounted price.]