Fool.com: Fundamentally Strong (Workshop) September 4, 1998

Fundamentally Strong

Atlanta, GA. (Sept. 4, 1998) -- Over the last few days, I've received a lot of great feedback, and I want to reiterate what Bogey has said before. We know you love the mechanical models, and we're going to do our best to keep you happy. Period. We'll be getting you all the data you need and offering continued commentary similar to what Robert has provided in the past.

At the same time, though, I'd like to try to interject more fundamental analysis into the workshop. That means making more use of the previously ignored rising/falling margin screens to generate specific investment ideas. It also means looking at how greater emphasis on fundamental analysis can bring something valuable to the existing mechanical models. Even unemotional investors need to analyze what they're buying, in my view. So rather than sift through the rising margins list today as I had promised to do, I want to try to make what I'm doing a little more obviously relevant to you, the workshop reader.

To do that, I think you should know where I am coming from. I personally don't believe in black box investing as a general practice. Buying a Standard & Poor's 500 Index fund makes sense to the extent that it guarantees you a market performance, and that's a major accomplishment for most mutual fund investors. The Dow Four strategy makes sense because it targets relatively undervalued stocks among an incredibly select group of behemoths, and thus offers built-in safety. Outside of the various Dow approaches, though, I'm uncomfortable using any screen as an immediately and totally investable basket of stocks. Broadening your universe of stocks beyond the biggest of the big boys simply introduces additional risks.

Let me explain by way of example. Relative strength (RS) rankings from Investors Business Daily play a crucial role in several of the mechanical models. Yet some issues that appear on a screen of stocks with 90+ relative strength rankings are great stocks to avoid or to sell short. (Short-sellers sell borrowed shares with the hope of replacing them later at a lower price after a stock falls.) For example, that disco duck music retailer K-tel <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: KTEL)") else Response.Write("(Nasdaq: KTEL)") end if %> would have appeared on some RS screens this spring, yet there's rarely been a better example of a stock likely to crash once the hype had died down.

Now consider ICN Pharmaceuticals <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ICN)") else Response.Write("(NYSE: ICN)") end if %>. ICN made it onto several of the mechanical model screens in late December at around $49 a share. Though it spiked into the high $60s in March, it has since plunged below $16. Given this company's poor management and turbulent history, this collapse isn't surprising. I would argue that adequate fundamental research on the stocks produced by these relative strength screens would have led an investor to avoid ICN. Assuming you had done so but invested in the other nine stocks on the RS-26 screen, you would have managed, as of August 26, a market-beating 15.8% return instead of a market-losing 10.5% return. In this example, then, you would have boosted your results by 50% simply by avoiding one obvious dog.

Why, then, go to the trouble of researching the fundamentals? Because you can almost certainly enhance your investment returns.

Let's look closer at the latest Workshop Returns. Looking at just one period of time can be no more than suggestive, but I'd like to point out that nearly all of these portfolios benefited disproportionately from one stock, Dell Computer <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: DELL)") else Response.Write("(Nasdaq: DELL)") end if %>, which the other workshop screens might have highlighted as one of the, if not the, strongest fundamental investment candidate. Moreover, I'm fairly certain that the rising margins screen would have found Dell as well as the other top performer, Best Buy <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BBY)") else Response.Write("(NYSE: BBY)") end if %>, before they showed up in these models.

Here are seven of the models with their year-to-date (YTD) performance (to August 26), with Dell (up 206.25%) excluded and, where applicable, with Best Buy (up 175.93%) also excluded.

 
 Model      YTD    -DELL   -DELL/BBY 
 Keystone   35.9%   17.0%   N/A 
 RS-IBD     35.6%   16.7%  -3.3% 
 RS-26W     10.5%   N/A    -7.8% 
 UG          1.3%  -21.5%   N/A 
 IFG-C       6.9%  -15.2%   N/A 
 IFG-RS     20.9%    0.4%   N/A 
 F90        22.2%    1.7%   N/A

With the S&P up 11.7% year-to-date as of August 26, no investor using the Keystone or RS-IBD model would have been disappointed, even without Dell. But investors using the other models would have been hurting without one or the other. Though this sounds like I'm making the same stupid argument used against the Fool Port ("Throw out AOL and Amazon and it's not doing so hot!"), I hope I'm actually not. I'm more interested in figuring out how we might have put together a portfolio that included just the top performers from the various screens by comparing screen results and digging a little deeper into the fundamentals.

Would triple digit returns be possible? Probably not, but since this is a workshop, I'm going to take a look next time at how the rising margins screen alone might have helped us spot these two winners early on (as it would have done with American Woodmark, discussed Tuesday). I also would like to determine if (and when) a rising margins screen would have filtered out some of the losers in these model portfolios.

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

What Happened to Robert Sheard?