Is Four Enough?

by Ethan Haskel ([email protected])

Baltimore, MD. (Oct. 7, 1998) -- Last week we waxed poetic about why I use mechanical screens to choose stocks. One logical question rolling off Foolish tongues might be, "Cormend, why do we need yet another screening model besides the Dow Dividend approach? Won't that terrific track record of the Foolish Four (or its variants) allow us to continue raking in the green stuff for many years to come?"

Yes... and no.

If there's one characteristic of Fools that I admire, it's their amazing ability to count -- a talent finely honed over the years. These same Fools recognize that strategies based on the Dow Dividend theory (such as the Foolish Four and the RP4) choose an excellent group of four stocks as the bedrock of one's portfolio.

It doesn't make much sense to me to have the quality of one's retirement years hanging on a portfolio in which any one stock consumes a quarter of the investment pie. I don't care if the stock is Union Carbide, Eastman Kodak, or even Microsoft for that matter. As Robert Sheard has so eloquently illustrated, a basket of 15 or 20 stocks is the best insurance policy against owning that inevitable stinker.

Simply put, I feel much more comfortable holding about nine or ten Dow Dividend-like stocks. From many conversations I've had with Fools through the years, apparently I'm not alone. A strategy like the High Yield 10, composed of the 10 highest yielding stocks of the Dow, might serve the same purpose. Yet the performance of the High Yield 10, although market-beating, might leave Fools craving more.

There was another nagging question about the Beating the Dow strategies that I just couldn't dismiss. Maybe it's those multimillion-dollar Unit Investment Trusts, which invest in the Beating the Dow strategies, currently offered by many of the largest investment firms. Maybe it's those persistent advertisements for "Dogs of the Dow" workshops advertised ad nauseam in my local paper. Or mutual funds created to invest in those Dogs. Or local TV finance reporters extolling the canines' virtues. It just seems to me there's a whole lot of money that's becoming Foolish money, and the contrarian in me wants to stay a wee bit ahead of the game.

(I'm not going to get up on my cyber soapbox and say that the Dow Dividend strategies have become too popular to continue to produce All-World returns. That's still an open question in my book, and one I hope to address in more detail in a future column.)

For further guidance, let's turn to James O'Shaughnessy. In his landmark book What Works on Wall Street, O'Shaughnessy searched 43 years of an extensive database to find what strategies worked consistently, decade in and out. One of his conclusions:

"Large, well-known market-leading companies are much better investments when they have a value characteristic like low P/E ratio or low price-to-cashflow ratio, but the best criterion is dividend yield [italics mine]."

"The returns from buying the 50 market-leading stocks with the highest dividend yields are so outstanding that this strategy should serve as a cornerstone value strategy for all portfolios... [This strategy] has the highest risk-adjusted returns of all strategies examined... [and] does better than Large Stocks in bull and bear markets, leading the market in most bull years and providing a cushion in bear years."

That's the cornerstone strategy I need and one other Fools might find useful. Though a 50-stock portfolio is impractical for individual investors, why not unearth five additional market-leading companies that pass a few simple screens? Voila, we're set!

Beating the S&P (BSP) was created out of such dreams and machinations. There are many fine market-leading companies that don't happen to be included in the Dow Jones Industrial Average. In my next column we'll discuss how Fools might go about finding these companies, and how we all might profit from their discovery.

Year to date returns (as of 10-06-98): 
 BSP        +12.2% 
 S&P 500     +1.5%

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

What Happened to Robert Sheard?