<FOOLISH WORKSHOP>
A Value Percentage Index?
by Ethan Haskel ([email protected])
Baltimore, MD (Feb. 10, 1999) -- I'd like to elaborate a little bit on last Friday's Rule Breaker Portfolio column by Paul Larson, which touched on some topics of interest to us here in the Workshop. In a report running under the title "Low Blood Pressure," Paul mentioned that minimizing stress was an important part of maintaining a financial portfolio, a subject I discussed in a past column. He noted the excellent blood pressure readings of the editors and staff of the Rule Breaker Portfolio in a week during which their portfolio had lost over four percent of its value.
Check out the latest file updates for the Workshop:
Paul later mentioned that the Rule Breaker Portfolio was coming due to make its annual turnover for the Foolish Four stocks, the current Dow Dividend strategy for the Motley Fool. He had duly noted that last year's Foolish Four (excluding dividends) had underperformed the Standard & Poor's 500 Index, gaining 9.2% compared to 20.5% for the S&P 500. Partially because of this, and also due to the huge run-up in some of the other stocks in the portfolio, the Foolish Four composition had dropped to only about 9% of the overall dollar value of the portfolio.
The question was raised: Should the Rule Breaker Portfolio continue its previous policy and invest up to 20-25% of its capital in the Foolish Four stocks? Or should it, rather, keep them underweighted?
The issue really boils down to the role of value-style investments versus those of growth-style in one's portfolio. Value-style investors believe in owning companies whose intrinsic value is higher than that currently recognized by the market. Growth-style investors look for companies that have the potential to achieve skyrocketing earnings or revenue growth. There's no doubt about it. The last few years have seen the triumph of the growth investor over the value adherent. The S&P 500/BARRA Growth Index has outperformed its counterpart, the S&P 500/BARRA Value Index for the most recent one-, three-, five-, and ten-year periods. Yet using a longer term perspective, the returns of both indexes since 1975 are remarkably similar.
The undisputed victory of growth-style investing over the past decade has made it a tough go for value players recently, but if history is any indication, the pendulum will swing back eventually. When it does, those steroid-pumped growth stock hares are likely to get tripped up, while the value tortoises will creep slowly past them.
It's for these reasons that I feel every portfolio should have some component of growth and value investments. Assuming the portfolio is meant to stand on its own, so should the Rule Breaker Portfolio. This balancing maintains one basic component of diversification and certainly keeps the blood pressure in control on those days, like yesterday, when the Nasdaq decides to implode.
In fact, the more you tend to worry about your stocks, the higher the percentage of value stocks you should own in your portfolio. In general, the value stocks tend to be less volatile and do better in bear markets (some of us still remember what those are like). As you age, it's often a good idea to shift your investments to the steadier value companies, since you theoretically have less time to make up for the crashes that can accompany high volatility.
How much of a value component might be appropriate for your investments? Certainly there's no easy answer to this question, as there are a multitude of factors to consider. But I'd like to propose a Value Percentage Index (or VPI), which accounts for two important factors in making this decision: age and risk tolerance. For risk tolerance, I'll use a surrogate -- one's blood pressure.
Value Percentage Index = Age * (systolic blood pressure/140)
Thus, if I'm 41, and I have a systolic blood pressure of 120, I should consider placing 35% (41*120/140) of my stock portfolio in value stocks and the remainder, 65%, in growth stocks. For someone 65 years old whose systolic pressure is 160, consider maintaining 74% in value stocks (65*160/140).
Of course, this is no scientifically proven formula, but it makes some sense to me. You might consider trying out the VPI as a fun yardstick with which to measure your investments.
So, my recommendations to the Rule Breaker honchos? Definitely keep up at least a 20-25% investment in those value-added Fool stocks. Hey, and while you're at it, you might check into the Beating the S&P (BSP) variation of high yield investing as an alternative to the Foolish Four.
I just ran the numbers, and if you guys had invested in the BSP stocks instead of the Foolish Four, you'd be ahead of the game. Here are the returns if you'd gone with BSP instead of the Foolish Four last February:
Anheuser Busch <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BUD)") else Response.Write("(NYSE: BUD)") end if %> +46.7%
Ford <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: F)") else Response.Write("(NYSE: F)") end if %> +42.7%
Texaco <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: TX)") else Response.Write("(NYSE: TX)") end if %> -7.5%
Emerson Electric <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: EMR)") else Response.Write("(NYSE: EMR)") end if %> -12.0%
Mobil <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MOB)") else Response.Write("(NYSE: MOB)") end if %> +22.8%
BSP (without dividends) +18.5%
S&P 500 (with dividends) +20.5%
Throw in the dividends for the BSP stocks, and you'd be about even with the S&P 500 for the year.
Fool on!
******
Beating the S&P year-to-date returns (as of 02-09-99):
Schlumberger <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SLB)") else Response.Write("(NYSE: SLB)") end if %> +8.6%
Kimberly-Clark <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: KMB)") else Response.Write("(NYSE: KMB)") end if %> -16.1%
Campbell Soup <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CPB)") else Response.Write("(NYSE: CPB)") end if %> -24.8%
Ford Motor Co. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: F)") else Response.Write("(NYSE: F)") end if %> -1.2%
BankAmerica <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BAC)") else Response.Write("(NYSE: BAC)") end if %> -0.6%
BSP -6.8%
S&P 500 -0.8%
Compound Annual Growth Rate from 1-2-87:
Beating the S&P +19.8%
S&P 500 +17.5%
$10,000 invested on 1-2-87 now equals:
Beating the S&P $88,900
S&P 500 $70,200
New Rankings
| Workshop Returns