<THE FOOLISH FOUR>

Foolish Four Report
by Robert Sheard

LEXINGTON, KY. (June 15, 1998) -- By definition, this area is focused virtually exclusively on the thirty stocks which make up the Dow Jones Industrial Average. And for the most part, we limit ourselves to discussions of methods to invest in these companies based on high dividend yields.

There are other successful methods for use with these stocks as well, but our testing on them isn't nearly as complete as with the yield methods. One element we've followed here in the past, as well as extensively in the Workshop, is relative strength (how well one stock's share price is doing relative to the rest of the stocks).

As many writers and readers have pointed out, some of the best-performing stocks in the Dow aren't always the high yielders. In fact, on occasion, the lowest-yielding Dow stocks do very well indeed, simply because the stocks at the very bottom of the yield list are sometimes growth-oriented companies, and instead of paying out a good percentage of their earnings in dividends, they plow their earnings back into growth in the company itself. (This has not always been the case, however, as Knowles & Petty point out in The Dividend Investor. The lowest-yielding Dow stocks have not traditionally been a promising group to buy.)

This strength in a handful of Dow growth stocks doesn't mean the Dow high-yield approach isn't working anymore. Some good Dow stocks simply never qualify for the High-Yield 10. It's just a different part of the spectrum.

For example, look at last year's top ten performers on the Dow. Several of these companies rarely come near the high-yield list, yet they are undoubtedly exciting investments. The following list is ranked in order by 1997 total returns and includes this year's total return through June 10:

18.34 Travelers Group <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: TRV)") else Response.Write("(NYSE: TRV)") end if %>
50.47 Wal-Mart Stores <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WMT)") else Response.Write("(NYSE: WMT)") end if %>
20.92 Amer. Express <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AXP)") else Response.Write("(NYSE: AXP)") end if %>
3.88 AT&T Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: T)") else Response.Write("(NYSE: T)") end if %>
16.64 General Electric <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GE)") else Response.Write("(NYSE: GE)") end if %>
9.44 Procter & Gamble <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PG)") else Response.Write("(NYSE: PG)") end if %>
20.02 Disney (Walt) <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: DIS)") else Response.Write("(NYSE: DIS)") end if %>
12.51 International Business Machines <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: IBM)") else Response.Write("(NYSE: IBM)") end if %>
19.89 Merck & Co. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MRK)") else Response.Write("(NYSE: MRK)") end if %>
11.28 Johnson & Johnson <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: JNJ)") else Response.Write("(NYSE: JNJ)") end if %>

The group of ten is averaging 18.34% so far this year, compared to the High-Yield 10 return of 8.70%. Is this cause to abandon the High-Yield Dow approach? Of course not. It's one brief period and doesn't mean anything for the long run.

We've read article after article recently in the Wise press about the Dow approach being worthless. Their reasoning? The approach lagged the Standard & Poor's 500 in the last three- or four-year periods. This is a logical conclusion? The last several years have been monster years for the S&P 500 index, bolstered a great deal by enormous gains in large-cap tech and drug stocks, which make up a lot of the S&P 500's market-cap weighting but don't get included in the DJIA. So it's no surprise that the S&P 500 outpaced the Dow approach. The S&P outperformed the Dow significantly.

The beauty of this approach is that while it generally does pretty well in strong bull markets, in mediocre and bear markets it really tends to shine. So if one wants to base a conclusion on a three-year period, why pick 1995 through 1998 instead of 1972 through 1974? (The High-Yield 10 averaged 9.2% a year while the S&P 500 averaged a loss of 9.3% a year.) Any such brief period, though, is a pretty lame test in light of the 70-year history for the Dow high-yield approach.

So, yes, low-yielding Dow stocks can be very strong, too, but that fact doesn't in any way weaken the Dow high-yield approach. Hey, it might even be a way for you to pick up some more Dow components overlooked by the Dow high-yield approach.

When I get my hands on Sandy's new monthly database for Dow stocks, I'll look at a 6-month relative strength test for the Dow stocks to see how it fares over the long term. Until then, smile when the Wise tell you "it's different this time." You choose: seventy years of history, or three? Fool on!

Current Dow Order | 1998 Dow Returns

[Robert Sheard is the author of the The Unemotional Investor (Simon & Schuster, 1998) available now at Amazon.com and your local bookseller.]

TODAY'S NUMBERS

Stock Change Last -------------------- UK -2 45.31 IP -1 43.94 MO - 5/16 36.94 EK -1 15/16 67.94

Day Month Year FOOL-4 -2.62% -5.20% 0.98% DJIA -2.34% -3.06% 9.10% S&P 500 -1.99% -1.27% 10.98% NASDAQ -1.68% -3.55% 9.26% Rec'd # Security In At Now Change 12/31/97 206 Eastman Ko 60.56 67.94 12.18% 12/31/97 291 Union Carb 42.94 45.31 5.53% 12/31/97 289 Int'l Pape 43.13 43.94 1.88% 12/31/97 276 Philip Mor 45.25 36.94 -18.37% Rec'd # Security In At Value Change 12/31/97 206 Eastman Ko 12475.88 13995.13 $1519.25 12/31/97 291 Union Carb 12494.81 13185.94 $691.13 12/31/97 289 Int'l Pape 12463.13 12697.94 $234.81 12/31/97 276 Philip Mor 12489.00 10194.75 -$2294.25 CASH $415.96 TOTAL $50489.71