<THE FOOLISH FOUR>

Disaster Stocks, Part 2
by Chris Rugaber
(TMF RFK)

Alexandria, VA. (Oct. 8, 1998) -- Last week, we looked at a few well-known examples of Dow stocks that hit bottom, and also those that had left the Dow. Considering that the Dow Dividend Approach is based on buying out-of-favor stocks, what happens to Dow Dividend investors when those stocks stay out of favor?

The examples I looked at showed that some of the better-known cases didn't prove very hazardous to the Dow Dividend investor. This week I'd like to take a more systematic approach. By looking at all the Dow stocks for the past 37 years, and all the High-Yield 10 stocks and Foolish Four stocks, we see that a Dow Dividend investor is less likely to own a real "disaster stock" then someone who just randomly buys a selection of the Dow 30. As a result, while the Dow Dividend Approach aims to buy beaten-down Dow stocks, it has in the past avoided the worst of the Dow -- especially when the Foolish Four variation has been used.

This makes sense, actually, considering how this strategy is supposed to work. The Dow Dividend Approach is supposed to select Dow stocks that have had some bad times and are about to turn around. As a result, the Dow approach should avoid at least part, if not most, of these stocks' downturns.

The numbers seem to support this idea. Using the Dow Dividend Spreadsheet, available in FoolMart, we can take a look at the Dow stocks for the past 37 years. We'll somewhat arbitrarily decide that any stock that declines more than 15% in a year is a "disaster stock." Arguments could be made for other numbers, but I will use a low number in order to be conservative. How many were there, and how many of those ended up as Dow Dividend investments?

We'll assume that all stocks were purchased at the beginning of the year and sold a year and a day later. The thirty Dow stocks over 37 years equals 1,110 possible stock choices. Of those, the High-Yield 10 investor would have purchased 370, and the Foolish Four investor would have purchased 148 (37 * 4 = 148).

Scanning our list of stocks year by year, we see that from 1961-97, 161 Dow stocks had one-year declines of over 15%. As a result, 14.5% of the Dow stocks over this period qualify as "disaster stocks." Of those stocks, 37 were in the High Yield 10 category and 12 were Foolish Four stocks. From a proportional standpoint, while 14.5% of all Dow stocks declined by 15% or more, only 10% of High-Yield stocks (37 out of 370) fell by that much and only 8.1% of Foolish Four stocks (12 out of 148) suffered such declines.

Given these numbers, we can therefore argue that while the Fool Four strategy relies on selecting and buying downtrodden stocks, it also proportionately avoids the really bad ones. One reason is that the new Foolish Four, aka the UV4 approach developed by Robert Sheard, throws out a stock if it is both the highest-yielding and the lowest-priced, which frequently is a real dog stock.

But the main reason is the one stated earlier: this is how the strategy is supposed to work. Most of the bad times for a Foolish Four stock should have occurred before it is purchased as part of the Fool Four strategy. Nevertheless, it's always nice to see the numbers support the theory.

Current Dow Order | 1998 Dow Returns

10/08/98 Close

Stock Change Last -------------------- UK - 15/16 41.31 IP - 15/16 44.19 MO -1 1/8 47.75 EK +2 7/16 80.06

Day Month Year FOOL-4 -0.63% -0.36% 10.44% DJIA -0.13% -1.41% -2.23% S&P 500 -1.15% -5.66% -1.13% NASDAQ -2.97% -16.22% -9.63% Rec'd # Security In At Now Change 12/31/97 206 Eastman Ko 60.56 80.06 32.20% 12/31/97 276 Philip Mor 45.25 47.75 5.52% 12/31/97 289 Int'l Pape 43.13 44.19 2.46% 12/31/97 291 Union Carb 42.94 41.31 -3.78% Rec'd # Security In At Value Change 12/31/97 206 Eastman Ko 12475.88 16492.88 $4017.00 12/31/97 276 Philip Mor 12489.00 13179.00 $690.00 12/31/97 289 Int'l Pape 12463.13 12770.19 $307.06 12/31/97 291 Union Carb 12494.81 12021.94 -$472.88 CASH $754.73 TOTAL $55218.73