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More Basics
Q&A with TMF Sandy

by Bob Price
([email protected])

Houston, TX (November 17, 1998) -- As you'll recall, last week we answered a lot of questions about the Dow strategies from an inquisitive beginner. He isn't done yet.

Why does the Foolish Four have bad years that are worse than the Dow?

Been off reading Ann's column on worst cases and the new book on the Foolish Four, haven't you?

The Foolish Four (and RP, for that matter) selects high yielding stocks with lower prices. In general, stocks with lower prices tend to be more "lively." They have bigger percentage moves. That's called "volatility." Since most of the time Dow stocks are moving up, the lower price, and thus higher volatility, tends to move them up more. The downside is that in bad years, that same volatility can mean they drop more than higher-priced stocks.

With the Dow Dividend strategies, though, the high dividend yield provides a floor for the stock price. Investors know that they will at least be getting that dividend, so the price of the stock is unlikely to sink through the floor. Can you imagine all those Growth and Income mutual fund managers overlooking a stock (with its potential for capital gains) that was paying dividends in the same ballpark as bond interest rates (where no capital gains are even possible)?

So why not just pick the highest yielding stocks?

The High Yield 10 is exactly that, the 10 highest yielding Dow stocks. Those stocks outperform the Dow by several percentage points per year, most of the time. You could increase your yield (and increase your downside protection) by picking fewer high yielding stocks. If you select the 5 highest yielders, you have the High Yield 5 (HY5), a strategy that averages one percent or so higher than the High Yield 10 and generally does better in bad years.

In fact, the HY5 performs better in down years than the Fool Four or RP4. Its worst down year is a drop of 15.65%, about the same as the Dow's worst year of minus 15.64% (looking at the last 37 years in the Dow Dividend Spreadsheet). [Note: The spreadsheet we used today has some corrections made in it. The numbers in this column may vary slightly from those in the current spreadsheet. The differences are very minor.]

I hate to see my stocks go down! Should I use the High Yield 5?

Well, how do you feel if they don't go up? The overall return for the HY5 is much weaker than the Foolish Four or the RP. Over the past 25 years (from 1973-1997), the compounded annual return of the HY5 lags the Foolish Four by 3 percentage points per year (18.60% versus 21.86%). Over 25 years, the difference between the total return for the same amount of money held at the two different rates is about 2:1. With the Foolish Four you would have twice as much money after 25 years, but HY5 does have the advantage you wanted -- it falls less in down years.

This is confusing. How can I decide what strategy to use?

To a large extent, it's going to come down to individual preferences. You can take a look at the rolling returns and decide you will just ignore what happens in periods of less than five or 10 years. Most Fools will probably do just that. In addition, there is some help available from statistics. We'll look at one approach -- looking at standard deviations -- next week.

One more comment. We've heard a lot about how this and that Dow strategy is "not working any more" because it's underperformed for the last year or two. Click in on the 1998 Dow returns on this page and see what's happening this year. It's not over yet, but so far the Fool Four and RP4 are making a comeback!

Fool on!

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Current Dow Order | 1998 Dow Returns

11/17/98 Close
Stock  Change   Last
--------------------
UK   +   5/8   44.50
IP   +   1/16  45.31
MO   +  15/16  54.25
EK   -2  9/16  75.25

                   Day   Month    Year
        FOOL-4   -0.12%   3.89%  15.22%
        DJIA     -0.29%   4.58%  13.62%
        S&P 500  +0.30%   3.70%  17.40%
        NASDAQ   +0.90%   6.05%  19.62%

    Rec'd   #  Security     In At       Now    Change

 12/31/97  206 Eastman Ko    60.56     75.25    24.25%
 12/31/97  276 Philip Mor    45.25     54.25    19.89%
 12/31/97  289 Int'l Pape    43.13     45.31     5.07%
 12/31/97  291 Union Carb    42.94     44.50     3.64%


    Rec'd   #  Security     In At     Value    Change

 12/31/97  206 Eastman Ko 12475.88  15501.50  $3025.63
 12/31/97  276 Philip Mor 12489.00  14973.00  $2484.00
 12/31/97  289 Int'l Pape 12463.13  13095.31   $632.19
 12/31/97  291 Union Carb 12494.81  12949.50   $454.69


               Dividends Paid YTD  $1092.81
                            TOTAL  $57612.12

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