<FOOLISH FOUR PORTFOLIO>

Beginning of the End?
Or just a dip in the road?

by Ann Coleman (TMF [email protected])

Reston, VA (February 8, 1999) -- This weekend on Wall Street Week, Louis Rukeyser took a look at the Dogs of the Dow investing strategy and found it had underperformed the Dow recently. Now, I didn't see the show, so I cannot speak to his numbers or his conclusions directly, but enough people e-mailed me about it that I thought this would be a good time to review exactly what it is we are doing here and why.

Our Foolish Four strategy is a refinement of the Dogs of the Dow, so anything that concerns the Dogs' effectiveness necessarily reflects on the Foolish Four. The Dogs of the Dow is a very old strategy that enjoyed renewed interest in this decade due to the publication of Michael O'Higgins's Beating the Dow, Knowles and Petty's The Dividend Investor, and How to Retire Rich by James O'Shaughnessey.

Originally, the strategy was simply to buy the ten Dow stocks with the highest yields, and that was the strategy that I believe Mr. Rukeyser was looking at this weekend. Knowles and Petty found that a 5 stock strategy (the 5 highest yielding Dow stocks) performed better, but as far as I know, that one wasn't mentioned.

First, none of the Dow strategies, including the Foolish Four, has been exactly tearing up the track the last three years if you compare our returns to the Standard & Poor's 500 Index -- which is what we teach you to do here at the Motley Fool. The S&P's performance has been unprecedented, in the literal sense, meaning the market has never been this hot for this long. But even so, the Foolish Four has outperformed both the Dow and the Dogs of the Dow over the last 5 years. It's that darn S&P that's giving us trouble.

Here's how the strategies stack up over the last 5 years:

(Dow Dogs 10 & 5)

	Dow 30	S&P 500	HY 10	HY 5	Foolish 4
1994	3.73%	1.31%	2.43%	6.26%	7.59%
1995	36.69%	37.43%	37.10%	30.13%	47.05%
1996	24.32%	23.07%	27.47%	26.62%	26.56%
1997	22.33%	33.36%	20.39%	17.70%	19.49%
1998	15.99%	28.70%	9.67%	12.49%	15.64%
Average	20.12%	24.08%	18.77%	18.31%	22.57%

To put it in perspective, this is the first time that the Foolish Four has lost to the S&P 500 over a 5 year period since 1972, but there were five years (three prior to 1994) during that time in which the S&P beat the Foolish Four, and other years that were close. What we are seeing here is quite likely a combination of a very hot market in general and a statistical cluster of underperforming years.

But maybe not. The most frequent criticism of mechanical strategies is that they tend to stop working once "everyone" knows about them. That could be what is happening with the Dogs of the Dow, at least those portfolios starting at the beginning of the year. We saw a lot of activity in these stocks right at the beginning of the year, indicating that Unit Investment Trusts and mutual funds might have been bidding them up looking for top dog performance. If that was the reason the price rose temporarily, that would certainly put the UITs, and anyone who bought at the same time, at a disadvantage.

One thing we have always stressed is that this is a long-term strategy. There have always been periods when it did not beat the market and years in which other strategies beat it, including two in a row when the S&P beat the Foolish Four. What counts is the long-term average.

Should we find that the Foolish Four can no longer beat the market over the long term, we will no longer recommend it. But I don't see that the verdict is in yet, and given the strategy's incredible performance over the last 30 years, I see no reason to cut and run when it hits a rough patch. Rough patches have happened before, but so far, at least, they have been part of the normal ups and downs of investing. The investor who departed early usually found that the market rewarded best those who waited it out.

Fool on and prosper!

Today's Stock Lists | 1998 Dow Returns

02/08/99 Close

Stock Change Last -------------------- CAT +1 47.25 JPM -2 7/8 99.25 MMM -1 11/16 76.50 IP -1 1/2 43.19

Day Month Year History FOOL-4 -1.41% 2.57% 0.42% 1.92% DJIA -0.14% -0.72% 1.34% 0.94% S&P 500 +0.35% -2.80% 1.50% 1.75% NASDAQ +1.32% -4.03% 9.68% 11.18% Rec'd # Security In At Now Change 12/24/98 24 Caterpillar 43.08 47.25 9.68% 12/24/98 14 3M 73.57 76.50 3.98% 12/24/98 22 Int'l Paper 43.55 43.19 -0.83% 12/24/98 9 JP Morgan 105.51 99.25 -5.93% Rec'd # Security In At Value Change 12/24/98 24 Caterpillar 1034.00 1134.00 $100.00 12/24/98 14 3M 1030.00 1071.00 $41.00 12/24/98 22 Int'l Paper 958.12 950.13 -$8.00 12/24/98 9 JP Morgan 949.62 893.25 -$56.37 Cash $28.26 TOTAL $4076.64 </FOOLISH FOUR PORTFOLIO>