<FOOLISH FOUR PORTFOLIO>
Moving Targets, Part Deux and learning to live with luck
by Ann Coleman (TMFAnnC)
Reston, VA (June 7, 1999) -- How quick is too quick? How often is often enough? The questions about how rapidly the Foolish Four stock list keeps changing are still coming in.
Our new "Instant Foolish Four" stock list generating feature, Today's Stock Lists, is generating more than stock lists that change as prices change all day long. It has generated a very good discussion about just what is important. It also seems to have generated a bit of discomfort. Suddenly we find ourselves less in control than we thought we were.
For example, on our Quotes and Data Feedback board, Misterkaygee wrote (quoting from the Friday Foolish Four Portfolio Report):
"Just because you CAN get a new Foolish Four stock list every five minutes doesn't mean you SHOULD."
Can't the FF list be made more stable on a day-to-day or week-to-week basis, perhaps by using moving averages? The way that stocks jump on and off the list would seem to reduce confidence in the strategy, or at least to lead to the conclusion that it's not as systematic as its adherents suggest.
I think that what is happening is not that the system is less systematic that we have suggested, but that we are now able to see just how dynamic it has always been. I fully understand how uncomfortable that makes people, myself included, but changing the way we select stocks by using moving averages or any other method would be window dressing only. And it might reduce the effectiveness of the strategy.
What we didn't realize before was that this kind of shifting around was happening all the time, but because we simply used closing prices on certain days, it wasn't very obvious.
The fact that we can now see how the list shifts around due to price movement is like looking in one of those magnifying make-up mirrors for the first time -- "Oh, NO! Look at those enormous pores! And the blackheads and freckles and hairs. Ick!" But your face is no different than it ever was.
Maybe this is not an analogy everyone can identify with (MISTERkaygee!). OK, then how about all the little critters you find swimming in a drop of lake water under the microscope? Ick -- I've been swimming in THAT??
If you watch the system for a while, you will see that the shifts are not as dramatic as they might seem at first. Mostly the stocks shift from position to position (except for Philip Morris <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MO)") else Response.Write("(NYSE: MO)") end if %> firmly anchored in the uncoveted number one spot). When a position shift (say from 5 to 6) drops a stock off the Foolish Four list, that looks like a big deal, especially since it could be the result of a fifty-cent change in price that reverses a few minutes later. Horrors! A big block trade just changed the stocks I'm supposed to buy and hold for the next year and upon which my retirement security depends!
Yes, I can see the reason for the discomfort.
In theory, getting a fresh Foolish Four list moments before buying could be an advantage to Foolish Four buyers. The stocks would tend to be at the lowest relative price. I doubt that that will be much of an advantage, though, since in reality, each year's return is more affected by which stocks are chosen than by the initial price. So much for that theory.
At any given time, 6 or 7 "good candidates" are cycling in and out of the Foolish Four. All of them are high yielding, low priced stocks that will likely rally at some point in the future. Although most of these stocks will do well, some will do better than others. We just don't know which. (See Moving Targets if you are wondering why not just buy all 6 or 7 stocks.)
Which four you get will depend on when you run the numbers, but that's always been true -- throughout the entire 38-year backtested history of the Foolish Four -- during the last 25 years, when returns averaged 24.5% per year, and last year, when it got creamed by the market. You have always had to freeze the process at some point and buy.
Since the decision on what to buy is made by numbers, not by people, there will always be a certain "luck of the draw" element that governs which set of stocks does best for any given year. The only answer I have for this uncomfortable realization is to remember that, over time, everyone has the same odds of getting the best set. And, of course, the other possibilities often do quite nicely, too.
That's the key phrase: Over Time. We need to keep sight of the fact that this is a strategy that generates high returns fairly consistently over a long time period. It will have bad years. It will have a lot of pretty good years, and it will have outstanding years. But if you expect every single year to be outstanding, you will be very disappointed. Of course, that is equally true of any kind of investing.
I'd like to find a way to refine the procedure further, to capture the three or four best stocks of the Dow or Standard & Poor's 500 Index almost every year, but we have to recognize that it may not be possible to do so. We're probably pretty lucky that the strategy can predict future performance as accurately as it does now.
Fool on and prosper!
Today's Stock Lists | 1999 Dow Returns
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Today's Stock Lists
| 1999 Dow Returns
06/7/99
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Stock Change Last
--------------------
CAT + 7/16 63.25
JPM + 13/16 133.38
MMM +2 15/16 90.69
IP - 7/16 50.00
Day Month Year History
FOOL-4 +1.37% 4.81% 27.27% 29.16%
DJIA +1.01% 3.31% 19.21% 18.73%
S&P 500 +0.51% 2.51% 8.88% 9.15%
NASDAQ +1.85% 2.17% 15.12% 16.70%
Rec'd # Security In At Now Change
12/24/98 24 Caterpillar 43.08 63.25 46.82%
12/24/98 9 JP Morgan 105.51 133.38 26.41%
12/24/98 14 3M 73.57 90.69 23.27%
12/24/98 22 Int'l Paper 43.55 50.00 14.81%
Rec'd # Security In At Value Change
12/24/98 24 Caterpillar 1034.00 1518.00 $484.00
12/24/98 9 JP Morgan 949.62 1200.38 $250.76
12/24/98 14 3M 1030.00 1269.63 $239.63
12/24/98 22 Int'l Paper 958.12 1100.00 $141.88
Dividends Received $49.99
Cash $28.26
TOTAL $5166.25