<FOOLISH FOUR PORTFOLIO>
BSP 101
An investing lesson
by Ethan Haskel ([email protected])
Baltimore, MD (June 9, 1999) -- It's time for a little review session on an investment strategy called Beating the S&P, or BSP for short. We'll start off with the most basic question of all -- what is it?
Before we can understand the concept of BSP, we briefly need to review the concept of Dow dividend investing and why it works. The Foolish Four, or any variant of a Dogs of the Dow strategy, works because it uses the basic measurement of a stock's dividend yield as a marker for a company that is undervalued. Since the dividend a company pays out is generally fixed over the short term, when a stock's price drops, by definition its dividend yield (equal to the annualized dividend divided by current stock price) will rise.
But high-yield investing doesn't work for just any old stock. It's mainly the very large, multinational corporations that have demonstrated the uncanny ability not only to maintain their dividend when things are looking grimmest, but also to bounce back from adversity. It's this propensity to rebound when things seem most gloomy that really gets a value investor's heart a-twittering.
It's important to realize that the rationale for high-yield investing has an empiric as well as theoretical basis. The Foolish Four returns have outperformed the markets for the past 38 years. Furthermore, James O'Shaughnessy, in his landmark book What Works on Wall Street, searched 43 years of an extensive database to find what strategies worked consistently, decade in and out. One of his conclusions:
"Large, well-known market-leading companies are much better investments when they have a value characteristic like low P/E ratio or low price-to-cash flow ratio, but the best criterion is dividend yield [italics mine]."
"The returns from buying the 50 market-leading stocks with the highest dividend yields are so outstanding that this strategy should serve as a cornerstone value strategy for all portfolios.... [This strategy] has the highest risk-adjusted returns of all strategies examined... [and] does better than Large Stocks in bull and bear markets, leading the market in most bull years and providing a cushion in bear years."
But merely buying the companies with the highest yields doesn't cut it. From 1954 to 1994, the return of all stocks averaged a compound annual return of about 12.5%. Buying the top 50 market-leading stocks with the highest yields returned 14.6% annually. Investing in just the stocks with the highest yields, regardless of size or anything else, returned a paltry 10.6%.
As defined by O'Shaughnessy, "market-leading stocks" are those from large companies, with cash flows per share that are above average and sales that are 1.5 times the average of all stocks. Utilities also were excluded, "so they don't dominate the list." These exclusive companies make up only about four percent of his entire database. Many are called, but few are chosen.
Where can we Fools find such market leading companies? We can rely on the editors of The Wall Street Journal, who select the 30 stocks in the Dow Jones Industrial Average. These are the very same companies we use to choose the Foolish Four stocks. Alternatively, we can let the marketplace unearth for us a distinct group of high quality, all-world companies. We'll call such a group of stocks the BSP 30.
How can an anonymous, indifferent marketplace find such preeminent companies to suit our purpose? Ever in the spirit of keeping it simple, we'll allow a stock's market capitalization to serve as our surrogate here. Recall that a company's "market cap," as it's affectionately known, is the product of the total number of available shares of the stock multiplied by its current price. It's the total price you'd pay if you were to buy the entire company. A company that's bigger and does things better is going to be worth more than one that's smaller and not as good. Hey, this ain't rocket science.
Although the markets may not be completely efficient in valuing companies, for our purposes we consider them good enough. If we choose from among the highest capitalized companies that aren't included in the 30 Dow stocks, we stand a pretty good chance of snatching up the market leaders that the Dow overlooks. Throw in a few basic rules to assure a diverse group of dividend-paying, American companies, and we're headed home.
That's basically what the Beating the S&P strategy is all about. It's a method for choosing a diverse group of market-leading stocks so we can apply our time-proven system of high-yield investing. I consider it a parallel strategy to Foolish Four investing, with a few minor twists and turns along the way.
In future columns, we'll discuss how the specific BSP stocks are chosen and why you might consider investing some of your hard-earned moolah in these companies.
*****
[Editor's Note: Following are the returns of a "paper" Beating the S&P portfolio that Ethan has been reporting on in the Foolish Workshop for many months. The stocks were selected December 31, 1998 and "purchased" in equal dollar amounts to be "held" for one year.]
Beating the S&P year-to-date returns (as of 06-08-99):
Schlumberger <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SLB)") else Response.Write("(NYSE: SLB)") end if %> +31.7%
Kimberly-Clark <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: KMB)") else Response.Write("(NYSE: KMB)") end if %> +7.6%
Campbell Soup <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CPB)") else Response.Write("(NYSE: CPB)") end if %> -19.1%
Ford Motor Co. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: F)") else Response.Write("(NYSE: F)") end if %> -3.0%
Bank of America <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BAC)") else Response.Write("(NYSE: BAC)") end if %> +11.2%
Beating the S&P +5.7%
Standard & Poor's 500 Index +7.5%
Compound Annual Growth Rate from 1-2-87:
Beating the S&P +20.5%
S&P 500 +17.8%
$10,000 invested on 1-2-87 now equals:
Beating the S&P $108,000
S&P 500 $76,500
Today's Stock Lists | 1999 Dow Returns
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06/9/99
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Stock Change Last
--------------------
CAT - 5/8 61.50
JPM -1 1/4 129.88
MMM -2 3/16 87.25
IP +1 3/4 52.06
Day Month Year History
FOOL-4 -0.36% 3.27% 25.39% 27.25%
DJIA -0.70% 1.24% 16.82% 16.36%
S&P 500 +0.10% 1.29% 7.59% 7.85%
NASDAQ +1.81% 1.98% 14.90% 16.47%
Rec'd # Security In At Now Change
12/24/98 24 Caterpillar 43.08 61.50 42.76%
12/24/98 9 JP Morgan 105.51 129.88 23.09%
12/24/98 22 Int'l Paper 43.55 52.06 19.55%
12/24/98 14 3M 73.57 87.25 18.59%
Rec'd # Security In At Value Change
12/24/98 24 Caterpillar 1034.00 1476.00 $442.00
12/24/98 9 JP Morgan 949.62 1168.88 $219.26
12/24/98 14 3M 1030.00 1221.50 $191.50
12/24/98 22 Int'l Paper 958.12 1145.38 $187.26
Dividends Received $49.99
Cash $28.26
TOTAL $5090.00