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Rather, it's the time of year when many Foolish readers will be making their annual Foolish Four and Beating the S&P (BSP) portfolio turnovers. As we've noted previously, Dow investors might receive a little holiday bonus for starting a Foolish Four investment in December or January. Backtesting confirms that the average return on a Foolish Four investment increases slightly for portfolios started in December or January, compared to those portfolios started in other months.
Although such a seasonal trend hasn't been investigated for BSP, Foolish e-mail questions about the specifics of BSP investing have increased in recent weeks, suggesting that the portfolio shopping season is once again upon us.
In the spirit of the season, and with many new readers becoming more and more Foolish every day, it seems like a good time to review some of the basics of BSP investing. Here are some of the more frequently asked questions about the BSP strategy.
What is BSP?
BSP is a mechanical strategy for choosing stocks. It was developed originally to complement the high-yield Dow strategies in that the chosen stocks have similar characteristics to the stocks in the Dow, but are selected from a different universe of stocks. Recognizing that there are other very large, market-leading corporations that are not included in the Dow 30, BSP attempts to find another such group of 30 companies. BSP then sorts these 30 stocks (known as the BSP 30) by yield and price in order to find a set of undervalued stocks that may outperform the markets.
How are the BSP stocks chosen?
In order to find the BSP stocks, we first must find a group of 30 stocks that have similar characteristics to those in the Dow. The details of this process are described here. Using the Business Week annual top 500 stocks issue (usually published in March), a diversified list of the 30 largest, dividend-paying, non-utility, non-Dow stocks is created. These stocks comprise our BSP 30 and remain there for a year until the new Business Week listing is published.
Once we have our BSP 30 stocks, it's a relatively simple process of finding the 10 highest-yielding stocks in the group. We then rank these 10 stocks from lowest-priced to highest, discard the lowest-priced stock of all (an underperformer, both in BSP and Dow backtesting), and invest in the next five lowest-priced stocks. Analogous to the Dow strategies, we then chill for a year (go to the movies or read some good books), and after a year (and a day, for taxable accounts), we do it all over again. Lather, rinse, repeat. If you can shampoo your hair, you can do this stuff.
We've made one other refinement to the strategy. On occasion a BSP stock might be chosen under the rules above because its price has dropped as a result of a split rather than poor performance. The stocks that split within the past year usually do so because they had been outperforming the market and thus don't fit with the philosophy of buying stocks when they are out of favor. In keeping with the philosophy of buying undervalued stocks, BSP excludes any company whose stock has split within the past year.
A review of the performance of these stocks, both in the BSP universe and the Dow universe since 1963, revealed that these stocks almost universally underperformed the market after their split.
Has BSP been backtested?
BSP has been backtested to 1987, which is the first year the Business Week stock list was published in a usable format. The results, shown weekly at the end of my column, indicate that BSP returned 24.6% annually since 1987, compared to 17.5% for the S&P 500. For comparative purposes, the Foolish Four method has returned 22.0% for the same period, a difference from BSP that is not statistically significant.
Can I use the RP method for choosing the BSP stocks?
As many readers of this column are aware, a few years ago (after BSP was developed) the RP formula was devised as an alternative method for choosing the stocks for Dow high-yield investing. The RP formula has some theoretical advantages, and backtesting since 1963 has shown the best results over time compared to other methods of choosing the Dow stocks. Since the BSP strategy was developed to be analogous to the Dow strategies, there seems no reason that an RP formula should not work for the BSP stocks. However, this approach hasn't been fully backtested. Furthermore, it's unlikely any backtesting of RP for the BSP stocks would give any statistically meaningful results, given the relatively few years of data available.
How can I find the current BSP stocks in which to invest?
The best way to find the current BSP stocks is to use the BSP formula (explained above) on the current BSP 30 stocks, using the daily price and yield information available in most newspapers as well as online. It should take less than 30 minutes, which shouldn't be too taxing for an investment strategy used once a year. I recommend doing this at least once, since it gives a good feel for the strategy.
If you prefer, our couch potato method, Stocks Strategy Live!, will save you even those few minutes. To find the current BSP stocks at this site, click on "I want to beat the... S&P" using the "High Yield/Low Price" method. The five stocks listed in bold are the current stocks to buy. (There is one important caveat with this calculator, however. The calculator doesn't list the stocks that have split within the past year, which are excluded from BSP investments. As of today, the only stock on the list that split recently is Xerox <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: XRX)") else Response.Write("(NYSE: XRX)") end if %>, which would be excluded anyway because it is also the lowest-priced stock on the list.)
Why would anyone invest in BSP?
There are many reasons to invest in BSP. If one wants to find a group of high-quality, dividend-paying, blue-chip companies that may well outperform the markets over time, BSP may be right for you. The strategy can be implemented with less than an hour of work a year and requires very little maintenance, important factors in many of our hectic lives. BSP is a great complement to a growth portfolio, lending balance and a degree of stability.
Some investors use BSP to find additional stocks to complement the Foolish Four, when four stocks may not be enough. Others may be uncomfortable following the much more popular Dow strategies, fearing that their popularity may weaken what is basically a contrarian investment strategy.
Why would anyone not invest in BSP?
There are many reasons not to invest in BSP. You shouldn't be invested in BSP if you're not comfortable investing in individual stocks in the first place, or if you aren't ready to start investing in stocks. Check our 13 Foolish Steps to see what you need to do to get ready to invest. Do not pass Go. Do not even collect $200 if you don't completely understand the BSP strategy (or the concept of high-yield investing), or if you don't have a thorough understanding of market risk.
Although BSP was developed upon sound fundamental principles that have been backtested for many, many years on the Dow stocks, backtesting results for BSP are more limited. (Of course, even this limited data is often much more than is available to mutual fund investors or investors without a mechanical strategy.) There's no guarantee that methods that have worked in the past will continue to work in the future. Finally, if you think you have a better strategy that could achieve greater returns (depending on the level of risk you're willing to take), go for it.
Should I invest in BSP?
Hopefully you've been around these parts long enough to know that no true Fool will answer this question. The only one who can do that is the person you see when you look in the mirror. By reading The Motley Fool, reading elsewhere, and making use of the message boards, you'll probably come up with the right answer for you.
One final note today: Interested in being on The Motley Fool Radio Show this week? Drop an e-mail to [email protected] with a question or comment on investing and a daytime phone number.
Beating the S&P year-to-date returns (as of 11-30-99):
Schlumberger <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SLB)") else Response.Write("(NYSE: SLB)") end if %> +32.1%
Kimberly-Clark <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: KMB)") else Response.Write("(NYSE: KMB)") end if %> +18.7%
Campbell Soup <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CPB)") else Response.Write("(NYSE: CPB)") end if %> -17.2%
Ford Motor Co. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: F)") else Response.Write("(NYSE: F)") end if %> -10.7%
Bank of America <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BAC)") else Response.Write("(NYSE: BAC)") end if %> +0.5%
Beating the S&P +4.7%
Standard & Poor's 500 Index +13.0%
Compound Annual Growth Rate from 1-2-87:
Beating the S&P +24.6%
S&P 500 +17.5%
$10,000 invested on 1-2-87 now equals:
Beating the S&P $171,800
S&P 500 $80,400