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But this is a very good time to look at some alternative strategies that have been developed right here in Fooldom as variations on the Foolish Four. Because of data limitations, these strategies have not been backtested as extensively as the Foolish Four -- 12 to 14 years is about it. Come to think of it, though, that's better than the historical records of most mutual funds.
The first alternative strategy is Beating the S&P, which we report on most Wednesdays right here in this space. The BSP strategy started out as a way to see if the high yield/low price formula worked for stocks other than Dow stocks. Yep, it did. Very well, in fact. Ethan Haskel's latest version, which eliminates stocks that have split recently (see this article for the reason why), has actually beaten the Dow-based Foolish Four over the last 12 years.
Another variation, which focuses on growth stocks instead of undervalued stocks, is called the Keystone. This was the brain child of the original Dowman, Robert Sheard. He wanted to find a growth stock strategy that focused on large-cap stocks, as opposed to the small-cap companies that are so often associated with fast growth. To do that he used the Value Line Timeliness rankings, which ranks stocks according to a formula that predicts how well the stock will do over the next 12 months.
From the top two categories of timely stocks, Robert selected the 30 U.S. companies with the highest market cap and then ranked them by recent price growth. The Keystone strategy selects either the top 5 or 10 stocks and holds them for a year and a day. Why U.S. companies only? Why 30? Because this strategy was an analog of the Dow. That's the only reason.
As it turns out, the returns are actually much better if you don't limit your selection to U.S. companies (although we do limit it to foreign companies who trade on U.S. exchanges) and if you widen the net a bit and go for the top 100 stocks by market cap. That strategy, the Keystone 100, proposed by Powerphill in the Workshop area, has proven to be a real winner with returns of 26.2% over the past 12 years as opposed to 23.8% for the original Keystone.
Hummm. That got me thinking. What is it about 30 stocks? There are an awful lot of really great large-cap, blue-chip companies out there. While I think that it is very important to limit our picks to major companies that have the strength to rebound from whatever problem put them in High Yield-land, limiting that universe to 30 stocks seems sillier and sillier the more I think about it.
An independent test of the BSP strategy performed by Elan Caspi for the Workshop area confirmed that the high yield/low price strategy applies to companies other than those on the Dow or the BSP 30 list. Elan used Value Line to identify large market cap stocks rather than the Business Week list that Ethan used, but the average return over the last 12 years was virtually identical.
OK, so all this is going through my head and I'm thinking, "Heck, what's so magic about the Dow?" Yes, yes, I know we've made a big deal about how the strategy is safe because the stocks that we start with are the creme de la creme. But really, I think that the originators of all of these high yield/low price strategies used the Dow at least partly because it was easy.
Back then (the dark ages of the late '80s), databases were not nearly as commonly available. Using the Dow made a lot of practical sense, but if one can expand the universe without compromising the quality of the companies that are being considered, then why not?
But all this is speculation. We need to test it. Things that seem logical don't always work out as expected when reality rears its ugly head. For example, not a week goes by that someone doesn't write to me suggesting that we modify the strategy to include selling stocks when they reach a certain point, like a 30% increase, and replacing it with a new stock from the current Foolish Four. Sounds good, and it certainly would have worked to your advantage this year.
But not most years. Board participant William Lipp tested such a strategy and found that unless you set the threshold very, very high -- so high that you might as well not bother because it kicked in so rarely -- such a strategy produced lower returns overall, probably because it has you selling out of a rising stock and switching to one that may be stagnant for months.
So I believe in testing. Even though past performance doesn't predict future returns, it's the best guide we have. For right now, I'm sitting tight with the Dow-based Foolish Four while we test other possibilities. Frankly, I'm really excited about those other possibilities.
In the meantime, what should you do?
1) Stick with the Dow-based Foolish Four;
2) Switch to the BSP;
3) Use the BSP Blend list we mentioned yesterday; or
4) Explore the growth stock possibilities of the Keystone 100 strategy.
You expected a definitive answer?
Fool on and prosper!
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