By Ann Coleman (TMF AnnC)
March 2, 2000

A couple of weeks ago I mentioned a mechanical strategy that was similar to the Foolish Four but looked for growth stocks. It's followed in the Foolish Workshop area, but I think it deserves a closer look so we will be discussing it off and on over here as well. The name of the strategy is the Keystone 100, and it is really on a roll this year.

Before I tell you how well it is doing, maybe I had better reiterate that I don't see this as a replacement strategy for the Foolish Four. Despite its rotten performance lately, the Foolish Four is still a strong value-investing strategy. It's just that few investors are looking for value stocks right now. Everyone is chasing growth. That means two things -- growth stocks are going up like crazy, and growth stocks are wildly overpriced by most traditional stock evaluation methods. Where and when that will end is anybody's guess, but it's fair to assume that the kind of growth that we have seen for the last five years cannot continue forever.

When the market switches from a growth-investing mode to a value-investing mode, it tends to do so abruptly and with unpleasant consequences (at least short term) for growth investors. When it switches from value to growth, the transition is usually more gradual, but the short-term consequences for value investors are still unpleasant if they have limited themselves to value-style investing.

Most money managers recommend that a portfolio contain both growth and value stocks with the expectation that the growth stocks will beat the value stocks for a while and then the value stocks will take over for a few years. This approach is often suggested for mutual fund investors who are told to "pick a good value fund and a good growth fund." Long-term returns for growth funds are about the same as long-term results for value funds, but the yearly returns can be quite different.

I know that a lot of people are unhappy with the recent Foolish Four returns. Since the Foolish Four is a classic value strategy that looks for solid companies that are temporarily selling for less than their true value, and since those companies are exactly what investors are ignoring in droves as they snap up the latest Internet IPOs and high-flying biotech companies, it's not surprising to me that the Foolish Four is suffering. The question is what to do about that.

One way is to sit tight and wait for the market to swing back to value stocks. When that has happened in the past, the Foolish Four has soared. Another perfectly respectable way is to invest in some growth stocks as well. No one knows when the tech boom will slow. My personal opinion (and my sincere hope -- hey, I've got a few of those biotechs in my portfolio, too!) is that the boom goes on for several more years and then simply tapers off slowly rather than crashing abruptly as it is wont to do. Well... I can hope.

But the thing about growth stocks is that they tend to grow fast enough that even when they crash, you still come out ahead if you got in early enough. (For instance, if the Rule Breaker Portfolio took a 70% hit tomorrow, it would still have an average rate of return of around 35% per year -- better than 97% of all mutual funds.) Of course, the fear of getting in just before the crash has kept many, many investors out of growth stocks. That's understandable, especially considering how long this growth cycle has been going on.

Maybe the best solution is to just forget about the future -- no one can know what's going to happen -- and look at your own portfolio. Do you have a balance of growth and value stocks? If not, adding some growth stocks might be a good move, no matter what the market does. If the tech boom goes bust the next day, the chances are good that your poor, crushed, and gasping Foolish Four will be snapped up for investors who are looking for value.

So.... just how is the Keystone 100 doing this year? The five stock strategy is up 41%. That's not 41% for the past 12 months. That's 41% for the past two months, specifically from December 31, 1999, through February 28, 2000. Here's how the portfolio looks:

 YTD Return                   Cost Basis*  Price 2/28
 34.57%  JDSU  JDS Uniphase      $188.00    $253.00 
-20.11%  QCOM  Qualcomm Inc.     $179.31    $143.25 
 16.19%  ORCL  Oracle Corp.       $59.06     $68.63 
116.47%  NTAP  Network Appliance  $85.00    $184.00 
 58.46%  SEBL  Siebel Systems     $85.00    $134.69 
 41.12% Average for 5 stocks 

*Cost Basis is the price on 12/31/99 adjusted for splits

Now, this is not a real money portfolio like the one below. It's one of 12 paper portfolios that we maintain in the Workshop area. I've singled this one out, not because it is the best performing Workshop portfolio (it's actually #2), but because it started out as a direct analogue of the Foolish Four, that is, a simple screen that looked for very large companies, but in this case, looked for large companies that were showing rapid price growth as opposed to high dividend yields.

Another excellent Workshop screen for growth stocks is the PEG. The PEG doesn't look for large companies, but it does look for companies who are growing earnings very fast. Then it looks for those whose price hasn't already gotten totally out of whack. In the last year or two it has proven very successful, in real time, at picking high-growth companies before they are the talk of the town. And its backtested returns are equally impressive.

Is the Keystone 100 a good idea for you? Only you can answer that, but if you're interested in learning more about it, A Foolish Five of Growth Stocks has more details and links to the current stock picks. Key100: A Keystone Variation in the Workshop describes the screening process that produces the stock picks.

And no, I'm not following the Keystone 100, personally. I have some other Workshop screens in my personal portfolio. But I am trying to get my mother into it. If that's not confidence, I don't know what is!

Fool on and prosper!