By Ethan Haskel (TMF Cormend)
April 12, 2000

I'm going out on a limb here. I know I shouldn't, and will probably get burned. I rarely make predictions. In fact, I think predictions about the markets are downright silly. But I'll make one today: This is a great time to buy Foolish Four or Beating the S&P (BSP) stocks.

Why now? Here are a few random observations:

• A secretary at work tells me that she and her husband are looking to buy some stocks for the first time. They are going to open an account at Merrill Lynch and want to make money "the best and quickest way."
• A doctor colleague has a 16-year-old daughter who will enter college in a few years. He's only invested in "Nasdaq stocks," which he occasionally buys on margin. He's told his wife that he does this because that's the only way he can make enough money in the short amount of time he has. A recent margin call during last week's tumultuous sell-off hasn't deterred him.
• Another doctor friend recently bought stock in a high-flying tech company that had previously doubled in the last month. He isn't sure what business the company's in.
• People I barely know are coming up to me wanting to know what's a good "hot" company to buy. They don't want to know the company's name as much as the ticker symbol. I get the distinct and uneasy impression that tonight they're going to buy whatever stock I might casually mention.
• Almost everyone I know has portfolios that include shares of the same short list of leading technology companies like Cisco Systems <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CSCO)") else Response.Write("(Nasdaq: CSCO)") end if %>, Intel <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: INTC)") else Response.Write("(Nasdaq: INTC)") end if %>, or Microsoft <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MSFT)") else Response.Write("(Nasdaq: MSFT)") end if %>.
• If you check out Morningstar's site for mutual funds, looking for the top 40 ranked domestic stock mutual funds (based on Morningstar's five star system), you'll find all but two funds follow a growth-oriented investment style.

A type of feeding frenzy is going on here. Everyone seems to be investing in virtually all the same types of stocks en masse. And that's why I think this is a great time to invest in the Foolish Four and BSP stocks. Virtually everyone hates them now -- hates them now more than ever before.

When I suggest to people that they might want to look into buying some value stocks chosen by the Foolish Four or BSP, companies like Bank Of America <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BAC)") else Response.Write("(NYSE: BAC)") end if %> or Ford <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: F)") else Response.Write("(NYSE: F)") end if %>, they get this look on their faces like they've just swallowed some sour milk. But the mention of a small, money-burning pharmaceutical company I've been following lights up their faces, and brings the inevitable question: What's that ticker symbol?

The essence of high-yield investing strategies is to buy the stocks of world-class companies when they're temporarily beaten down, based on short-term market factors. Not only are many of the current Foolish Four or BSP stocks out of favor because of company-specific factors, but the entire cohort of value stocks is out of favor like never before.

I've put together data on some of our value stocks to demonstrate this phenomenon. The following table shows the current price-to-earnings ratios for five BSP stocks, compared with the ratio for the same stocks at the start of last year. The five BSP stocks shown are those that you'd buy as of the close of the markets yesterday: Wells Fargo <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WFC)") else Response.Write("(NYSE: WFC)") end if %>, Ford <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: F)") else Response.Write("(NYSE: F)") end if %>, Bank of America <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BAC)") else Response.Write("(NYSE: BAC)") end if %>, Kimberley-Clark <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: KMB)") else Response.Write("(NYSE: KMB)") end if %>, and Fannie Mae <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: FNM)") else Response.Write("(NYSE: FNM)") end if %>. The table also shows how the price of each stock has changed in the last year, and the estimated earnings per share (EPS) growth, based on analysts' expectations for next year's earnings. At the bottom of the table are the numbers for the S&P 500 stocks as a whole, comparing them with the average of all five of our BSP stocks.

           P/E         Price
          Ratio       Change    EPS
      1/99   Today    (1 yr.)  Growth
WFC    31     18        +3%     +15%
F      11      8       -12%     + 3%
BAC    18     12       -28%     +13%
KMB    36     18       +19%     +11%
FNM    23     16       -12%     +12%
   
BSP    24     14        -6%     +11%
S&P    32     31       +20%     +12%

Keep in mind that the P/E is one very rough (and very imperfect) gauge of how cheap or expensive a stock might be. It's found by dividing the company's stock price by its earnings per share over the past year. A stock with a large P/E ratio is considered expensive compared with one with a smaller ratio, assuming the companies are growing earnings at the same rate.

The average P/E for our BSP stocks has dropped almost in half since the beginning of last year, from 24 to 14. At the same time, the P/E for the S&P 500 stocks has barely budged, falling from 32 to 31. Viewed another way, at the start of 1999, the BSP stocks' P/E as a whole was 75% that of the S&P 500. Currently, though, the P/E ratio for the group has dropped to 45% of that of the S&P 500.

Note that the average stock price of our BSP stocks has dropped 6% the past year, while the S&P 500 stocks have gained 20%. Our BSP stocks would deserve a low P/E ratio if their expected earnings growth rate was low compared to the average stock in the S&P 500. But the last column in the table shows that the BSP stocks are expected to grow earnings at roughly the same rate as the S&P 500 stocks as a group. It's just that no one wants to buy these BSP stocks now.

Except me.

I'm not sure just how long these value stocks will remain outcasts. No one does. Over the long run, value-style and growth-style investing comes in and out of favor. It seems to me that the best time to buy these value stocks is when everyone's looking the other way.

Beating the S&P year-to-date returns
(as of 04-11-00):

Bank One <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ONE)") else Response.Write("(NYSE: ONE)") end if %>          +4.2%
PepsiCo <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PEP)") else Response.Write("(NYSE: PEP)") end if %>           +5.5%
Ford Motor Co. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: F)") else Response.Write("(NYSE: F)") end if %>      -1.6%
Bank of America (NYSE: BAC     +5.3%
Fannie Mae <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: FNM)") else Response.Write("(NYSE: FNM)") end if %>        -4.5%
Beating the S&P                +1.8%
Standard & Poor's 500 Index    +2.1%

Compound Annual Growth Rate from 1-2-87:
Beating the S&P               +23.9%
S&P 500                       +17.8%

$10,000 invested on 1-2-87 now equals:
Beating the S&P            $171,400
S&P 500                     $87,300