The Motley Fool has always been committed to educating investors, not providing stock tips. When it comes to mechanical strategies like the Foolish Four, though, investors are advised to simply buy the stocks picked by the mechanical screen. We recommend the mechanical approach (for some investors) but the decision to commit to a specific strategy, like the decision to buy a specific stock, is made by each individual. You still have to do your homework.
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Friday, I wrote about the Fool's oft-stated and recently centralized philosophy of teaching people how to invest rather than telling them what to invest in. Sure enough, a few hours later I got two e-mails suggesting that the Don't Mimic Us article was prompted by recent market conditions, as though we encourage people to buy the stocks in our portfolios when they are going up, but when there is a downturn we warn people that "it's your decision" in some sort of pathetic effort to evade responsibility.
That would be pretty shabby if it were true.
One person wrote he was "suspicious of the timing." Another said, "You want independence from this year's results." Sigh. It never entered my mind that anyone would think that we were trying to duck responsibility for the recent market downturn or portfolio underperformance by saying "don't mimic us." Obviously that's a failure of the imagination on my part -- probably because I've been around the Fool a long time, and I know that we had exactly the same attitude when everything was up. And also because I am so thoroughly unworried about the current downturn. But I should have known better. This attitude is nothing new.
For the record: Our goal has always been to educate investors, not lead them. The portfolios establish our credentials -- they illustrate how the principles we preach work in real time. But those investing principles work for all stocks, not just the one's we buy (not that they always work).
I know we've been saying this since the Fool opened its cyber-doors in 1994, through all kinds of markets, so I decided to look through the archives for an illustration of that. I didn't have much hope that I would actually find anything useful -- it's a big archive. You know how you can never find the one thing you are looking for? I figured this would be that kind of experience.
But as it turned out, I didn't have to look very hard. Here's a bit from the second (and last) article I opened. It's from the December 28, 1995 Rule Breaker report (then known as the Fool Portfolio because we only had one). It was written by our third founder, the silent-online-but-not-in-the-office Erik Rydholm. At that time the portfolio was up an astounding 67% for the year, doubling the S&P 500 and almost doubling the Nasdaq.
A few weeks after I bought it, the stock suddenly dropped six points to $14, the start of a slippery slide that left it below $3. What happened? Who knows? I sure didn't. I knew very little about the company's finances before I bought it. My entire rationale for the purchase consisted of, "Heck, David's in it, and he knows stocks, so I'll get into it, too."
What did I learn here? Where do I start?
OK, I'm done with this issue. I'm undoubtedly taking the suspicious attitude far too seriously. As usual, such criticism says more about the critics than the criticized.
There is one more thing that I do need to clear up, though. Mechanical strategies like the Foolish Four, Beating the S&P, and the Workshop strategies probably work best when followed exactly as described. In other words, when mimicked. How does that square with our "Don't Mimic Us" manifesto?
Good question and one that provides an excellent illustration of what it means to invest Foolishly. First, we do recommend techniques and strategies, even if we don't recommend individual stocks. Our guidelines have evolved over the years, but we are perfectly willing to take credit or blame for our general investing advice.
Here in the Foolish Four area and over in the Workshop we actually provide lists of stocks for people to buy if they are following a particular strategy. You should have heard the debates that went on about that practice! We feared that people would see those lists as "stock tips" and seriously considered dropping the lists at one time because of that.
The conflict was resolved when we realized that the decision to follow a particular mechanical strategy was like the decision to buy a stock. We advise people to do their homework before buying a stock, then, once committed to the stock, stick with it as long as the reasons why you bought the stock remain valid. Hopefully, you didn't buy it just because it had gone up in price. So if it were to go down but the company still had good earnings, great cash flow ratios, a lock on the market, etc., you would stick with the company through temporary (hopefully) downturns. For centuries, that kind of long-term commitment to good companies has been the surest road to wealth for investors.
The basic idea behind mechanical investing is that you develop a model, test it, and, if it tests well (and books could be written about that phase!) and seems appropriate for your investing goals, follow it exactly, and stick with it.
There is a pretty strong consensus in the Foolish Four and Workshop communities that "following the screens" is the most effective way to invest mechanically. Of course, one can mess around with the strategies. That's how new strategies are devised. And mechanical investing is not for everyone. Some investors are better off in index funds, some prefer the excitement and challenge of picking their own stocks. Many investors use the Workshop as a way to find stocks worthy of further investigation. Wonderful.
But I believe that the majority of the mechanical investing community just follows the screens -- when it's renewal time, they sell the stocks not on the current list and buy the ones that are. Like investing zombies. How is that Foolish?
It's the "buy and hold" approach applied to the strategy, not individual stocks.
Discipline is important in any investing approach. You do your homework, make your decision, then, as long as the fundamentals don't change, you stick with it and don't let the vagaries of the market shake you out. You also periodically evaluate the fundamentals to make sure they haven't deteriorated. (The other reason to sell a stock or change a strategy is if you find a "a better place to put your money." But that one has to be used with discretion, not as an excuse for frequent trading.)
This discipline applies equally to individual stocks or mechanical strategies. It's that simple. You do your homework when picking your strategies, then you stick with them as long as the reasons why you picked them don't change.
Right now we are in the process of reevaluating the Foolish Four. Bob Price and I (well, mostly Bob) have been working with the CRSP database to see how the Foolish Four formula works for non-Dow stocks. There were some problems with a few of the returns CRSP sent us so we don't have any real numbers to report yet, but the process is underway and our formulas can be transferred to the corrected database when it arrives.
We already know that the strategy hasn't performed as expected over the last couple of years, nor did it work well in the '60s (the previous tech craze). What we are investigating now is how it performed in the '50s, and how well the RP strategy works when not limited to the Dow stocks. If the RP formula is a valid indicator of stock performance, it should work in various time periods and for other large-cap stocks. Until now we have had no way to test this, but our new database lets us address these, and many other, questions. I will be reporting on the findings as they come in. Stay tuned.
Oh, and tune in tomorrow for Barbara Bayer's report on J.P. Morgan's <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: JPM)") else Response.Write("(NYSE: JPM)") end if %> terrific earnings. On Thursday I will attempt to explain how badly I screwed up last week's report, Confusing Genius With a Bull Market. That should be very entertaining for those who enjoy watching me squirm.
Fool on and prosper!
Your investing lesson for the day comes from me, the guy who knows nothing about stocks. It's about the time I took a really bad stock tip and lost a whole bunch of money. And it's a particularly appropriate tale, since it was our own David Gardner who gave me the tip....