The value-oriented Foolish Four is struggling in this growth-oriented market. Diversifying with a large-cap growth strategy can improve returns and balance one's portfolio to take advantage of both growth and value markets.

By Ann Coleman (TMF AnnC)
July 27, 2000

Growth! It's all about growth these days, isn't it? Growth stocks, tech stocks, biotech... any of that sound like Foolish Four companies? I didn't think so.

From time to time we've talked about the possibility of adding a growth component to our official Foolish Four. One candidate, proposed in the Workshop by Powerphil, is looking pretty good. The Key100 strategy modifies Robert Sheard's Keystone approach, which was originally developed as -- surprise! -- a growth stock alternative to the Foolish Four. Here's how the strategy was originally designed.

Instead of using the Dow for the initial universe of stocks, you use Value Line's top-rated stocks for timeliness (Timeliness ranks 1 and 2). That gives you a total of 400 companies. Sort them by market cap and take the top 30 (because the Dow has 30 stocks). Sort those 30 stocks by their six-month price performance (instead of by dividend yield and low price) and buy the five that have risen the most. That is the original Keystone. Powerphilexpanded the first cut to include the 100 largest companies instead of 30, which significantly improved the returns.

The Key100 is analogous to the Foolish Four approach because it starts with large-cap companies that are financially strong (that's part of Value Line's Timeliness ranking). But it is the exact opposite of the Foolish Four in that it looks for growth rather than value. Instead of looking for beaten-down stocks that have the strength to turn around, Key100 identifies companies that are already growing fast under the theory that "what goes up keeps going up."

To me, it makes a lot of sense to cover, if not all bets, then at least the two opposing investing cycles: growth and value.

Last week I suggested that these two strategies might complement each other -- that the Key100 might zig when the Foolish Four zags. I used a table contributed by Moe Chernick that showed how the Key100 had performed in a bear market, a moderate bull market, and the recent roaring bull market. Here's the same table with the Foolish Four's numbers added (and one S&P number corrected).

               Bear   Bull  Roaring Bull
Strategy     1969-74 1975-94  1995-99
Keystone 100   -5%     28%      61%
Foolish Four    8%     24%      26%
S&P 500        -4%     15%      29%
Dow 30         -2%     15%      24%

Remember, you need to compare the returns going down the column. We are comparing these strategies with the indices during three different markets.

Caveats: These returns are for January starts, which tend to be higher. The actual returns averaged over all months could be a few points lower for both the Foolish Four and the Key100, but we don't have monthly returns for the extended back test period for the Key.

So what are we seeing here? The Foolish Four is the only strategy that made money during the bear market of the early '70s. It beat the Dow by 10 percentage points and the S&P by 12. The Key100, on the other hand, lost to both indices when the bear was prowling the street. In the bull market from 1975 to 1994, everybody did great with the Foolish Four beating the market by an average of nine percentage points per year and the Key100 by 13. But in the recent roaring bull market, the Foolish Four barely beat the Dow and lagged the S&P 500, while the Key100 more than doubled the S&P 500.

It's silly to read too much into such numbers. I wouldn't take this little exercise to mean that the Foolish Four is recession-proof, by any means. In the mini-recession of 1990, the Foolish Four lost big time to a very ugly market, and the same thing seems to be happening right now. The Dow is struggling and the Foolish Four is struggling even harder.

The '70s recession was precipitated by skyrocketing oil prices and a technology stock crash. Ooops. Just kidding. Yes, that is a true statement -- it's the implication that there is a similarity between then and now that is the joke. I knew some of you would be thinking that. It's fun to speculate about such associations, but mostly such speculations turn out to be wrong. Predicting macro-economic trends isn't something I'm about to take on. Besides, there are far more economic differences than similarities between the early '70s and now.

The table above is interesting and even useful, but I feel you can get an even better feel for how a strategy has performed with a year-by-year comparison. Since we all like to peruse numbers, I'll include a table below that lets you compare both the Keystone and the Foolish Four over the past 31 years. Note that when the market was bad, it was pretty rare that either strategy had a great year. Also note that when the market was way up, the Keystone was often, but not always, remarkable.

Bottom line: It makes sense to me that investors who like the idea of mechanical stock picking would consider diversifying their portfolios to include a growth component. For investors who want to stick with large-cap stocks, the Keystone 100 looks like a good way to expand. As always, mechanical strategies include a risk that they will not perform in the future as they have in the past. They are theories, not guaranteed systems.

          Dow      S&P     F4.2   Key100
1969   -9.27%   -8.50%   -8.41%  -17.26%
1970    5.06%    4.01%  -14.20%    3.97%
1971    9.06%   14.31%   19.74%   27.45%
1972   16.73%   18.98%   16.59%   -6.02%
1973  -10.86%  -14.66%   17.28%    5.40%
1974  -15.64%  -26.47%   20.00%  -32.57%
1975   44.24%   37.20%   68.71%   50.52%
1976   29.37%   23.84%   37.93%   62.60%
1977  -12.56%   -7.18%   -2.96%    1.55%
1978    2.50%    6.56%    9.89%   38.21%
1979   11.34%   18.44%   17.70%   21.65%
1980   25.30%   32.42%   22.68%   70.41%
1981   -3.26%   -4.91%    9.66%  -18.09%
1982   19.53%   21.41%   56.88%   39.36%
1983   35.58%   22.51%   36.72%   22.00%
1984   -0.12%    6.27%   10.30%  -12.80%
1985   30.98%   32.16%   49.82%   39.20%
1986   21.87%   18.47%   29.67%   45.98%
1987   15.74%    5.23%   17.89%   40.06%
1988   13.70%   16.81%   21.68%   27.34%
1989   31.95%   31.49%   47.34%   77.31%
1990   -9.14%   -3.17%  -17.61%   -5.02%
1991   30.36%   30.55%   34.81%   52.51%
1992   11.04%    7.67%   30.24%    6.69%
1993   17.91%    9.99%   30.26%   58.45%
1994    3.70%    1.31%    7.38%    5.32%
1995   36.69%   37.43%   47.05%   40.70%
1996   24.32%   23.07%   26.56%   23.95%
1997   22.33%   33.36%   19.49%   46.23%
1998   15.95%   28.70%   15.64%   67.73%
1999   20.57%   21.04%   21.47%  156.26%
CAGR   12.92%   12.93%   21.04%   25.53%

Fool on and prosper!