At heart, the Foolish Four is a contrarian strategy. Contrarians aren't doing too well these days because the market has been very consistently heading in one direction for many years. But, if the market changes, and it always changes, the Foolish Four should do particularly well.
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In one sense, I agree totally with the critics. The Foolish Four is not a statistically proven strategy. I'm pretty certain it never will be statistically "proven" to everyone's satisfaction. Very few things are. In fact, I would venture to guess that anything that needs statistical proof will never be provable to everyone's satisfaction. Look at smoking. There are still people who don't believe it causes lung cancer or strokes.
Statistics cannot prove anything. They can only show how likely it is that something occurred by chance. If an association was fairly likely to have occurred by chance, then it makes sense not to assume that there is any kind of causal relationship that might hold in the future. That's the heart of most of the criticism -- that we haven't shown that low price and high yield are correlated with high returns in a statistically significant way.
In general, the critics aren't saying that the correlation doesn't exist; they are saying either that we haven't shown it or that it is not statistically significant. I grant that. That's why we are buying a larger database of stocks. Maybe there will be some answers there.
But, there are a lot of reasons other than statistics that make a compelling case for the Foolish Four as a good, long-term investment strategy. One of the best could be the current poor performance. Yes, you read that right.
The Foolish Four is, at heart, a value-oriented contrarian strategy. As we have discussed on other occasions, value investing is very, very out of favor right now. (Value investors look for companies that are underpriced relative to their intrinsic value. Intrinsic value is tough to pin down, but one classic definition of intrinsic value is the discounted value of all future dividends. Yep, dividends. We will talk about that formula some next week when we do a rundown of our poor, neglected companies.)
Contrarian investors like to buy what everyone else isn't buying. When the market is off chasing growth stocks, they buy value stocks. When value stocks are the rage, they look for growth. When biotechs are all the rage, they sell them. When biotechs fall out of favor, contrarians start looking for the biotechs with promise.
Contrarian strategies have worked quite well, as long as one is patient and waits for the winds of change to blow. The trick is to have your portfolio of neglected stocks in place before the majority of investors make the switch.
Does anyone doubt that our Foolish Four stocks are out of fashion? We have four companies with solid earnings and good prospects for moderate growth. They are all economic powerhouses generating billions of dollars of revenue every year, yet the market is holding its collective nose and treating them like the dregs of capitalism. The market shuns these money-making companies in favor of companies that might one day make a lot of money.
Now, I love growth companies. I love technology. In fact most of my portfolio is in high-tech growth stocks. And, I hope that there really is a new paradigm that will keep those growth stocks growing steadily forever. But, then I remember the last high-tech growth market. The '60s were very much like the '90s. Electronics were all the rage, and the market bid them up far beyond any possibility of them delivering enough earnings to justify their prices.
Late in the 1960s, disillusionment set in and the trend turned to the Nifty Fifty, "one-decision" stocks that you could supposedly buy and forget. Then the bottom fell out in the early '70s when the oil crisis hit and we entered the worst recession since the Great Depression.
How did the Foolish Four do during all of this? Well, of course, it wasn't around then. But, our back test shows how they would have performed. During the '60s, when tech stocks were the rage, the Foolish Four was up one year and down the next, generally averaging a few points less than the Dow. But, when the bottom fell out and the S&P dropped 37% in two years, the Foolish Four actually went up 41%. It out-performed the market by 78 percentage points over those two, miserable years.
After the tech crash, value stocks were not so out-of-favor anymore and the Foolish Four roughly doubled the Dow for 20 years.
Now, I do not expect history to repeat itself. That said, I am also quite aware that "Those who do not remember the past are condemned to repeat it." I don't know what is going to happen in the future, but ask yourself this: How likely is it that the tech-stock and growth-stock craze that has driven the markets at an unprecedented rate of growth for the last five years will continue?
Contrarian investors are patient. They believe that whatever's going on now, it just won't last. So far, they've been right. Of course, they've also been doing rather badly in the market lately, since there has been just one trend: Growth.
I may love growth stocks, but I also love my Foolish Four companies. I'm not worried about how they are doing now, because it makes sense to me that they would not do well in this kind of market.
And, if we are in the midst of a paradigm shift and the Old Economy stocks never come back, I will still love them, because they were the insurance I didn't need.
Fool on and prosper!