Although it might seem fruitful to apply Foolish Four principles to Canada's Dow sister index, the TSE 35, the backtested results are mediocre. This finding shouldn't come as too much of a surprise, because the stocks in the Dow are very different from those in the TSE 35. Adapting mechanical stock strategies from one group of well-tested stocks to a different group is fraught with hazards.
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If investing in high-yielding, low-priced, quality stocks works for the Foolish Four and Beating the S&P (BSP) in the United States, it makes sense that it also should work in foreign markets -- at least in concept. In preparation for my trip, I decided to look at the results for the Foolish Four when compared to the 35 stocks in TSE 35, Canada's closest sister index to the Dow 30. (TSE stands for Toronto Stock Exchange.)
Here are the compound annual growth rates (CAGRs) for the TSE 35, Dow, and the RP4 strategy when applied using both groups of stocks. The data, much of which is courtesy of the Beating the TSE discussion board, goes back to 1988, when the TSE 35 Index was born.
Strategy
CAGR (%)
RP4 TSE
+13.1
TSE 35
+11.7
RP4 Dow (F4)
+22.5
Dow 30
+17.7
The RP4 strategy applied to the TSE 35 slightly outperformed the TSE 35 for the past 12 years. The RP4 TSE outperformed the entire TSE by 1.4 percentage points, a 12% outperformance. Not bad, but not exactly cause for unbridled celebration. In contrast, the Foolish Four outperformed the Dow by 4.9 percentage points, or 27%. It's nice to see that the RP selection method picked stocks that performed better than average, but the overall returns are disappointing.
Do these results indicate that the Foolish Four method is a failure because the same outstanding results seen for the Dow version aren't replicated for the Canadian index? The answer is an unqualified "no."
For starters, the 12-year timeframe for backtesting the Foolish Four TSE approach is too short to make any definitive conclusions. Perhaps more importantly, the very process of trying to apply the Foolish Four approach to the TSE 35 highlights a common error many inexperienced Fools make when they try to adapt certain of our mechanical investment strategies to completely different groups of stocks.
It's not uncommon to hear Fools try to find the Foolish Four stocks for the Nasdaq, the entire S&P 500, or another group of stocks like the TSE 35. Usually, though, it's not a good idea to even attempt these exercises.
When trying to adapt a mechanical strategy from one group of stocks to another, it's critical that you don't lose too much in the translation. The two groups of stocks should be as similar as possible. For instance, the Foolish Four and the BSP strategies work because they start with a group of very large, very well-established companies, most of which pay dividends because they have a very long history of steady positive cash flows. If you're going to use high-yield investing strategies like the Foolish Four, you should try to find another group of stocks that has characteristics similar to those in the Dow.
Some Fools have asked about adapting the Foolish Four strategy to a group of Nasdaq stocks like the Nasdaq 100 Index. This is not a good idea. Applying the RP formula to a group of Nasdaq stocks is pointless, since dividends for Nasdaq companies are usually minuscule. The Foolish Four formula is also very unlikely to work with growth-style stocks typical of those on the Nasdaq. If you're interested in mechanical investing for growth stocks, I'd suggest wandering over to the Workshop, or checking out the Keystone 100 strategy.
Similarly, choosing a Foolish Four strategy based on all the stocks in the S&P 500 Index will be hazardous to your financial health. Even though the S&P 500 contains virtually all the highest-capitalized stocks in the U.S. markets, as you go further down an S&P 500 list that's ranked for market cap, you find quite a few companies that simply are too small to recover fully during prolonged rough stretches -- no matter how high their current dividend payout.
For instance, Potlatch Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PCH)") else Response.Write("(NYSE: PCH)") end if %>, a forest products company, is in the S&P 500. Although Potlatch is yielding almost 5%, I'm not sure anyone would call this company a world-beater. In fact, earlier this month it announced a layoff of 21 workers. That's not a typo. Even though Potlatch has a great RP ratio, I would never include it in any variant of a Foolish Four portfolio. My Foolish Four portfolio also would never include those Pep Boys <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PBY)") else Response.Write("(NYSE: PBY)") end if %> -- Manny, Moe, or Jack. These kids were dropped from the S&P 500 only recently, despite a very high RP ratio.
When we look at the actual stocks in the TSE 35, we immediately see problems with trying to adapt the Foolish Four to these Canadian stocks. Almost half of the TSE 35 stocks sell commodities like gold, paper, oil, or metals. Four are utility or transportation stocks, which are excluded from the Dow. Most have market capitalizations that are smaller than the smallest Dow stocks. The large majority of these companies are just not world-beaters. High-yield strategies like the Foolish Four or BPS work because they start with a team of huge, financially strong, relatively diversified companies that almost always have the wherewithal to thrive when conditions temporarily turn against them.
That's not to belittle any of these Canadian companies, many of which are fine organizations -- such as Nortel <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: NT)") else Response.Write("(NYSE: NT)") end if %>, which accounted for about a third of the TSE 35 returns last year. It's just that these companies represent a completely different universe of stocks than those in the Dow. It would be a tremendous leap of faith to expect the Foolish Four rules to apply to this set of stocks. Compounding the problem, recently the entire TSE 35 has been declared extinct, soon to be rolled into the S&P TSE 60 Index.
For investors looking to apply high-yield investing concepts overseas, perhaps using an index like the relatively new S&P Global 100 Index would be a good place to start. I'm not aware of anyone who has looked at this, but the companies listed are, by and large, truly multinational and diversified. Alternatively, Foolish investors might be content to know that when they buy Foolish Four or BPS stocks, they're already getting a hefty dose of built-in foreign exposure.
Finally, some trivia, courtesy of the I Knew That Once But Forgot Department. I once knew but forgot that the following celebrities all are Canadian: Dan Aykroyd, Keanu Reeves, Alex Trebek, Mike Myers, Pamela Anderson, Peter Jennings, Donald Sutherland, Raymond Burr, Michael J. Fox, Celine Dion, William Shatner, Leslie Nielsen, and Neil Young. And, for even more north-of-the-border amusement, here's the Canadian-inspired Alanis Morisette lyric generator. With this much fun up here, I may never come home!