<FOOLISH WORKSHOP>

Timing the BSP?      

by Ethan Haskel ([email protected])

Baltimore, MD (March 17, 1999) -- Of all the questions that cross my path regarding Beating the S&P (BSP), the second most frequent one deals with the timing issue: "Is there an optimal time of year to start a BSP Portfolio?"

These queries become even more frequent from January to March, since it's recognized that the annual Business Week listing, from which we develop our BSP 30 list, is usually published at the end of March. Many readers wonder if it's best to use a "fresh" BSP 30 list, rather than one that may be almost a year old.

The easy answer, and perhaps the most accurate, is that we don't know. No one has done the backtesting, which would be a tedious process indeed. The results would also probably have limited statistical significance, given the relatively small amount of data available (about 12 years' worth).

As definitively reviewed by Ann Coleman, there is a seasonality trend for Dow Dividend investing. For the Foolish Four, a portfolio started in December or January seems to outperform those started in other months. Might we expect this trend to hold for BSP, a strategy developed to be analogous to that of Dow Dividend investing?

If one looks at the possible explanations for the Dow seasonality differences, as discussed by Bob Price, it seems that most would apply to BSP as well. Most notably, there are definite tax issues that could cause the price of already depressed stocks to become even cheaper towards the end of the year. These overly sold stocks might then rise dramatically when the tax-selling pressure abates after the new year.

Many large investment trusts and institutional investors buy heavily into the Dow strategies at the beginning of the year. The timing of these investments might also exaggerate the price swings, giving any of us "early birds" an advantage. Since it's unlikely that the "big money" has yet found its way into the BSP strategies, this particular seasonality factor wouldn't have a significant effect on BSP investors.

What about the issue of working with a "fresh" list of BSP stocks at the end of March, versus a "stale" one in January or so? Each year, on average, about five stocks change in the new BSP 30 list. How does a stock drop out? Most commonly there are three ways this occurs:

-- A company becomes relatively smaller in terms of market capitalization, compared with other companies in the Standard & Poor's 500 Index. This mechanism explained why Schlumberger <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SLB)") else Response.Write("(NYSE: SLB)") end if %> replaced Texaco <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: TX)") else Response.Write("(NYSE: TX)") end if %> in the BSP 30 last year.

-- A company merges with another company that is already in the Dow. For instance, Citicorp merged with Dow component Travelers, forming Citigroup <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: C)") else Response.Write("(NYSE: C)") end if %>. Alternatively, a BSP company can merge with a foreign entity. Chrysler's merger into DaimlerChrysler <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: DCX)") else Response.Write("(NYSE: DCX)") end if %> and Amoco's merger into BPAmoco <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BPA)") else Response.Write("(NYSE: BPA)") end if %> are two recent examples.

-- A company joins the Dow Jones Industrial Average, as did Hewlett Packard <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HWP)") else Response.Write("(NYSE: HWP)") end if %> recently.

Let's keep in mind that the annual turnover for the BSP 30 stocks is far higher than that of the Dow 30 from which the Foolish Four stocks are chosen. The last time there was a significant change in the Dow stocks was in March of 1997, when four stocks were switched. In fact, from 1976 to 1999, a grand total of 15 stocks were substituted in the Dow, or much less than one per year. Thus, compared with the Dow 30 listing, the BSP 30 list would have to change just about once every five years to be equally as "fresh" as the Dow.

Indeed, a stock can fall a long way down the list of highest capitalized companies yet still remain a Dow stock. International Paper <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: IP)") else Response.Write("(NYSE: IP)") end if %> and Alcoa <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AA)") else Response.Write("(NYSE: AA)") end if %> are two examples. Both companies are not even among the top 150 in the S&P 500 in terms of market cap.

Sometimes the companies that fall off the BSP list one year are temporarily depressed and rebound strongly. Anheuser Busch <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BUD)") else Response.Write("(NYSE: BUD)") end if %> is one notable example here, gaining about 65% since being ousted last March. Other times, a delisted stock will be in a downward spiral, never to return. K-mart <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: KM)") else Response.Write("(NYSE: KM)") end if %>, which eventually canceled its dividend, comes to mind here.

Since it seems clear that the BSP 30 stocks in January are "fresher" in a sense than the Dow 30 stocks just about any time of the year, a slightly aged BSP list doesn't really bother me all that much. The issue of losses of BSP companies due to mergers and incorporation into the Dow 30 still has some merit, although in the grand scheme of things, this probably plays a fairly minor role.

So what can we conclude? Probably not much. (Go ahead, try to get your money back from the head Fools for this column if you think it was a waste of time!) Here are some common-sense (i.e., unproven) thoughts concerning the issue of BSP timing:

-- Probably the optimal time of the year to start a BSP Portfolio, as with the Foolish Four, is in December or January. This effect may be a little muted compared with that of the Dow Dividend strategies.

-- Other starting dates certainly would be acceptable. I personally have had great results with a July starting date, and others anecdotally have had similar positive experiences starting in other months.

-- If one were about to start a BSP Portfolio in March, I'd probably wait a few weeks, until the end of the month when the new BSP 30 list comes out.

Finally, I'd urge potential investors not to become too bogged down in these fairly arcane details, especially if it paralyzes one with indecision. I'm reminded of a saying by Oliver Wendell Holmes:

There is one disadvantage which the man of philosophical habits of mind suffers, as compared with the man of action. While he is taking an enlarged and rational view of the matter before him, he lets his chance slip through his fingers.

May today's luck o' the Irish stay with you all year round!