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A Better Keystone: Keystone EPS      

By Moe Chernick ([email protected])

El SEGUNDO, CA (June 29, 1999) -- The Keystone strategy is a complementary strategy to the Foolish Four. Both look for their stocks only among the largest and most successful U.S. companies. But while the Foolish Four selects value stocks, Keystone selects growth stocks.

By adding this growth screen to a portfolio that already contains Foolish Four or another, value-oriented Dow Investing variation, you can increase your returns while balancing your portfolio between value and growth.

In my last two columns, we have talked about the mechanics of the Keystone strategy and the legitimacy of the Keystone strategy. Today, we will conclude our series on Keystone by talking about a variation called Keystone EPS.

The Keystone EPS screen was developed by Jim Lynn. By adding a screen for the Keystone stocks with the highest Earnings Per Share number, Jim's method helps avoid stocks that might be rising on hype that is not sustained by strong earnings. Jim's improved stock selection method goes as follows:

  1. Take the top 10 Keystone stocks. These stocks will already be sorted by Relative Strength using the "26 week total return" numbers from Value Line.

  2. Number the stocks 1-10 (the number 1 stock will be the stock with the highest relative strength)

  3. Re-sort these 10 stocks (keeping their RS ranking number with them) based on EPS growth over the last 12 months as provided by Value Line. Write down the number 1-10 next to each stock with the number 1 going to the stock with the highest EPS growth.

  4. Add the two numbers for each stock.

  5. Buy the 5 stocks with the lowest combined number. Break ties by buying the stock with the higher RS.
Like the original Keystone, rebalance annually.

This version may improve your average annual performance by as much as 5�%. According to the data collected by Brian Malcolm, over the past 12 years the Keystone EPS returned 36.4% compared to 31.4% for the traditional Keystone for portfolios starting/renewing in January. For other months, the results varied but only in April were the results significantly better for the traditional Keystone. Here are the average annual returns, for 1987-1998, for portfolios starting in all months:
Start Month   Keystone     Keystone EPS   
   Jan.        31.4%         36.4%
   Feb.        29.2%         34.8%
   Mar.        20.1%         24.0%
   Apr.l       23.8%         20.7%
   May         19.6%         19.9%
   June        23.0%         27.3%
   July        23.7%         23.5%
   Aug.        28.5%         31.1%
   Sept.       22.5%         22.9%
   Oct.        18.2%         18.3%
   Nov.        26.7%         25.0%
   Dec.        36.8%         36.6% 
 
   Ave.        25.3%         26.8%
You can see that, on average, the Keystone EPS gives you a 1.5% advantage over the traditional Keystone. And, like the original Keystone, it beats the S&P 500 in every case.

Should you use the Keystone EPS variation? Like all investing decisions, that is a matter of personal choice. If you do the Keystone 5 and rebalance early in the year, Keystone EPS seems to have an advantage.

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