What is the Complaint?
Posted: Sun Sep 05, 2004 3:44 pm
What is the Complaint?
In this post
http://nofeeboards.com/boards/viewtopic ... 342#p23342
Alec provided a link to Mining Fool's Gold from the Financial Analysts Journal of March/April 1999
http://papers.ssrn.com/sol3/papers.cfm? ... _id=158409
I have read a lot of complaints about the Foolish Four investment strategy. Now that I know what it is, I want to know what people are complaining about. Is their complaint about the strategy? Or is their complaint about the sales pitch?
The Foolish Four
The Foolish Four is best characterized as a mechanically implemented trading strategy.
Here it is:
Once per year (which usually means in January), a person identifies the ten highest yielding stocks selected from the thirty that make up the Dow Jones Industrial Average. He eliminates the stock with the lowest price (per share). He invests 40% of his money in the stock with the second lowest price (per share) and 20% of his money in each of the next three stocks with the lowest prices. He does not invest in any of the five remaining stocks with the highest dividend yields. Nor does he invest in any of the remaining twenty Dow Stocks. At the end of a year, he liquidates his holdings and repeats the process for the following year.
Notice that the annual turnover can be as high as 100%. This is why I call it a trading strategy. If the same company appears on the following year's list, it does not have to be sold in its entirety. Some shares may have to be sold in order to restore allocations.
If you are going to engage in trading, the Foolish Four is not a horrible choice. Thanks to the internet, it is possible to reduce transaction costs sufficiently to keep the financial cost of trading low enough to limit the damage. Depending upon the size of one's portfolio and how much time remains for accumulation, owning only four stocks can make sense. At worst, it can be thought of as an intermediate step towards implementing the ten-stock Dogs of the Dow trading strategy.
There is an element of the Foolish Four trading strategy that makes sense: buying high quality stocks with high dividends.
As with the Dogs of the Dow, popularity attracts front running, which kills most of its upside potential.
Dividend Strategies
The best dividend strategy that I have read so far is in The Single Best Investment by Lowell Miller. He selects stocks using the following criteria: buy high quality companies with high dividend yields and high dividend growth rates. He prefers to own many stocks, typically thirty or forty. He prefers not to sell, but will in certain circumstances such as a discontinued dividend or a financial scandal.
The Gordon Equation is that the Discount Rate (which equals the total return if future investments are financially identical to currently available investments) equals the dividend yield plus the dividend growth rate. We see that this is built into Lowell Miller's approach.
James O'Shaughnessy has conducted extensive research that used Standard and Poor's entire Compustat database (covering the years 1951-1996). He has presented his findings in What Works on Wall Street. He has recommended five trading strategies in How to Retire Rich. Four of those strategies emphasize high dividend yields. Although he prefers to own 50 stocks, he allows holding as few as 25 stocks in his two best strategies. His three remaining strategies are concessions. Each has only ten stocks, but each emphasizes high quality and high dividends. These three include the Dogs of the Dow, a Utility strategy and a Core Value strategy. Quality is assured with the Dogs of the Dow because of the composition of the Dow Jones Industrial Average. Quality is assured with the Utility strategy because it limits selections to those with rated highest for Safety by Value Line. [The strategy does not limit your choice to utilities. The requirement for the highest levels of safety causes it to end up with utilities.] Quality is assured with his Core Value strategy through an initial screening according to Value Line's Financial Strength ratings. He limits selections to those with the very highest A++ ratings. Otherwise, his selection process is similar to Lowell Miller's, but differs in the details.
Sales Pitches
When I read the claims that were made for the Foolish Four, I did not have any reaction. I considered them to be absurd and left it at that.
In my formative years, I learned to try for a 10% (nominal) return from stocks (with dividends reinvested). In those days, the long-term return of the stock market was considered to be 10%. If you are able to avoid making serious blunders, you can expect to make at least 8%. If you do exceptionally well, you might even get 12%, but 11% is excellent. Higher returns are possible, but seldom achieved.
An 11% return compounded over a long period of time shows a tremendous advantage when compared to a 10% return.
It is likely that the initial rules for IRAs were based upon a 10% return from the stock market. A worker who invests $2000 per year for 42 years ends up with just over $1 million if the return is 10%. A worker who starts at age 20 could be a millionaire by the time that he reached his minimum social security age of 62. [The IRA was one of the earlier solutions to an impending, future social security crisis.]
Because of my early training, I have never reacted to claims of ridiculously high returns. I automatically reject any claim bigger than 3%. Even then, it takes a lot of convincing for me to accept a number as high as 2%. Show me how to get an extra 1% and you have my attention. Show me that I can count on that 1% and I am enthusiastic.
Have fun.
John R.
In this post
http://nofeeboards.com/boards/viewtopic ... 342#p23342
Alec provided a link to Mining Fool's Gold from the Financial Analysts Journal of March/April 1999
http://papers.ssrn.com/sol3/papers.cfm? ... _id=158409
I have read a lot of complaints about the Foolish Four investment strategy. Now that I know what it is, I want to know what people are complaining about. Is their complaint about the strategy? Or is their complaint about the sales pitch?
The Foolish Four
The Foolish Four is best characterized as a mechanically implemented trading strategy.
Here it is:
Once per year (which usually means in January), a person identifies the ten highest yielding stocks selected from the thirty that make up the Dow Jones Industrial Average. He eliminates the stock with the lowest price (per share). He invests 40% of his money in the stock with the second lowest price (per share) and 20% of his money in each of the next three stocks with the lowest prices. He does not invest in any of the five remaining stocks with the highest dividend yields. Nor does he invest in any of the remaining twenty Dow Stocks. At the end of a year, he liquidates his holdings and repeats the process for the following year.
Notice that the annual turnover can be as high as 100%. This is why I call it a trading strategy. If the same company appears on the following year's list, it does not have to be sold in its entirety. Some shares may have to be sold in order to restore allocations.
If you are going to engage in trading, the Foolish Four is not a horrible choice. Thanks to the internet, it is possible to reduce transaction costs sufficiently to keep the financial cost of trading low enough to limit the damage. Depending upon the size of one's portfolio and how much time remains for accumulation, owning only four stocks can make sense. At worst, it can be thought of as an intermediate step towards implementing the ten-stock Dogs of the Dow trading strategy.
There is an element of the Foolish Four trading strategy that makes sense: buying high quality stocks with high dividends.
As with the Dogs of the Dow, popularity attracts front running, which kills most of its upside potential.
Dividend Strategies
The best dividend strategy that I have read so far is in The Single Best Investment by Lowell Miller. He selects stocks using the following criteria: buy high quality companies with high dividend yields and high dividend growth rates. He prefers to own many stocks, typically thirty or forty. He prefers not to sell, but will in certain circumstances such as a discontinued dividend or a financial scandal.
The Gordon Equation is that the Discount Rate (which equals the total return if future investments are financially identical to currently available investments) equals the dividend yield plus the dividend growth rate. We see that this is built into Lowell Miller's approach.
James O'Shaughnessy has conducted extensive research that used Standard and Poor's entire Compustat database (covering the years 1951-1996). He has presented his findings in What Works on Wall Street. He has recommended five trading strategies in How to Retire Rich. Four of those strategies emphasize high dividend yields. Although he prefers to own 50 stocks, he allows holding as few as 25 stocks in his two best strategies. His three remaining strategies are concessions. Each has only ten stocks, but each emphasizes high quality and high dividends. These three include the Dogs of the Dow, a Utility strategy and a Core Value strategy. Quality is assured with the Dogs of the Dow because of the composition of the Dow Jones Industrial Average. Quality is assured with the Utility strategy because it limits selections to those with rated highest for Safety by Value Line. [The strategy does not limit your choice to utilities. The requirement for the highest levels of safety causes it to end up with utilities.] Quality is assured with his Core Value strategy through an initial screening according to Value Line's Financial Strength ratings. He limits selections to those with the very highest A++ ratings. Otherwise, his selection process is similar to Lowell Miller's, but differs in the details.
Sales Pitches
When I read the claims that were made for the Foolish Four, I did not have any reaction. I considered them to be absurd and left it at that.
In my formative years, I learned to try for a 10% (nominal) return from stocks (with dividends reinvested). In those days, the long-term return of the stock market was considered to be 10%. If you are able to avoid making serious blunders, you can expect to make at least 8%. If you do exceptionally well, you might even get 12%, but 11% is excellent. Higher returns are possible, but seldom achieved.
An 11% return compounded over a long period of time shows a tremendous advantage when compared to a 10% return.
It is likely that the initial rules for IRAs were based upon a 10% return from the stock market. A worker who invests $2000 per year for 42 years ends up with just over $1 million if the return is 10%. A worker who starts at age 20 could be a millionaire by the time that he reached his minimum social security age of 62. [The IRA was one of the earlier solutions to an impending, future social security crisis.]
Because of my early training, I have never reacted to claims of ridiculously high returns. I automatically reject any claim bigger than 3%. Even then, it takes a lot of convincing for me to accept a number as high as 2%. Show me how to get an extra 1% and you have my attention. Show me that I can count on that 1% and I am enthusiastic.
Have fun.
John R.