Variations on Variations
by Ann Coleman
(TMF AnnC)

Reston, VA. (October 28, 1998) -- The RP4 variation of our Foolish Four strategy has returned an outstanding 24% per year (average) over the last 25 years. Of course, this figure is based on backtested data, meaning no one has actually made money with the strategy over the past 25 years, because no one knew about it back then. Still, that is pretty impressive.

The RP4 is not the only variation on our Foolish Four theme, however. We have a few that we have been following on the 1998 Dow Returns page that have even better long-term track records, although none is beating the Foolish Four this year. It is also nice to keep track of how some of the original Dow strategies, like the Dogs of the Dow and the Beating the Dow 5, are doing.

Today we are going to take a little tour of strategies that you might want to keep an eye on. Each strategy is followed by its 25 year average annual return. (CAGR, or compound annual growth rate, based on a one-year holding period and a January 2 renewal date. Dividends are reinvested annually.) For comparison, the Dow as a whole returned 13.61% per year on average during this period, and the average annual return of the Standard & Poor's 500 Index was 13.06%.

The Dogs of the Dow (a.k.a. the High Yield 10): This one's been around for years and years. Buy the 10 highest yielding Dow stocks and hold for one year. Rinse, repeat. 17.44%

High Yield 5: Knowles and Petty's The Dividend Investor showed that the five highest yielders did even better. 18.29%

Beating the Dow 5: In Beating the Dow, Michael O'Higgins proposed a variation on the Dogs of the Dow. He suggested ranking the 10 dogs by price and only buying the 5 cheapest. 19.40%

Beating the Dow 4: Our first variation -- drop the lowest priced BTD5 stock. 21.70%

PPP: Another Michael O'Higgins strategy -- buy only the second-lowest priced high yielder. This is a very risky strategy. It has had some incredible years (136%, 181%) and some terrifying ones (-37%). For thrill seekers only. 25.05%

The Old Foolish Four: Our original improvement to Beating the Dow, the Old Foolish Four drops the lowest priced BTD stock and doubles up on the second-lowest priced stock. 23.17%

Foolish Four: Starting with the BTD5, drop the lowest priced stock only if it is also the highest yielder. Buy stocks 1, 2, 3, 4 or 2, 3, 4, 5, depending on whether the #1 stock is dropped. This improvement let us eliminate the double weighting in the second-lowest priced stock, which reduced the riskiness of the strategy while still beating Beating the Dow. 21.86%

Foolish Four Plus: Double the amount invested in the two lowest priced Foolish Four stocks. 22.61%

Foolish Two (a.k.a. UV2): Buy only the two lowest priced Foolish Four stocks. 23.71%

All of the above strategies pick stocks exclusively from the Dogs of the Dow. The RP variation widens the net by looking at the relationship between price and yield. Mostly it picks from those same 10 stocks, but occasionally the formula will reach out and touch one of the other Dow Stocks. All RP strategies skip the #1 ranked stock.

RP2: Buy the stocks with the 2nd and 3rd highest RP ratio. This is the best performing Dow strategy we know of. Over the last 25 years, it even outperformed the PPP -- but you are limited to two stocks and the ride can get wild, although not as wild as the PPP. 26.24%

RP4: Buy stocks ranked 2, 3, 4, and 5 by the RP ratio. 24.62%

RP4 Plus: A combination of the RP2 and RP4. You buy double helpings of the 2nd and third ranked stocks. 25.23%

Or, you can vary the strategy to suit yourself. For example, an RP5 (22.24%) strategy would include the next stock on the RP list. Invariably, when you add a stock, the long-term returns drop slightly, but those returns become somewhat more stable.

Friday we turn the RISK spotlight on these strategies.

Survey update: Still counting, still reading. (Memo to me -- Next time you get a bright idea like this, hire a temp.)

Fool on and prosper!

Current Dow Order | 1998 Dow Returns

10/28/98 Close
Stock  Change   Last 
 UK   +   1/8   38.06 
 IP   -   3/16  44.50 
 MO   +   7/8   51.63 
 EK   -   1/8   74.50 
                    Day   Month    Year 
         FOOL-4   +0.37%  -2.04%   8.57% 
         DJIA     +0.07%   6.75%   5.86% 
         S&P 500  +0.26%   5.03%  10.07% 
         NASDAQ   +1.15%   2.57%  10.63% 
     Rec'd   #  Security     In At       Now    Change 
  12/31/97  206 Eastman Ko    60.56     74.50    23.01% 
  12/31/97  276 Philip Mor    45.25     51.63    14.09% 
  12/31/97  289 Int'l Pape    43.13     44.50     3.19% 
  12/31/97  291 Union Carb    42.94     38.06   -11.35% 
     Rec'd   #  Security     In At     Value    Change 
  12/31/97  206 Eastman Ko 12475.88  15347.00  $2871.13 
  12/31/97  276 Philip Mor 12489.00  14248.50  $1759.50 
  12/31/97  289 Int'l Pape 12463.13  12860.50   $397.38 
  12/31/97  291 Union Carb 12494.81  11076.19 -$1418.63 
                              CASH    $754.73 
                             TOTAL  $54286.92