FOOLISH FOUR PORTFOLIO

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Beating O'Higgins
Dow investing outlasts BTDWB

by Chris Rugaber (TMF RFK@aol.com)

Alexandria, VA (January 21, 1999) -- Ann Coleman's discussion of Michael O'Higgins's new book, Beating the Dow with Bonds, has certainly sparked debate on our message boards as Dow investing Fools respond to Mr. O'Higgins's Ursa Major view of the market's future. A Fool with the user name of Lowell posted his own excellent (and negative) review of O'Higgins's book a couple of weeks ago.

Since O'Higgins is so closely identified with Dow Dividend investing, does the fact that he now advocates something different mean that Dow investing no longer "works?" This is sort of a perpetual worry here in this area of Fooldom and is separate from the question of whether the market is overvalued. So let's look at the two questions individually.

Regarding the Foolish Four and Dow investing overall, it's important to remember that while O'Higgins popularized the low-priced/high-yield approach in his book Beating the Dow, he wasn't the first to discover it, and its effectiveness is completely independent of O'Higgins himself. He is not some kind of swami clueing us in to some mystical strategy that only he can divine. Dow investing has a logic to it that stands on its own.

Simply put, the reasoning behind Dow strategies is that stocks with high dividends and relatively lower prices are frequently facing difficulties that end up being temporary, and since they're large, wealthy American corporations, they're able to weather those difficulties and, ideally, bounce back in better shape than before. Our current stocks provide excellent examples: J.P. Morgan (NYSE: JPM) is being hit by economic instability in Brazil, where it has loans outstanding; Caterpillar (NYSE: CAT) and 3M (NYSE: MMM) are facing reduced orders from the Asian countries, where big chunks of their revenue are derived; and International Paper (NYSE: IP) is in a commodity business that currently has excess capacity, which increases supply and therefore reduces the prices of its products. (Please excuse these simplistic summaries.)

For another, more in-depth look at the reasoning behind Dow strategies, check out Ann Coleman's article on the subject last fall. In addition, Robert Sheard, our former Dow investing master, wrote about O'Higgins's change of heart last spring.

Since there is a logical basis for Dow investing, we can track the Dow companies and see if any of the elements start to break down. Are companies no longer reliably maintaining dividends? Has the market become so efficient that "Dow Dogs" are quickly scooped up and therefore don't experience the price downturns they might have before? These kinds of things are potential hazards, but there's absolutely no sign they're happening now. We'll know it when they do. We won't have to wait for someone like O'Higgins to tell us.

Then there's the question of valuation and O'Higgins's apparent concern that the market is so overvalued that it's going to crash. As all good Fools know, it's generally useless to discuss whether the market is "overvalued," for a variety of reasons. First, as an investor you really should be primarily concerned with the stocks you are invested in or are considering buying. The overall market is much less important. Secondly, "the overall market" these days is segmented into the large cap universe -- especially the 50 largest Standard & Poor's 500 Index companies, which have grown tremendously in recent years -- and the rest of the market -- which hasn't. To speak of "the market" as one coherent whole is not very meaningful.

Finally, no one has ever figured out how to accurately predict the market's movements in advance. Therefore, the market may or may not be "overvalued" on someone's subjective calculation, but this tells us nothing about what will happen to the stock market. Many people thought it was overvalued four years ago, when it was on the cusp of our greatest bull market in history. Oops!

In addition to these basics, there are some important things to consider regarding one of O'Higgins's primary metrics, the P/E, or price to earnings ratio. Fellow Fool Louis Corrigan has done an excellent job of explaining how, especially when it comes to market indices, P/E ratios and other valuation measures ain't what they used to be. Check out Wednesday's Evening News to get the full scoop.

'Til next week, Fool on!

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Today's Stock Lists | 1998 Dow Returns

01/21/99 Close
Stock  Change   Last
--------------------
CAT  -   5/16  44.88
JPM  -2 15/16  105.88
MMM  +2  7/16  71.94
IP   +1  5/16  42.31
                   Day   Month    Year   History
        FOOL-4   +0.73%  -1.56%  -1.56%  -0.10%
        DJIA     -0.77%   0.90%   0.90%   0.50%
        S&P 500  -1.70%   0.48%   0.48%   1.87%
        NASDAQ   -2.93%   6.94%   6.94%   8.40%

    Rec'd   #  Security     In At       Now    Change

 12/24/98   24 Caterpillar   43.08     44.88     4.17%
 12/24/98    9 JP Morgan    105.51    105.88     0.35%
 12/24/98   14 3M            73.57     71.94    -2.22%
 12/24/98   22 Int'l Paper   43.55     42.31    -2.84%


    Rec'd   #  Security     In At     Value    Change

 12/24/98   24 Caterpillar 1034.00   1077.00    $43.00
 12/24/98    9 JP Morgan    949.62    952.88     $3.26
 12/24/98   14 3M          1030.00   1007.13   -$22.88
 12/24/98   22 Int'l Paper  958.12    930.88   -$27.25


                             Cash     $28.26
                            TOTAL   $3996.14

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