Workshop Portfolio

The Daily Workshop Report
by Robert Sheard (TMF Sheard)

LEXINGTON, KY. (Nov. 6, 1997)

Scroll to the bottom for year-to-date Growth and Value Screen results.

In the past, I've discussed on occasion an aggressive method for those investors who love the stability and long-term record of the Dow Approach, but who want to juice up the returns beyond the standard approach's level. Many readers have suggested options or LEAPS (long-term options), but I'm not a fan of them because they add too many more variables to the equation that you have to be correct about (time horizon and degree of move, for example).

Instead, aggressive Dow investors might turn to a bit of margin leverage to boost the normal returns for the approach. Today, let's look at a couple of margin alternatives. I'm not necessarily endorsing these, mind you, but simply presenting some possibilities.

As our test case, let's use the Unemotional Value four-stock approach where one doubles the weight of the cheapest two stocks (UV4+). This approach has returned an annualized return of 23.37% from 1971 to 1996.

The easiest margin method is simply to use a steady leverage percentage each year when you update your holdings. If you borrow an additional 25% of your portfolio value, for instance, 80% of your total exposure is your own money and 20% is on margin (50% is the current limit).

Had you done this each year from 1971 through 1996, the UV4+ returns would have been boosted from 23.37% to 25.02% (not accounting for taxes and assuming a constant interest charge of 8% for the margin balance).

You could have boosted the returns further, of course, had you borrowed more, but when you get beyond 20% on margin, your risk begins to increase exponentially and the likelihood of a margin call soars in a big correction.

Harvey Knowles and Damon Petty, authors of The Dividend Investor, mentioned another strategy where one uses leverage only in the two years following a losing year for the DJIA. Let's apply that to the 1971-1996 returns for the UV4+ approach.

If you had borrowed 50% of your portfolio value (that is, 33.3% on margin) in each of the two years following a loss for the DJIA, you would have been using leverage in nine of the last twenty-six years. But doing so increased the annualized returns for the whole period to 27.28%. And for the ultimate in aggression, the investor who used maximum margin (50% your own money, 50% margin) for this approach, the annualized gains jump to 30.80%.

Keep these possibilities in mind, while being fully aware that margin leverage works in the same exaggerating way when your investments are going down, and you may find an alternative to investing in more volatile approaches that require more trading. Leveraging your Dow Approach can boost your long-term returns without putting you into an extremely high-risk category. (I'd never be able to use real high rates of margin, though, despite these dramatic returns).

To close, here's a table listing the growth of $10,000 using these various levels of margin over the last 26 years:

$2,351,731 UV4+ with no margin

$4,724,486 with 20% margin each year

$5,293,761 with 33.3% margin for two years following a down year for the DJIA

$10,767,872 with 50% margin for two years following a down year for the DJIA

Of course, there are lots of margin levels in between these four points, so if you're considering using margin as part of a regular strategy, do some homework into the costs, dangers, and potential benefits. Be a true Fool and understand this topic thoroughly (including your broker's minimum equity requirements) before plunging in. This is not something investors should look at without experience and education.

Monthly Growth Screens
(Jan. 3 to present)
87.64%  Relative Strength  
32.68%  Investing for Growth  
31.33%  EPS Plus RS  
25.40%  S&P 500 Index  
20.59%  Formula 90  
16.54%  Unemotional Growth  
16.24%  YPEG Potential  
12.07%  Low Price/Sales  

Annual Value Screens
(Jan. 1 to present)
22.56%  Dogs of the Dow  
22.32%  Dow Combo  
21.61%  Beating the S&P  
20.80%  Unemotional Value  
20.80%  Beating the Dow  
20.44%  Foolish Four  
19.15%  Dow Jones Ind Avg