Unreasonable Expectations
What NOT to expect
from the Foolish Four

by Ann Coleman (TMF

Reston, VA (June 22, 1999) -- Yesterday we discussed the question: What is a reasonable rate of return to expect from the Foolish Four strategy? We suggested that over a 25-year period, for strategies renewing in December or January, an average annual return somewhere around 20% would be a more reasonable expectation than the 24+% returns that the strategy has been raking in during the 25-year periods that have ended recently.

Most folks took the shock pretty well.

Today, let's explore some expectations that are often expressed, but that are not reasonable.

1. I bought the Foolish Four stocks last month and they've gone down! What did I do wrong?

The Foolish Four stocks are selected because they are out of favor at the moment. That's how the strategy works. It is very unrealistic to expect that just because you bought them, they should start their turnaround immediately. Everyone sing along: "Ti-i-ime is on my side -- yes it is."

2. My Foolish Four stocks haven't beaten the market for the last two years. Why isn't the strategy working any more?

No strategy is perfect. Occasionally, the Foolish 4 has been beaten by the market. The Standard & Poor's 500 Index has beaten the Foolish Four two years in a row twice during the period from 1961 through 1998: 1979-80 and 1997-98. It will probably beat it three years in a row at some point. Expect that.

3. The Foolish Four list this week is different from the stocks I bought last week (or month). Should I sell them and buy the new ones?

The Foolish Four list skitters around like a waterbug in a trout stream. Ignore the day-to-day changes in the list. The changes are less dramatic than they might appear at first, for one thing. Usually the same 6 or 7 stocks are shifting on and off of the list as prices change. They could all be good buys, although some will undoubtedly turn out to be better performers than the others. Also, selling early has been shown to be a real return killer.

Unfortunately, we can't tell which stocks will do best at this point. If you buy the stocks that are currently on the Foolish Four list, you are probably getting them at the best price (for that day and relative to the other stocks). That's about as good as you can expect to do.

4. Two of my stocks are up more than 30 percent. Should I sell them and lock in my profits?

This is an interesting question. Sometimes it comes from folks who expect that the strategy will provide 25% returns every year regularly like interest payments. Boy, are they in for a surprise! Others are wondering about the viability of a strategy that uses a certain percentage gain to determine the best sell point rather than a certain time period. The first group simply needs to take a look at the actual, year-by-year historical performance to see that the returns vary widely. A policy of selling out early would simply eliminate the possibility of a great year.

The second group has a very interesting question, which we will be exploring via our monthly database. My feeling is that developing a sell strategy based on percentage gains will be difficult, if not impossible, because you will often end up replacing a stock that is "going places" with one that has just arrived on the Foolish Four list and has a few months of downtime ahead of it (see #1). But only a detailed look at the data will give us the answer.

By the way, I received a couple of e-mails from folks who were confused about the table that accompanied yesterday's column. The returns shown there are for 25-year periods that ended in the year listed. They are not single-year returns. For example, the line that starts "1993" gives the average annual return for the period that started in January of 1969 and ended in December of 1993.

Fool on and prosper!

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06/22/99 Close
Stock  Change   Last
CAT  -  11/16  60.19
JPM  -  15/16  135.00
MMM  -   5/8   89.63
IP   -1  7/8   52.63

                  Day    Month   Year   History
      FOOL-4   -1.43%   4.49%  26.87%  28.76%
        DJIA     -0.87%   1.53%  17.56%  17.09%
        S&P 500  -0.97%   2.61%   9.26%   9.52%
        NASDAQ   -1.89%   4.46%  17.69%  19.31%

    Rec'd   #  Security     In At       Now    Change

 12/24/98   24 Caterpillar   43.08     60.19    39.71%
 12/24/98    9 JP Morgan    105.51    135.00    27.95%
 12/24/98   14 3M            73.57     89.63    21.82%
 12/24/98   22 Int'l Paper   43.55     52.63    20.84%

    Rec'd   #  Security     In At     Value    Change

 12/24/98   24 Caterpillar 1034.00   1444.50   $410.50
 12/24/98    9 JP Morgan    949.62   1215.00   $265.38
 12/24/98   14 3M          1030.00   1254.75   $224.75
 12/24/98   22 Int'l Paper  958.12   1157.75   $199.63

              Dividends Received      $49.99
                             Cash     $28.26
                            TOTAL   $5150.25