Runaway Dogs

By Ethan Haskel (TMF Cormend)

BALTIMORE, MD (August 18, 1999) - The soaring stock markets of the '90s have been accompanied by an unprecedented number of stock splits. The official Foolish interpretation of these splits is that they are essentially "nonevents." But not so fast there, high-yield investors!

As succinctly explained by Barbara Eisner Bayer, when one of our stocks splits, we acquire additional shares. The total value of our portfolio doesn't change a dime, however, because the stock price is altered to reflect the increased number of shares outstanding. But a stock's price does matter a great deal to Foolish Four and Beating the S&P (BSP) investors, since the formulas we use to choose our stocks incorporate price as a major factor.

For instance, the RP formula for choosing the Foolish Four uses the stock's yield divided by the square root of the price. BSP selects among the lowest-priced stocks of the top 10 high-yielding BSP 30 stocks. A stock split decreases the stock price, with a significant effect on a stock's ranking.

The announcement of a stock split usually means a company is firing on all cylinders. The business seems to have a rosy outlook; profits are soaring. The stock price (before the split) is anything but in the dumps. Does this scenario sound like a "dog" stock to you, the kind we cherish around here? I think not.

Recall why we invest in these dogs in the first place. Usually, their stock prices have been beaten down due to a pessimistic outlook. Because the Foolish Four and BSP companies are huge, multinational corporations, they usually have the wherewithal to weather these storms; in retrospect, the stock prices were overly depressed. Fools buy them when no one else wants them, not usually when they appear to be runaway winners and are splitting their shares.

To examine the effect of splits on the performance of the BSP stocks, let's look at the five-stock Official BSP Portfolio, which had split in the previous year. Since the strategy has been backtested through 1987, there are 65 stocks in all. A total of 11 of these 65 stocks, or 17%, had split during the previous year.

The following table shows the performance of these 11 stocks compared with the S&P 500. The "Rank" designation refers to the rank of that particular stock out of the five BSP stocks for the year, with "1" representing the best performing stock for the group, "5" the worst.

Year          Stock                Return  (Rank)   S&P 500  
1987   Chrysler (NYSE: DCX)         -6.6%    (4)     5.2%
       Ford (NYSE: F)                39.6    (2)     5.2
1988   Bristol Myers (NYSE: BMY)     12.9    (4)    16.8
       J.P. Morgan (NYSE: JPM)        0.5    (5)    16.8
1989   Ford                          -7.7    (5)    31.5
1995   Ford                           8.0    (5)    37.5
1997   Anheuser Busch (NYSE: BUD)    12.5    (4)    33.2
       Chrysler                      11.5    (5)    33.2
1998   Emerson Electric (NYSE: EMR)   9.4    (4)    28.7
       Kimberly-Clark (NYSE: KMB)    12.6    (3)    28.7
       Texaco  (NYSE:TX)              0.8    (5)    28.7

                   Average Return    8.5%           24.2%
Mama Mia! In every case but two, each stock which split the previous year was the worst-performing stock of the portfolio. (In cases where two or more stocks split, these stocks were at the bottom of the barrel.) The exception was 1987, when Chrysler was the second-worst performer. That same year, Ford was the only stock of our 11 which outperformed the S&P 500.

Keep in mind that these "losers" were included in an overall strategy that has handily outpaced the S&P 500 since 1987. How much better could we have done without them?

Ignoring any potential BSP stocks that had split the previous year, our returns for the BSP Portfolio improve dramatically. Through last week, the compound annual return for BSP from 1987 increases from 19.9% to 25.2%. In dollar terms, a $10,000 portfolio started in 1987 would have grown to $160,600 had we omitted these 11 stocks, compared with $99,600 if they were included.

So, should we make a modification to our BSP strategy to incorporate these new findings? Next week we'll consider the pros and cons of such a change. Feel free to chime in on the message boards if you' have an opinion. Vote early and often!

[Editor's Note: Following are the returns of a "paper" Beating the S&P portfolio. The stocks were selected December 31, 1998 and "purchased" in equal dollar amounts to be "held" for one year. To see a list of stocks for portfolios starting now, see Today's Stock Lists.]

Beating the S&P year-to-date returns (as of 08-17-99):
Schlumberger (NYSE: SLB)     +44.5%
Kimberly-Clark (NYSE: KMB)   +12.8%
Campbell Soup (NYSE: CPB)    -16.2%
Ford Motor Co.  (NYSE: F)    -13.7%
Bank of America  (NYSE: BAC)  +9.0%
Beating the S&P               +7.3%
Standard & Poor's 500 Index   +9.9%

Compound Annual Growth Rate from 1-2-87:
Beating the S&                +20.3%
S&P 500                       +17.7%

$10,000 invested on 1-2-87 now equals:
Beating the S&P              $102,300
S&P 500                       $78,200

Today's Stock Lists | 1999 Dow Returns

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Foolish Four Portfolio

8/18/99 Closing Numbers
 Ticker   Company   Dly Pr Chg   Price 
CAT  CATERPILLAR INC              -1   $61.00
IP  INTL PAPER                   -1 3/8   $52.75
JPM  MORGAN (JP)                  -1 9/16   $132.94
MMM  MINNESOTA MIN'G/MFG          -1 13/16   $95.56

  Day Week Month Year
To Date
Foolish Four -2.00% -1.77% 4.96% 29.06% 30.98% 51.31%
S&P 500(DA) -.84% .39% .31% 9.01% 9.07% 14.25%
NASDAQ -.51% .86% .73% 21.21% 22.33% 36.25%
DJIA -1.13% .16% 3.16% 19.71% 19.45% 31.35%

 Trade Date   # Shares   Ticker   Cost/Share   Price   LT % Val Chg 
  12/24/98  24CAT    43.083  $61.00  41.59%
  12/24/98  14MMM    73.571  $95.56  29.89%
  12/24/98  9JPM    105.514  $132.94  25.99%
  12/24/98  22IP    43.551  $52.75  21.12%

 Trade Date   # Shares   Ticker   Cost   Value   LT $ Val Ch 
  12/24/98  24CAT    $1,034.00  $1,464.00  $430.00
  12/24/98  14MMM    $1,030.00  $1,337.88  $307.88
  12/24/98  9JPM    $949.63  $1,196.44  $246.81
  12/24/98  22IP    $958.12  $1,160.50  $202.38
  Cash: $80.43  
  Total: $5,239.25  

• S&P 500 (DA) = dividend adjusted. Dividends have been added to the total return of the index.
• DJIA (DA) = dividend adjusted. Dividends have been added to the total return of the DJIA.

The Foolish Four Portfolio was launched on December 24, 1998, with $4,000. Additional cash is never added, all transactions are discussed and explained publicly before being made, and returns are compared daily to the S&P 500 and the Dow. (Dividends are included in the yearly, historic and annualized returns.) Stocks are chosen once per year using a formula based on dividend yield and price. See The Foolish Four Explained for details.