Boring Portfolio

The Bell Curve
...maybe you can improve your average
by Mark Weaver

SPRINGFIELD, IL. (July 13, 1998) -- Hashimoto resigns and our market shrugs. There is no news that is bad news to traders in the U.S. The S&P 500 tacked on another 0.08% while the Nasdaq added a strong 1.16%. The Borefolio didn't participate in the festivities, dropping 0.34%. Three Boring stocks were up, but our other holdings declined. Only one stock moved more than a full point.

There was a small bit of news today on two of our holdings. First of all, Cisco Systems (Nasdaq: CSCO) was tangentially in the news as Hewlett Packard (NYSE: HWP) and Bay Networks (NYSE: BAY) announced slashed prices on computer switches. An analyst from Forrester Research was quoted as saying, "There's no secret recipe for these kinds of products, so (companies) are using price to differentiate themselves." Cisco makes these same switches, so a margin squeeze in that business segment might be anticipated as competitors slug it out. You might recall that Cabletron Systems (NYSE: CS) announced price cuts on routers last week. Although Cisco remains dominant in the networking world, it is not immune to competition. We will be keeping a close eye on those margins going forward.

Atlas Air (NYSE: CGO) announced an agreement with Lufthansa to provide maintenance to our company's new fleet of 747-400 freighters. This agreement locks in maintenance costs on a long term basis with a first class maintenance outfit. The agreement spans the next ten years.

While Greg uses a very analytical approach to picking the stocks for the Borefolio, there are other ways to find "boring" stocks which will outperform the market, and some of these techniques are real yawners.

The indexes we use as a bogey against which our performance is compared are the S&P 500 and the Nasdaq. Investors everywhere are in a relentless search to "beat the index." As has been pointed out relentlessly in these parts, most pros fail miserably in their efforts. There are many reasons for the failure, but one is that they simply own too many stocks. In essence, the performance of the "averages" is just that -- an average. The performance of the stocks in that average is grouped around the mean in a bell-shaped curve. Ultimately, an investor owning too many stocks will regress to that mean themselves. For professional investors, the fees they charge and costs they generate make it nearly impossible to beat the average. Heck, even an index fund underperforms by a small amount.

So, what is the point of this preamble? Investing is a game of playing the odds and trying to focus on stocks on the upper side of the bell curve. There are some folks that have wildly outperformed the markets and you can read all about them in any of a number of books -- Market Wizards, The New Market Wizards, The Money Masters all come to mind. These individuals are the investing equivalent of Michael Jordan, Mark McGwire or John Elway. They are superstars and attempts to "be like" them will be, in all likelihood, doomed to fail. That said, there is no reason an individual investor can't succeed in getting into the same league as these investing all-stars.

One simple way to "beat the averages" and put yourself in a position to excel in investing is to use screens to pick stocks. In many ways, because of the uncertainties inherent in evaluating stocks (the frequent worthlessness of analyst estimates, the gimmicks used in financial reporting by companies, the ever changing market environment), over-evaluation doesn't improve performance. One of the most successful investors of the past decade, Peter Lynch, made his investment decisions based on three minute presentations by his staff. In a way, using screens is a way to be nihilistic about stock evaluation while maintaining some order in stock picking.

The screen which has been most popular in Fooldom is Beat The Dow, or the Foolish Four. This is a simple screen based on only three variables: presence in the Dow Average, dividend yield and price. This simple system has bested the averages with regularity over the past several decades.

Another set of screens which have been successful are those promulgated by our own Robert Sheard in his book The Unemotional Investor. You will find continued updates and more screens in the Foolish Workshop. These systems can flat out work, as dull as they may be.

The screens I like to use are based on the work of two individuals - James O'Shaughnessy (What Works on Wall Street) and David Dreman (The New Contrarian Investment Strategy). These authors have looked at variables that statistically predict which stocks will be in the upper half of the bell shaped curve. Granted, there are some dogs generated by their screens, but the curve is shifted to a higher mean.

O'Shaughnessy puts an emphasis on the price/sales relationship for a growth stock strategy, and he combines this with measures of historical earnings growth. A good growth stock is one with a low PSR and a history of earnings growth. These stocks, as a group, have outperformed the "market" over time.

Dreman, on the other hand, emphasizes low PE, low Price/Book, and low Price/Cash Flow. After screening for these variables he analyzes a bit further to find stocks with reasonable leverage, historically sound return on equity and recent earnings growth. Looking at these variables protects the investor from buying a stock which deserves to be cheap. With this group of stocks the market can be bested without a lot of volatility. It takes patience though.

None of these strategies will give you the joy ride of an Iomega (NYSE: IOM) or Boston Chicken (Nasdaq: BOST). The market can take time to recognize value. Most of the stocks popping up in these screens and in Beating the Dow (Foolish Four) approaches are stocks that are down for some reason, albeit often a temporary one. It is hard to believe that stocks like AT&T (NYSE: T) or 3M (NYSE: MMM) will be down forever no matter what clouds are on the current horizon.

Space won't allow me to run all of the screens and list the results. Taking just David Dreman's low PE screen, juiced up as described, only 31 stocks out of the over 7300 listed in the Morningstar Stock Tools database fall out. Included in that number are Intel (Nasdaq: INTC), Anchor Gaming (Nasdaq: SLOT), Jabil Circuits (Nasdaq: JBIL), Lone Star Industries (NYSE: LCE), St. John's Knits (NYSE: SJK), Timberland (NYSE: TBL), Claire's Stores (NYSE: CLE) and a whole slew of oil service stocks. Some of these stocks are off their highs while others have had a tremendous year already. Statistically, at least, investing in this package of stocks -- with a quick review for overt bombshells (a meltdown in oil prices for one) -- would put an investor ahead of the pack.

Granted, it isn't as exciting as owning the Internet stocks, but you can sleep more easily at night. Zzzzz...

FoolWatch -- It's what's going on at the Fool today.

07/13/98 Close

Stock  Change    Bid 
 ANDW  -  3/8   17.56 
 CGO   -  1/4   36.81 
 BGP   -  11/16 38.13 
 CSL   -  1/4   45.19 
 CSCO  +1 5/16  94.19 
 FCH   -  3/4   30.94 
 PNR   +  5/8   42.25 
 TBY   +  1/4   9.06 
                   Day   Month    Year  History 
         BORING   -0.34%   2.15%   6.52%  34.03% 
         S&P:     +0.08%   2.77%  20.07%  87.45% 
         NASDAQ:  +1.16%   3.74%  25.16%  88.82% 
     Rec'd   #  Security     In At       Now    Change 
   2/28/96  400 Borders Gr    11.26     38.13   238.70% 
   6/26/96  150 Cisco Syst    35.93     94.19   162.12% 
   8/13/96  200 Carlisle C    26.32     45.19    71.65% 
    3/5/97  150 Atlas Air     23.06     36.81    59.65% 
   4/14/98  100 Pentair       43.74     42.25    -3.41% 
   5/20/98  400 TCBY Enter    10.05      9.06    -9.78% 
   11/6/97  200 FelCor Sui    37.59     30.94   -17.70% 
   1/21/98  200 Andrew Cor    26.09     17.56   -32.68% 
     Rec'd   #  Security     In At     Value    Change 
   2/28/96  400 Borders Gr  4502.49  15250.00 $10747.51 
   6/26/96  150 Cisco Syst  5389.99  14128.13  $8738.14 
   8/13/96  200 Carlisle C  5264.99   9037.50  $3772.51 
    3/5/97  150 Atlas Air   3458.74   5521.88  $2063.14 
   4/14/98  100 Pentair     4374.25   4225.00  -$149.25 
   5/20/98  400 TCBY Enter  4018.00   3625.00  -$393.00 
   11/6/97  200 FelCor Sui  7518.00   6187.50 -$1330.50 
   1/21/98  200 Andrew Cor  5218.00   3512.50 -$1705.50 
                              CASH   $5528.69 
                             TOTAL  $67016.19