Thursday, March 05, 1998

Cash-King Portfolio Report
by Tom Gardner (

ALEXANDRIA, VA (Mar. 5, 1998) -- On February 27th, the Associated Press ran an even-handed article entitled, "Beardstown Investors Called Frauds." The story highlighted that the sixteen-woman club may have been including annual membership dues in the statement of their overall investment returns. Whoops. The reporter, Nicole Ziegler, provided a sample year in which the women's membership dues of $4,800 were accounted for as gains off their total portfolio, which ranged in total value between $30,000 and $40,000.

If true, this means that the ladies, who became famous for mixing cranberry-pie recipes with market-beating stock advice, were (in that sample year) claiming between 12-16% of growth that didn't exist. In fact, in truly conservative accounting, those membership fees would be represented as an expense that should have been docked from the total investment returns. Under a system that deducted all membership and transaction costs, the Beardstown Ladies' portfolio not only wouldn't have received the additional double-digit growth, they'd have started the sample year at a 12-16% deficit to the market.

This possibility that the Beardstown Ladies' ten-year investment returns were substantially inflated has sent a few ripples through the marketplace.

The gaggle of skeptics is positing that our national celebration of what turned out to be substandard accounting is just another indication of a market top. After all, the Beardstown Ladies sold a stunning 800,000 copies of their first book to investors who were treated to unrealistically-high expectations for stock-market investing. The Ladies had, in their books, promoted annualized returns of 23.4% over the past decade. There's a good chance that hundreds of thousands of Beardstown-trained investors had been schooled to think that by investing in large companies that looked good, an investor could generate 20%+ yearly returns from common stocks.

Those same skeptics are quick to remind us that this apparent Beardstown bungle is another indication that individual investors cannot consistently outperform the stock-market's average return. That's a theory which has been reinforced time and again by a media contingent that believes the popularity of stocks among "ignorant middle-class investors" is a harbinger of dark days ahead for our financial markets. They write that "things will all end badly" and bemoan the fact that "shoeshine boys" (their term) are giving stock tips. The not-so-subtle implication is that only sharply-dressed, middle-aged men who've been living in Manhattan for a decade are shrewd enough to handle the chaos of our public markets.

For the sake of argument, I'm going to yield to a few of their points. It may be that our stock market has been artificially inflated by a slew of small investors unrealistically counting on double-digit short- and intermediate-term rewards. Their entrance into the equities markets en masse may have created a sloppiness of valuation that will take years to correct.

And it may even be that most individual investors will not beat the market's average return over the next ten to twenty years. I have a hard time believing that professionals in Manhattan with a compensation system that forgives their widespread, substantial undperformance of the market (with a heavy dose of capital-gains taxes each year) is the solution. But for the sake of argument, I'll grant the points about sloppy valuations and the chance that, on average, small investors will lose to the S&P 500 in the years ahead.

But even then, I choose to take a contrary position on this apparent Beardstown Ladies accounting snafu. Why?

The Ladies have already stepped forward to clarify and publicize their actual returns. They've contracted an outside auditor to restate their performance over the past decade and plan to broadcast that real rate of return. And if their ten-year annualized returns cruise in below market average, there'll be a simple lesson for the club:

If they want to improve their returns going forward, they should seriously consider investing in a low-cost, tax-light S&P Index Fund.

If publishing that lesson seems like small recompense to their followers, consider that it's a lesson that the mutual-fund industry hasn't abided in twenty years of booming popularity. Over the past five- and ten-year periods, between 85-95% of all mutual funds have done worse than market average, and we haven't yet come across a single article entitled "Mutual Fund Managers Called Frauds." This even as their advertisements cloud over the real underlying value of their managed funds (after the deduction of all costs and taxes) relative to that of an index fund. Do mutual-fund families plan to hire outside auditors to scrutinize and then publicize the after-tax returns of their products over the past decade?

(I've decided to start holding my breath now. Someone please tell me to stop.)

Ultimately, the results from the Beardstown Inquiry and documentation of their experience as investors will be incredibly valuable for all investors, because I believe it'll end up focusing our attention back on common stocks, back on bottom-line returns, and back to the benefits of investing in index funds or directly into public companies that are primarily motivated to return profits to their shareholders.

I do see the potential for some more lessons to be learned:

  1. That investment clubs should think very seriously about just gathering research together rather than incorporating their club and pooling resources -- an expensive and unnecessary procedure.

  2. That investors should employ two methods for accounting -- one that measures the real return on invested capital relative to the S&P 500, and the other that measures (and celebrates) the gain in the total value of the portfolio, including the inflow of new savings as part of the statement of total returns.
To close tonight's report, I don't mean to work a positive spin on an unfortunate development in the Beardstown phenomenon. One of the club's senior partners, Betty Sinnock, said that she was "just sick about" the possibility that their returns were artificially inflated. It'd be a real disappointment if true. But there are a host of positives to come from this, and I think the Beardstowner's contributions will be seen historically as a net gain for private investors, regardless of this outcome.

The Ladies have been fundamental in introducing investors of all classes, ages, shapes and sizes into the greatest wealth-builder of the 20th century. If their message has encouraged Americans to rid themselves of high-rated debt, to methodically add money to their investment portfolios, and to hold-on to solid companies for the long haul, they've performed an incredibly valuable service.

And now if those same investors can be exposed to the safety-net of the index fund, the historical performance of the Foolish Four, and the merits of Cash-King investing (among other Foolish precepts), the positives only compound. Wall Street's inside journalists may continue to wail about "shoeshine boys" (their term) gabbing about the stock market. Apparently, they don't want Fools in the market, but have forgotten that no man can be Wise till he knows himself a Fool.

I'm leaving my chips down on the table in favor of those motivated to learn before they earn. Wall Street certainly isn't a laboratory for learning yet. The Beardstown Ladies never haven't been.

Tom Gardner


Stock  Change    Bid 
 KO    +  9/16  69.31 
 INTC  -10 15/1675.50 
 MSFT  -2 1/4   80.00 
 PFE   +  9/16  85.56 
 TROW  -1 7/8   67.00 
                  Day   Month    Year  History 
         C-K      -1.58%  -2.18%  -0.46%  -0.46% 
         S&P:     -1.17%  -1.36%   3.37%   3.37% 
         NASDAQ:  -2.72%  -3.31%   3.57%   3.57% 
     Rec'd    #  Security     In At       Now    Change 
    2/3/98    22 Pfizer        82.30     85.56     3.97% 
    2/3/98    24 Microsoft     78.27     80.00     2.21% 
    2/27/98   27 Coca-Cola     69.11     69.31     0.30% 
    2/6/98    28 T. Rowe Pr    67.35     67.00    -0.51% 
    2/13/98   22 Intel         84.67     75.50   -10.83% 
     Rec'd    #  Security     In At     Value    Change 
    2/27/98   27 Coca-Cola   1865.89   1871.44     $5.55 
    2/3/98    22 Pfizer      1810.58   1882.38    $71.80 
    2/3/98    24 Microsoft   1878.45   1920.00    $41.55 
    2/6/98    28 T. Rowe Pr  1885.70   1876.00    -$9.70 
    2/13/98   22 Intel       1862.83   1661.00  -$201.83 
                               CASH  $10696.94 
                              TOTAL  $19907.75 
 *The year for the S&P and Nasdaq will be as of 02/03/98