I'm glad I got some responses to my post. I don't believe that
"Beating the Dow" is a bad strategy, it's certainly much better
than many strategies you could follow such as buying hot stocks.
I am just not convinced that it is such a sure fire method as
the Motley Fools and others claim. The stock market has a habit
of confounding people who think they have it figured out.
If you have data and go looking for patterns you can find them,
the question is will those patterns hold in the future. If you
require that the rule be simple (always pick the top 10 yielding
stocks) then it is more credible than if you make the rule more
complex (Out of the top 10 pick the 4 with the lowest price). The
Motley fools have a third rule which has ended up with them putting
40% of their portfolio into AT+T. The more rules you add the more
it looks as though you are trying to tailor the rules to fit the
data rather than looking for a significant trend. I'm sure that
if you were allowed two rules you could come up with many algorithms
for picking Dow stocks which would give you a very high return, even
if all you were allowed to use was the year and the first letter of
the stock. None of this says that the method will not work, just that
it is far from proven.
Brain, you raised a very good point about what happens if a large
number of people jump on this strategy. Unlike buying the S+P 500
it would not become a self fulfilling prophecy because you have to
adjust your portfolio each year. Let's just consider the strategy
of buying the 10 highest yielders without any of the tweaks. If
everyone readjusts their portfolio around the same time each year
then there will be a lot of sales volume which would push the price
up of stocks which entered the portfolio and down for the stocks
which got tossed out. If you were to time your trades ahead of
everyone else you would do well, if you were behind the crowd you
would end up buying after the price had risen and selling after it
had fallen. Of course the price changes could affect the rankings,
which leads me to scenario 2 where everyone picks a different day
to adjust their portfolio. The bottom 10 yielders will rise in price
and their yield will fall until their yield matches that of the 11th
and then the 12th etc until you get to a stage where 6-15 have almost
identical yields and keep trading places. This would be a kind of
dumbing down where for those 15 stocks nothing except yield mattered.
I'm not sure that enough people would ever jump onto this method
to the point that it affected the market, but then again who would
have thought that index funds would be so popular. The Beating the
Dow approach is a contrarian approach, the stocks with the highest
yield are precisely the same stocks that the market believes do not
deserve to trade at a high multiple of earnings. A contrarian approach
isn't going to work if too many people start to do it because then
it becomes following the crowd which is not at all contrarian.
It has been pointed out before that the Beating the Dow approach
involves adjusting your portfolio every year and taking capital
gains, which would cause you money to compound at a lower rate than
a buy and hold stategy and selling after a longer period of time.
I haven't done the math on how many percentage points you would
have to beat the Dow by to make this an improvement over buy and
hold, if anyone is interested I can try to put that together.
I haven't read O'Shaughnessy's book, I'll have to get a hold of it.
Last time I checked his funds were trailing the S+P 500 but that
doesn't mean that his book doesn't contain some good information.
Keep up the good posts. |
