A Socially Responsible “Foolish Four” Strategy

Mark Galassi

DRAFT

Abstract

On The Motley Fool bulletin boards people have discussed the possibility of using the Foolish Four strategy (based on the Dow Jones index) on a list of socially screened companies, such as the Domini 400 index.

Contributors to the Socially Responsible Investing board at The Motley Fool have selected a “Domini 30” list — analogous to the Down Jones list of 30 companies, but screened for social criteria — and from that have computed the equivalent of the Foolish Four for this list, but so far nobody has run historical tests on this strategy.

In this article I present software I have written to use World Wide Web data to automatically generate the Domini 30 list, to automatically compute the Foolish Four for any historical date, and to run simulated scenarios for this strategy. I also present the results of some sample runs, which show that the strategy is viable and tends to significantly outperform the standard market indices.


Table of Contents
The “Foolish Four” strategy and its evolution
Socially responsible investing
The Domini 30
The Domini Four
Results
Iterated performance
Appendix A. More tables and plots
Appendix B. Obtaining and using the software
Appendix C. Acknowledgements

Warning

The numerical results presented in this article have not been audited for possible errors. I do not recommend that you use my results as a guide for your own investment, unless you verify the results before using them.

The “Foolish Four” strategy and its evolution

The Foolish Four investment strategy was proposed by Tom and David Gardner in their excellent book The Motley Fool Investment Guide as high yield investment strategy which requires very little research (about fifteen minutes per year).

This strategy is based on the notion that companies in the Dow Jones list have certain properties, among which (1) they are large, (2) they have been around for a long itme, (3) most of them pay dividends, (4) each company tends to be internally diversified, and the list of 30 is also diversified, (5) they have a tendency to rebound when their stock is not performing well.

The strategy is explained in detail in the book The Motley Fool Investment Guide, and the updated algorithm is described in http://www.fool.com/school/dowinvesting/dowinvesting.htm. I describe the current revision of the procedure, called “The Foolish Four — RP Variation”:

Procedure — Selecting the Foolish Four

  1. Obtain the current price and the dividend yield for the 30 stocks in the Dow Jones Industrials index. (The dividend yield is the annual dividend divided by the stock price.)

  2. For each stock, calculate the RP factor by dividing the annual dividend yield by the square root of the current stock price.

  3. Sort the list of 30 stocks in descending order. The first few stocks will be those who have the highest RP factor. This is usually an indication that the company's stock has not been performing too well recently.

  4. Select the second, third, fourth and fifth stocks from the list — these are today's “Foolish Four” (unless you are doing this calculation with historical yield and price data, in which case these will be the Foolish Four for that historical date). The first company is skipped because being at the bottom of the list might imply that it has deeper long-term problems.

  5. Take the money you want to invest and divide it into five parts. Invest 2/5 of that in the second company, and 1/5 of it in the each of the others.

  6. After one year, rebalance the portfolio by selecting the new Foolish Four and repeating the allocation procedure.

This variation of the Foolish Four strategy has given historic returns of about 24% per year. This is a good return, especially when compared to the S&P 500 index and the Dow Jones index, which have historical returns of about 11.5%. Although there can be bad years, this strategy is also safer than some others because of the diversification in the Dow Jones stocks, the size of the companies, and the high dividend yield of the Foolish Four.

Since this is a mechanical strategy which is only applied once per year, and second-guessing is not allowed, the amount of work required is very small. Broker commissions will only come up once/year, and if the stocks are held for a year and a day they might qualify for long term capital gains taxes.

Caution

The description of the Foolish Four strategy given here is not complete, and there are many caveats and useful details missing. I will not give those details here, so before investing in this strategy you should read the original material (referenced above) and participate in the Foolish Four discussions on The Motley Fool web site.