BALTIMORE, MD (Feb. 2, 2000) -- This time last week, we found Snow White's evil stepmother, the Queen, gazing into that magic mirror on the wall. This special mirror gave her the opportunity to see the returns of certain stocks five years into the future.
She called up U.S. Steel (NYSE: X), a Foolish Four stock in 1967 that had been selected again for 1968. In 1967, the company had gained a relative paltry 15.7% compared with the S&P 500's return of 24.0% and the full Foolish Four's return of 34.1%. Should she put more money into that loser?
Here's what the Queen saw in her mirror at the beginning of 1968:
Future Annual Returns
U.S. Steel S&P 500
1968 9.0% 11.1%
1969 -14.6% -8.5%
1970 -0.3% 4.0%
1971 0.8% 14.3%
1972 7.3% 19.0%
Our malevolent monarch noted this dismal performance and decided to tinker with her Foolish Four strategy: Every time that U.S. Steel showed up on the Foolish Four, she'd invest its portion of her funds into an S&P 500 Index fund instead. (Of course, such an index fund didn't exist at that time, and the Foolish Four strategy wasn't discovered yet. If you're going to get technical on us, please leave now. This is a fairy tale, after all.)
Meanwhile, back in the woods, in a cabin far, far away, Snow White was having a grand old time of it. After fleeing from her wicked stepmother's death sentence, the princess fell in with those seven dwarfs, who had just returned from a hard day's work in the diamond mines.
Don't be fooled by appearances. These dwarfs, although superficially cuddly and naive, were actually more sophisticated than one might think. Their diamond mining days had blessed them with a fair amount of hard cash, and they put their cash to work. Yes, like the Queen, these dwarfs dabbled in the stock market. After exhaustive research, our elfin lads were convinced that the Foolish Four stocks would lead to that pot of gold at the end of the rainbow.
Like the Queen, our dwarfs gathered on New Year's Day, 1968, to assess their investments. Overall they were pleased with their Foolish Four returns for 1967, but they also had doubts about the wisdom of investing in U.S. Steel again for 1968, given the stock's recent underperformance.
Grumpy spoke up first. "Ain't no way I'm going to put my hard-earned money in such a dirty, low-down company that couldn't even come close to the S&P 500 last year. I'm no dummy! This stock smelled last year, and is going to stink again next year, no matter what this Foolish Four strategy says." So, like the evil Queen, Grumpy decided that any time U.S. Steel showed up on his Foolish Four list of stocks, he'd chuck it. Instead, he'd invest that portion of his portfolio in an index fund.
The other six dwarfs saw that there was some merit to his argument, but decided to stay put. They held their tiny little breaths and continued to have faith in their mechanical investing strategy. Except Grumpy, all dutifully included U.S. Steel in their renewed portfolios.
A year passed. On New Year's Day, 1969, the dwarfs gathered once more for their annual investment meeting. Grumpy gloated, since in 1968 (as shown in the table above), U.S. Steel again underperformed the S&P 500, losing to the index by over two percentage points, and to the Foolish Four as a whole by nine percentage points.
Bashful, embarrassed in the extreme by last year's mistake, took heed. He decided to take Grumpy's pledge not to invest in U.S. Steel, as long as the company continued to perform so poorly. Like Grumpy, Bashful's portion of funds that would normally be allocated to the steel company went into an index fund instead.
The years passed, and U.S. Steel continued to underperform the S&P 500. Yet the company, as if almost taunting them, remained on the Foolish Four list. Every New Year's Day the dwarfs met and duly noted this phenomenon. Their faith in such a mechanical system was tested severely.
Each year Grumpy would convert yet another dwarf, and the steel company would lose yet another investor. In 1970, Sneezy got cold feet. The next year, Doc abandoned U.S. Steel. Dopey gave up in 1972. Even Happy, normally the most contented dwarf, finally succumbed in 1973, with half a tear in his eye.
The only dwarf who had fully followed the Foolish Four's mechanical investing style to the letter was Sleepy. His behavior, alas, was due to sheer sloth, rather than any planned strategy on his part. Sleepy, with a major undiagnosed case of sleep apnea, just couldn't muster the energy to stay awake during these discussions. He had arranged by proxy to have his shares in the Foolish Four stocks automatically reinvested every year by Snow White. Consequently, he was stuck with U.S. Steel every single year.
Another year passed. On New Year's Day 1974, the dwarfs decided it was time to compare their investment returns. They each started 1967 with $10,000 in their accounts. Of course, there were no capital gains or trading costs incurred in such accounts. Remember, this is a fairy tale!
Year U.S. Steel Account
Dwarf was abandoned Value 1/1/74
Grumpy 1968 $20,370
Bashful 1969 $20,280
Sneezy 1970 $19,950
Doc 1971 $19,700
Dopey 1972 $19,160
Happy 1973 $18,700
Sleepy Never! $20,410
S&P 500 $15,210*
*Theoretical value if invested in an index fund
The dwarfs were stunned. Our snoring, somnolent Sleepy, snoozing through six straight cycles of U.S. Steel underperformance, had the fattest account at the end. Indeed, Sleepy had even outperformed our wicked Queen (whose return was the same as Grumpy's), magic mirror and all.
How could this be? It turned out that 1973, the last year of U.S. Steel's seven-year Foolish Four reign, proved to be a knockout year for the stock. In the midst of a grinding economic recession, the S&P 500 lost 14.7% that year, but investors finally woke up to the value that had been accruing in the steel sector. Our much-maligned U.S. Steel gained 24.8% that year, beating the S&P by 39.5%.
Our story, alas, has a bittersweet ending. In May of 1991, the steel company was banished from the Dow kingdom, probably forever. In one of life's major ironies (at least if you're a dwarf), the company chosen to replace it in the Dow Jones Industrial Average was, naturally, Walt Disney (NYSE: DIS).
Of course, our fable wouldn't be worth a darn if it didn't have a moral. The moral of our story? Good things come to those who sleep.
May you live happily ever after.
Beating the S&P year-to-date returns
(as of 02-01-00):
Bank One (NYSE: ONE) -5.7%
PepsiCo (NYSE: PEP) -3.5%
Ford Motor Co. (NYSE: F) -5.6%
Bank of America (NYSE: BAC) -2.4%
Fannie Mae (NYSE: FNM) -3.0%
Beating the S&P -4.0%
Standard & Poor's 500 Index -4.1%
Compound Annual Growth Rate from 1-2-87:
Beating the S&P +23.7%
S&P 500 +17.4%
$10,000 invested on 1-2-87 now equals:
Beating the S&P $161,100
S&P 500 $81,600
See Also
