The Dow Report: A Review of Buy and Hold

By Tim W Wood CPA, September 24, 2004

Earlier this year we set up two portfolios that were based on the Buy and Hold methods outlined in Michael O'Higgins' book, Beating The Dow. The intent was to set these portfolios up based on nothing more than the methods outlined in the book. Then, I was going to use the exact same two methods to set up two more portfolios when the technical picture turned positive. Well, so far the technical picture has not turned positive, so these two portfolios have never been set up. I will do so once the market reaches a significant cycle low and the Dow theory supports such an opinion. Until then, we can monitor these methods without the aid of technical timing.

On January 30, 2004 we set up a portfolio of 10 stocks that were based on a Graham and Dodd method. See the January 30, 2004 Dow Report for more details. In this method Mr. O'Higgins suggests that you look at the book values for each of the 30 stocks that make up the Dow Jones Industrial Average. He would then pick the 10 stocks with the lowest book values for his portfolio. According to Mr. O'Higgins, this method yielded a return of 1,283.39% between 1973 and 1991, while the DJIA itself yielded a return of 559.31%. This method clearly "Beats The Dow" during this bull market period. But, what about now?

The original portfolio was setup as follows:

STOCK	BOOK VALUE	STOCK PRICE
Alcoa (AA)	2.64	33.00
AT&T (T)	1.15	19.32
CitiGroup (C)	2.70	49.20
Walt Disney (DIS)	2.00	24.50
Eastman Kodak (EK)	2.86	28.93
Hewlett Packard (HDQ)	1.96	24.16
J.P. Morgan (JPM)	1.82	38.97
McDonalds (MCD)	2.71	25.48
SBC Communications (SBC)	2.23	25.55
International Paper (IP)	2.59	41.85

The Current Stock prices for this portfolio as of September 23, 2004 are as follows:

STOCK	STOCK PRICE	% GAIN or LOSS
Alcoa (AA)	33.00	-5.79
AT&T (T)	19.32	-27.72
CitiGroup (C)	49.20	-10.81
Walt Disney (DIS)	24.50	1.24
Eastman Kodak (EK)	28.93	10.54
Hewlett Packard (HDQ)	24.16	-22.10
J.P. Morgan (JPM)	38.97	1.26
McDonalds (MCD)	25.48	6.51
SBC Communications (SBC)	25.55	1.92
International Paper (IP)	41.85	-7.67

The average return on this portfolio has been -5.04%. During this period the DJIA has been down 3.6%.

In our second Buy and Hold portfolio we used another method from Beating The Dow. This portfolio was set up on February 6, 2004. To see the original article please see the February 6, 2004 Dow Report.

This method is known as the "Basic Method." The stock selection process for this method is simple. First, you list all of the 30 DJIA stocks on a spreadsheet with their closing price. Second, you list the dividend yield in a column next to the price column. Third, you identify the 10 stocks with the highest yield. Next, of the 10 stocks from step 3, you identify the 5 stocks with the lowest closing price. Lastly, you identify the next to the lowest priced stock of the 5 with the highest divided.

At this point we basically have three groups of stocks. The first group is the 10 highest yielding stocks in the DJIA. The second group is then selected from the first group of 10. The second group simply consists of the 5 stocks with the lowest closing price out of the first group. The third group is a single stock selected from the list of 5 from the second group. This single stock is the next to the lowest priced stock in the previous group of 5.

Now that we have our three stock groups, we have to decide which group we want to include in our portfolio. The first group (10 highest-yielding stock portfolio) is the most conservative in that it has the most stocks in it. The second group (5 high-yield/lowest-price stock portfolio) is a riskier selection because it has fewer stocks. The third group (Penultimate Profit Prospect or PPP) is by far the most risky in that it is a single stock, which is chosen, because it is the second lowest priced high yielder.

During the period from 1973 to June 30, 1991 Mr. O'Higgins shows that the first group returned 1,753.14%. The second group returned 2,819.41% and the third group yielded 6,245.49%. The diversification risk can clearly be seen by these returns. In our model portfolio I used the second group. The stocks that met this criteria when this portfolio was set up are listed below. These prices were taken from www.quicken.com after the close on February 4, 2004.

The original portfolio was setup as follows:

STOCK	DIVIDEND YIELD	STOCK PRICE
Exxon Mobil (XOM)	2.5	40.35
AT&T (T)	4.9	19.14
General Electric (GE)	2.4	33.18
J.P. Morgan (JPM)	3.5	38.92
SBC Communications (SBC)	4.8	25.56

The Current Stock prices for this portfolio, as of September 23, 2004, are as follows:

STOCK	STOCK PRICE	% GAIN or LOSS
Exxon Mobil (XOM)	40.35	18.36
AT&T (T)	19.14	-22.00
General Electric (GE)	33.18	0.72
J.P. Morgan (JPM)	38.92	1.39
SBC Communications (SBC)	25.56	1.88

The average return on this portfolio has been 2.89%. During this period the DJIA has been down 3.46%.

I have little doubt that the methods outlined for these portfolios is sound. These methods make perfect sense to me and I will use these methods when the technical picture turns positive. But, the fact that these proven methods of stock selection have performed so poorly goes to show, "This Ain't no Bull Market!" No, the reason that these methods have performed so poorly is because of the fact that the technical backdrop is indeed bearish. We are in a bear market and until this changes most stock selection methods are also likely to perform poorly. The rally out of the October 2002 low into the February 2004 high is a giant bear market rally. This rally should separate Phase I of this Great Bear Market from Phase II. You have been warned, Again!

There are ways to make money in this very difficult environment. To do so requires an understanding of the technical picture, enormous patience and discipline. If you're looking for a source that will teach, help you to understand and learn more about the current technical picture then you should visit www.cyclesman.com and consider Cycles News & Views.

Tim W. Wood

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Tim W. Wood CPA
Cycles Man
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