The Times' crack Valley business staff is trying to outwit the stock market and a 3-year-old girl.
The staff--four confident people whose investment successes in the real market have been unaccountably mixed--has invested a hypothetical $40,000, call it Monopoly money, in the stock market.
We have "bought" eight stocks, culled from our weekly index of 68 publicly held companies in the San Fernando Valley. (No real money could be used in such an exercise, because the newspaper's code of ethics instructs staff members to avoid investments in companies they write about.)
We've decided to call ourselves the Sepulveda Fund, after the successful New York-based Sequoia Fund. We set out to find some diamonds in the rough and limited ourselves to eight stocks. Purchase prices are based on the stocks' closing prices on Feb. 19.
One ground rule is that we are free to sell any of our stocks during the next three months but we cannot buy another stock until the quarter is over.
Our performance will be measured against the Dow Jones Industrial Average and the Crayon Fund. In effect, we've handed over $40,000 of our Monopoly money to Jennifer Foxworth, the 3-year-old daughter of a Times employee, and asked her to pick eight stocks to invest in. With crayon in hand, she jumped to her task.
Will Publish Updates
Every three months we will publish updates of how our investments would have fared in the real world. As any serious investor does, we will calculate our total return.
We will include transaction costs for buying and selling of stocks, using the rates of a discount broker such as Quick & Reilly. We will add any dividends our stocks pay. And, if a stock is sold at a profit, we will apply the new 28% long-term capital gains tax, or the 38.5% (maximum) tax on short-term gains. If any of our picks turn out to be dogs, we will subtract our losses.
Outperforming the stock market won't be easy. In the great bull market that began in August, 1982, the Dow Jones Industrial Average has jumped from 800 to nearly 2,300. Since Jan. 1 the market has shot up another 20%. With money market funds paying a meager 6% interest, and with the new tax law having eliminated so many investment havens, Jonathan Jacobs, head of Peat, Marwick, Mitchell's Woodland Hills office, theorizes that investors have little choice but to dump their money back into stocks.
But, according to the celebrated random walk theory, investors who really try to outperform the stock market are wasting their time.
In 1900, French mathematician Louis Bachelier came up with the random walk theory. It essentially says that the stock market's performance is utterly random and unpredictable; the past is not a prologue. Your chance of picking a good stock is no better than tossing a coin and getting heads, or having a 3-year-old girl pick stocks for you.
Dart Fund Initiated
In 1967 Forbes magazine tested the random walk theory. Malcolm Forbes and two others threw darts at a wall where the stock pages of the New York Times had been posted. The darts landed on 28 companies. The group invested a hypothetical $1,000 in each company. Over the next 17 years, the Dart Fund selections outperformed the Dow Jones Industrial Average better than 10 to 1. We'll see if Jennifer does as well.
Despite Bachelier's theory, in every era there are those who somehow manage to ring up consistent and extraordinary stock investments over a long period.
The most popular recent theory centers on the asset-based investing technique espoused by the late Benjamin Graham, a Columbia University business professor. Graham hunted for stocks that were cheap in relation to their true value. He would compare, for example, a company's per share book value or its net worth (assets minus liabilities), to its current stock price. Or he would look at the price-to-earnings ratio (p/e)--the price of a stock divided by the company's earnings per share. The lower the ratio, in theory, the greater the bargain.
Graham's theories are now held as golden, in large part because his disciple, Warren Buffet, chairman of Berkshire Hathaway in Omaha, has become a self-made billionaire while earning a reputation as the preeminent stock wizard of our time. His company routinely invests in Buffet's picks, and, as a result, one share of its stock has climbed from $14 in 1965 to $3,485 today.
Does Not Apply Anymore
The trouble with Graham's theory is that Wall Street suffers from an unceasing pack mentality. If something seems to be working, you can bet Wall Street will start marching in step. Inevitably, Graham's theory has lost much of its advantage.
Consider that in 1982, for example, the median price earnings ratio for New York Stock Exchange issues was 7.5. Today it has swollen, along with the price of most stocks, to 17.7.
What to do? Stock enthusiasts of the have-no-fear school remain undaunted and take inspiration from the Far East, where on the Tokyo Stock Exchange the average stock p/e is 60. This group advises: Look for a solid growth company and don't pay too much attention to the current stock price. If the company performs well, in a few years your investment will look like a bargain.
That is, unless the Denver Broncos win the Super Bowl next year. Another theory, the Super Bowl indicator, based on after-the-fact analysis dating to the first game in 1967, says that when a National Conference team wins the Super Bowl, as the New York Giants did this year, the stock market will have a good year.
It's hard to imagine, of course, that Joe Namath-types can really have an effect on the stock market. But there are as many investment theories as blades of grass. Here are the Sepulveda Fund's stock picks in alphabetical order:
1. Datametrics. A leading maker of military computer printers. The company has also moved into other military computer peripherals. It has an enormous order backlog. Analysts expect the company to earn 38 cents a share in the current fiscal year. We "bought" in at less than $4 a share. It seemed cheap.
2. Dick Clark Productions. Ex-disc jockey Clark only recently took his company public. He has TV shows on all three networks, including hardy perennial "American Bandstand," a hit since Dwight D. Eisenhower was President.
3. Martin Lawrence Limited Editions. Runs a chain of art galleries in shopping malls. Sells art like others sell furniture: 20% down and easy monthly payments. Customers take home lithographs of famous artists--Warhol, Miro--and obscure ones. With a bunch of galleries scheduled to open, it looks like a growth stock. Never mind that we bought in at $5, then the all-time high stock price.
4. 20th Century Industries. Popular California auto insurer with cheap rates because it sells direct, no agents. Company does no advertising; customers call them. With elderly management team, there's the possibility of a takeover bid, which could drive up the price. Major investors have started buying the stock.
5. Zenith National Insurance. Company has diversified, through acquisitions, from a workers compensation insurer into property, casualty and reinsurance. Earnings for fiscal 1986 were up thirteenfold. At current stock prices, it pays a healthy 3.3% dividend.
6. Zero Corp. Zero appears as solid as its famed Halliburton aluminum briefcases, although growth has slowed a bit recently. The company intends, thanks to lower corporate tax rates, to pay out 35% to 40% of its earnings in dividends.
Stock Shorts Final Picks
Our last two picks are not traditional buys, but for short selling. This type of deal reverses the usual stock investment procedure. Here's how it works. An investor goes to his brokers and says he wants to take a short position in a stock. The brokers lend the investor so many shares of stock, which are then sold to another buyer. The investor agrees to replace the same number of shares of stock at an agreed-upon date--in our case in three months.
If all goes well, the price of those shares of stock will have fallen. If so, the investor can buy back the same number of shares at a cheaper price, hand over the shares to the broker, and keep the difference in profit.
Of course, if the stock goes up, we have to pay more for the stock and take a loss.
Our short positions:
7. Amgen. The hot biotechnology company. Amgen's stock price has climbed steadily, as have most other biotech stocks. We shorted Amgen's stock at $34.00, contrasted with a low of $12.50 in the past 52 weeks. We're betting that institutional investors will sell some of their biotech holdings to insure some profits now, thus dropping the price of biotech stocks.
8. MCA. The $2.4-billion Universal City entertainment conglomerate had a $50-million write-down against expected TV earnings in its most recent quarter, primarily because of problems in the TV syndication market and weakened finances of independent TV stations. That could hurt sales of MCA's syndicated TV shows. Also, the company has been short on new movie hits.
Jennifer's Crayon Fund employed a somewhat different methodology. At her age, she is just warming to the alphabet. So her mother read to her the names of all 68 stocks and told her what each company did. For every company Jennifer selected, we invested about $5,000 of her Monopoly money.
1. American Ecology. She liked the Agoura Hills firm that specializes in radioactive waste disposal. Why? Her father works in construction and often comes home, she said, dirty. "Keep clean, not like Daddy," she remarked.
2. Cherokee Group. The fast-growing chain of women's shoe and clothing stores was her next choice. Jennifer favored Cherokee because she has an Indian friend.
3. Dick Clark Productions. This was the only stock Jennifer picked that was also on the Sepulveda Fund's list. Jennifer watches "American Bandstand" on Saturdays. She may be onto something about Dick Clark's enduring appeal.
4. Walt Disney. She has a Pinocchio poster in her bedroom. Need more be said?
5. GTE. Jennifer likes telephone technology. "Dial 911 and talk to firefighters," she said.
6. Hamburger Hamlets. The Sherman Oaks-based chain of hamburger restaurants caught her eye, or rather, her taste buds.
7. Redken Labs. The Canoga Park firm that sells hair care and skin products was another quick choice for Jennifer. She likes clean hair.
8. SFE Technologies. The troubled San Fernando electronics firm was in technical default on some industrial bonds last year. SFE's stock was trading at $3.88 a share when Jennifer bought in, down from a three-year high of about $23. Is Jennifer a contrary investor? Not really. "SFE. It's like A,B,C," she said.
Check back in a few months to see which fund turns in the best performance. For any reader who takes this too seriously, it's worth recalling what B.C. Forbes, the founder of Forbes magazine said: "You make more money from selling the advice than from following it." COMPETING STOCK FUNDS Listed below are local stock picks made by two stock funds, each with a hypothetical $40,000 to invest. The Sepulveda Fund selections were made by four members of The Times' San Fernando Valley business department. The Crayon Fund's picks come from the 3-year-old daughter of a Times staffer. The revenue and profit figures below are the most recent numbers available for each company's fiscal year. Sepulveda Fund
Company Industry Revenue Profit Amgen* Biotechnology $23.4 million $548,000 Datametrics Computer printers $18.2 million $1.9 million Dick Clark TV $32.3 million $3.8 million Martin Lawrence Art $6.0 million $265,742 MCA* Entertainment $2.4 billion $155.2 million 20th Cntry Inds Insurance $403.2 million $31.9 million Zenith Nat'l Insurance $411.0 million $42.2 million Zero Cabinets $128.7 million $12.8 million
Price per Number of share as of shares Company 2/19/87 "bought" Amgen* $34.00 150 Datametrics 3.75 775 Dick Clark 6.88 750 Martin Lawrence 5.00 1,000 MCA* 42.00 100 20th Cntry Inds 22.75 200 Zenith Nat'l 24.75 300 Zero 18.75 300
* shorted stocks results are for fiscal year ended Dec. 1985; 1986 results are not yet compiled. Crayon Fund
Company Industry Revenue Profit American Ecology Waste disposal $47.9 million $3.2 million Cherokee Group Apparel, shoes $104.1 million $6.8 million Dick Clark TV $32.3 million $3.8 million Walt Disney Entertainment $2.5 billion $247.3 million GTE Telephones $15.1 billion $1.2 billion Hamburger Hamlts Restaurants $38.9 million $1.7 million Redken Labs Hair care $103.2 million $2.0 million SFE Electronics $42.7 million ($15.9 million)
Price per Number of share as of shares Company 2/19/87 "bought" American Ecology 17.25 300 Cherokee Group 35.00 150 Dick Clark 6.88 700 Walt Disney 59.13 100 GTE 41.63 115 Hamburger Hamlts 5.75 800 Redken Labs 22.25 200 SFE 3.88 1,280