Wonder Tot Posts Loss, Still Bests Staff in Market Derby
In February, 1987, the four-member San Fernando Valley business staff set out with $40,000 in pretend money and the conviction that we could profoundly embarrass the legion of professional stock pickers. After 12 months of matching wits with the stock market and a 4-year-old girl, the results are in. We have achieved embarrassment, though not quite what we intended.
Over the 52-week contest, the Dow Jones Industrial Average and the Standard & Poor’s 500 Index did about twice as well as we, while the 4-year-old nipped us by a factor of five.
But it’s important not to lose sight of the big picture. We consulted Barron’s recent exhaustive 1987 survey of 1,400 mutual funds. Five stock funds turned in an even worse performance than the business staff’s Sepulveda Fund. In other words, fully one-third of 1% of the major mutual funds in the United States couldn’t match our performance in the past year.
The ground rules were simple. Each quarter, we selected eight stocks from our weekly index of 75 Valley stocks. Certainly the business staff, with a collective 25 years of experience covering the business beat, was confident. Why pay a mutual-fund manager half a percent of your investment each year in management fees? We’d do it ourselves, save the fees and trounce the market.
To have an added performance benchmark, we asked Jennifer Foxworth, 4, daughter of a Times employee, to make her own stock picks. Jennifer can’t read very well, so her mom read her the list of stocks each quarter and let her make buy and sell decisions. We figured to have the edge, though. Jennifer isn’t very far along on her math tables, either. “I can count to 28,” she said.
Loss of 26.2%
Unfortunately, Jennifer jumped in front during the first quarter and, by contest’s end, we were further behind than ever. Our Sepulveda Fund’s portfolio showed an annual return, ahem, a loss, of 26.2%. After adding up all the transaction fees and figuring in the stock dividends, it was even worse. Our $40,000 nest egg had somehow shrunk to $29,100. In other words, give us $1 and we’ll give you back 73 cents.
As for the Wonder Tot’s Crayon Fund, for a full year her portfolio lost 4.7% of its value. After deducting her transaction costs and adding in dividends, Jennifer had further trimmed her $40,000 down to $37,822. So the kid nipped us by $8,722.
“The only thing I know is I lost $2,000. How much do I get?” Jennifer asked.
Our experiment seemed to prove that inexperience doesn’t hurt. Jennifer not only beat us, she also outperformed the two most celebrated stock indexes. Over the same 52 weeks, the Dow Jones Industrial Average of 30 blue chip stocks fell by 10.2% in value, while the Standard & Poor’s Composite Index of 500 companies tumbled by 8.4%.
“I’m a star, and I practice and the other kids didn’t,” Jennifer said.
OK, so the Sepulveda Fund had a few problems. But, with the October stock crash, many portfolio managers lost money in the stock derby. It was merely a question of how much.
By November, we knew we needed a big spurt to catch the Wonder Tot, so we gambled by selling all eight of our stocks, exchanging them for mostly small, obscure firms with lower prices. Our hope was that those issues might take a big bounce.
Alas, our two biggest losses came on stocks that we shorted, that is, we bet that they would go down in value; unfortunately, they went up. Drewry Photocolor, a Burbank film processor, had been a sleepy performer for several years, but the stock kept climbing as the company’s earnings rose. Recently, Drewry announced a deal to sell its headquarters and a film processing lab for $5.7 million, further fattening the stock.
Another poor short was Superior Industries, a Van Nuys maker of wheel rims for the Big 3 auto makers. After half a dozen years of plenty in the car business, we felt certain that sales would slow this year. But, in the first two months of 1988, each of the Big 3 reported hefty sales increases, which helped Superior’s stock.
We dropped about $2,300 on those two shorts.
Although we did our best to anticipate takeover plays, shied away from overpriced stocks and tried to predict industry trends, Jennifer’s eclectic stock-picking techniques outmaneuvered ours.
Her most inscrutable trade of the year came last summer when she decided to buy a semiconductor firm called Semtech. “I like the sound of it, but only in the morning,” she said. After being stung for an $800 loss in three months, she dumped Semtech. “I don’t like the sound of it anymore,” she said.
Whatever her methods, Jennifer looked sage in the past three months. Hamburger Hamlets, the restaurant chain, was one of her original choices a year ago and, for most of the time, the stock was as flat as a hamburger patty. But Jennifer was farsighted (“I love hamburgers”), and it paid off in December when the company announced that it would be acquired in a $29-million deal. The stock jumped from $4.25 a share in November to more than $8 a share recently, and Jennifer padded her portfolio by $3,104.
Her other brilliant pick was United Education & Software, a fast-growing trade school chain, which had been squashed by the exit stampede during the October stock crash. But she held onto the stock--education is one of the words in her vocabulary because her aunt and uncle are teachers. Of such inspiration fortunes are made. Since November, UES’s stock has jumped from about $12 to $18 a share, boosting the Crayon Fund by another $3,022.
One enlightening fact from our experiment was the high cost of playing the market. We charged ourselves the same transaction fees for buying and selling stocks that any small investor would pay to a discount broker such as Quick & Reilly. One gripe against mutual-fund managers is that they simply churn stocks, buying and selling with consummate myopia, paying no attention to the long haul. In most pension funds, 80% of the stocks are turned over inside a year.
Guilty of Churning
Both Jennifer and we were guilty of churning. She owned 18 stocks, ringing up $1,729 in transaction fees. Meanwhile, the Sepulveda Fund owned 21 issues, which cost $2,090 to buy and sell, or a hefty 5% of our total investment.
Did the churning make a difference? Yes and no. Had Jennifer played her original hand of eight stocks for the whole year, she would have ended up losing another $4,600. As for the Sepulveda Fund, had we stuck with our original octet of stocks, we would have cut our losses by about $3,000, but we would still have been eating dust at the finish line.
One of the interesting aftershocks of the stock crash has been a reassessment by some private investors of whether it really pays to hire someone to try to outperform the market. James Flanigan, The Times’ financial columnist, recently pointed out that Wells Fargo Bank runs a popular stock index fund that doesn’t try to outperform the market. It merely buys a broad range of stocks in hopes of matching the S&P; 500.
In December the federal government decided that Wells Fargo’s performance was good enough to entrust it with the pension funds of a million of its employees. One study from 1979 to 1986 concluded that most money managers did no better than stock index funds. And, according to a Business Week survey, only one-third of the 590 mutual funds it surveyed managed to outperform the S&P; 500 index last year. Wells Fargo also charges lower fees than many stock funds because it doesn’t waste time picking stocks; it just buys a broad sample.
Which raises another question: Are stocks a good investment?
Certainly, 1987 was a year of extraordinary tumult. In October, all the lingering worries about the bloated trade deficit, a weak dollar, the budget deficit and a decline in the United States’ industrial base bubbled up Oct. 19. The market plunged 508 points and lost 23% of its value, or about half a billion dollars.
Only comedians enjoyed it. Johnny Carson said: “I was scared when I saw you waiting in line. I thought it was the first official bread line of the new Depression.
“I ran into my stockbroker on the street today. I didn’t mean to. He jumped in front of my car.
“Things are worse than I thought. The President opened his address by saying, ‘Good evening, my fellow Okies.’
“You people are lucky. You got in free. We’d charge you admission if the dollar was worth anything.”
But, over the course of the past century, American stocks have been an extraordinary investment, according to a study by the Institute of Econometric Research in Ft. Lauderdale. The study discovered that $1 invested in 1871 in New York Stock Exchange issues, when adjusted for inflation and with dividends reinvested, would have been worth $6,743 by 1986. That works out to a 12.6% compounded rate of return each year. Compare that extraordinary profit to the $8 value from Treasury bills over the same time, or about $2 from gold.
There were valleys, of course, along the way. That hypothetical stock investment would have been cut by more than 75% during the Great Depression, and the past is not necessarily a prologue.
Doom-sayers will argue that the past century reflected United States’ ascendance as a great industrial nation, whereas today we are shaping up as the next Great Britain as our decline becomes more evident. Among the concerns is our shift from an industrial economy to one far more dependent on service businesses. Or, as Speaker of the House Jim Wright (D-Tex.) recently put it, how are we going to keep growing “if we’re all delivering pizzas to one another?”
Certainly, those who read tea leaves are puzzled by the stock market this year. The market has recovered about one-third of the nearly 1,000 points it had dropped since the Dow average hit a record high in August. In Barron’s annual January round table of 10 eminent stock pickers, most thought that 1988 would be a bum year.
Jennifer was quick to offer a prediction about the stock market. “It’s going up 6% this year,” she said. Why? She shrugged.
Not to be outdone, the Valley business staff came up with its own prediction for the stock market in 1988. But, under the circumstances, we’ll just tuck it away in a time capsule somewhere so it can be opened later without damaging any innocent bystanders.
THE STOCK MARKET
Stock Market Performance between 2/19/87 and 2/19/88:
Crayon Fund: -4.7%
Standard & Poor’s 500 Index: -8.4%
Dow Jones Industrial Average: -10.2%
Sepulveda Fund: -26.2%
COMPETING STOCK FUNDS
CRAYON FUND
Purchase price Price as of Number Company Industry per share 2/19/88 of shares Dick Clark TV $6.88 $5.13 700 Walt Disney Entertainment $59.13 $58.25 100 General Motors Auto $59.25 $69.13 50 Hmbrgr Hamlets Restaurants $5.75 $8.13 800 House of Fabrics Fabrics $12.25 $16.38 250 Lockheed Aerospace $38.00 $40.50 80 Olson Industries Plastics $9.50 $8.75 323 United Education Career schools $9.13 $18.38 465
SEPULVEDA FUND
Purchase price Price as of Number Company Industry per share 2/19/88 of shares Cmptr Memories Disk drives $1.56 $1.69 2,220 Drewry* Photography $7.50 $11.50 400 HemaCare Medical $1.25 $1.38 2,710 MCA Entertainment $36.50 $45.00 100 Micom Systems Data comm. $6.75 $11.00 500 Price Pfister Faucets $8.25 $9.25 410 Superior Inds* Car wheels $11.00 $13.25 310
Purchase price Price as of Number Company Industry per share 1/4/88 of shares Digitext* Cmptr keyboard $1.75 $1.38 1,930
* sold short
