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.