One Up On Wall Street: How To Use What You Already Know To Make Money In
Kindle Highlights
• There is always something to worry about.
Be patient. Watched stock never boils. • Buying
There simply isn’t a stock you can own that you can afford to ignore.
Whether the stock is selling at a p/e ratio at or near the growth rate.
frequently built its units just off the access ramps of major turnpikes.
You won’t improve results by pulling out the flowers and watering the weeds.
The p/e ratio of any company that’s fairly priced will equal its growth rate.
Moderately fast growers (20 to 25 percent) in nongrowth industries are ideal investments.
It’s better to miss the first move in a stock and wait to see if a company’s plans are working out.
Buying stocks based on stated book value alone is dangerous and illusory. It’s real value that counts.
If the p/e of Coca-Cola is 15, you’d expect the company to be growing at about 15 percent a year, etc.
Invest at least as much time and effort in choosing a new stock as you would in choosing a new refrigerator.
That the company has duplicated its successes in more than one city or town, to prove that expansion will work.
“Do you know the only thing that gives me pleasure? It’s to see my dividends coming in.” —John D. Rockefeller, 1901
Although it’s easy to forget sometimes, a share of stock is not a lottery ticket. It’s part ownership of a business.
• If you don’t think you can beat the market, then buy a mutual fund and save yourself a lot of extra work and money.
THE COMPANY IS BUYING BACK SHARES Buying back shares is the simplest and best way a company can reward its investors.
And I can’t miss my sister-in-law’s wedding. You have to keep your priorities straight, if you plan to do well in stocks.
Only invest what you could afford to lose without that loss having any effect on your daily life in the foreseeable future.
$40. • Is business coming back? (This is what’s happening at Eastman Kodak, which has benefited from the new boom in film sales.)
section, I hope you’ll remember the following: • Sometime in the next month, year, or three years, the market will decline sharply.
Stock prices often move in opposite directions from the fundamentals but long term, the direction and sustainability of profits will prevail.
the large potential return is attractive to many small investors who are dissatisfied with getting rich slow. Instead, they opt for getting poor quick.
surprise. Since there’s no way to anticipate when pleasant surprises of various kinds might occur, you increase your odds of benefiting from one by owning several stocks.
Managerial ability may be important, but it’s quite difficult to assess. Base your purchases on the company’s prospects, not on the president’s resume or speaking ability.
What you want, then, is a relatively high profit-margin in a long-term stock that you plan to hold through good times and bad, and a relatively low profit-margin in a successful turnaround.
If you’re considering a stock on the strength of some specific product that a company makes, the first thing to find out is: What effect will the success of the product have on the company’s bottom line?
I don’t believe in predicting markets. I believe in buying great companies—especially companies that are undervalued, and/or underappreciated. Whether the Dow Jones industrial average was at 1,000 or 2,000 or
show promise. If you can’t convince yourself “When I’m down 25 percent, I’m a buyer” and banish forever the fatal thought “When I’m down 25 percent, I’m a seller,” then you’ll never make a decent profit in stocks.
Lately the mood has been downbeat. Interest rates have risen into the double digits, causing some people to fear we’ll soon be as bad off as Brazil, while others are satisfied that we’ll soon be as bad off as the 1930s.
The turnaround in Apple Computer was harder to predict. However, if you’d been close to the company, you might have noticed the surge in sales, the cost-cutting, and the appeal of the new products, which all came at once.)
There are five basic ways a company can increase earnings*: reduce costs; raise prices; expand into new markets; sell more of its product in the old markets; or revitalize, close, or otherwise dispose of a losing operation.
By the way, when you are figuring out how you’re doing in stocks, don’t forget to include all the costs of subscriptions to newsletters, financial magazines, commissions, investment seminars, and long-distance calls to brokers.
“Right now in October? You know what Mark Twain says: ‘October is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August, and February.’
That’s not to say that futures don’t serve a useful purpose in the commodity business, where a farmer can lock in a price for wheat or corn at harvest and know he can sell for that amount when the crops are delivered; and a buyer of wheat or corn can do the same.
What the growth rate in earnings has been in recent years. (My favorites are the ones in the 20 to 25 percent range. I’m wary of companies that seem to be growing faster than 25 percent. Those 50 percenters usually are found in hot industries, and you know what that means.)
There’s no point describing how futures and options really work, because (1) it requires long and tedious exposition, after which you’d still be confused, (2) knowing more about them might get you interested in buying some, and (3) I don’t understand futures and options myself.
If stockpicking could be quantified, you could rent time on the nearest Cray computer and make a fortune. But it doesn’t work that way. All the math you need in the stock market (Chrysler’s got $1 billion in cash, $500 million in long-term debt, etc.) you get in the fourth grade.
you are undecided and lack conviction, then you are a potential market victim, who abandons all hope and reason at the worst moment and sells out at a loss. It is personal preparation, as much as knowledge and research, that distinguishes the successful stockpicker from the chronic loser.
Before you call the company, it’s advisable to prepare your questions, and you needn’t lead off with “Why is the stock going down?” Asking why the stock is going down immediately brands you as a neophyte and undeserving of serious response. In most cases a company has no idea why the stock is going down.
$5 per share. The $5 doesn’t count for much with the stock selling for over $40. If the stock dropped to $15, it would be a big deal. Nevertheless, it’s always advisable to check the cash position (and the value of related businesses) as part of your research. You never know when you’ll stumble across a Ford.
If you can follow only one bit of data, follow the earnings—assuming the company in question has earnings. As you’ll see in this text, I subscribe to the crusty notion that sooner or later earnings make or break an investment in equities. What the stock price does today, tomorrow, or next week is only a distraction.
George Soros and Jimmy Rogers made their millions by taking esoteric positions I couldn’t begin to explain—shorting gold, buying puts, hedging Australian bonds. And Warren Buffett, the greatest investor of them all, looks for the same sorts of opportunities I do, except that when he finds them, he buys the whole company.
Reports out of Chicago and New York, the twin capitals of futures and options, suggest that between 80 and 95 percent of the amateur players lose. Those odds are worse than the worst odds at the casino or at the racetrack, and yet the fiction persists that these are “sensible investment alternatives.” If this is sensible investing, then the Titanic was a tight ship.
When you buy a share of stock, even a very risky stock, you are contributing something to the growth of the country. That’s what stocks are for. In previous generations, when it was considered dangerous to speculate in stocks of small companies, at least the “speculators” were providing the capital to enable the IBMs and the McDonald’ses and the Wal-Marts to get started.
You can see the importance of earnings on any chart that has an earnings line running alongside the stock price. Books of stock charts are available from most brokerage firms, and it’s instructive to flip through them. On chart after chart the two lines will move in tandem, or if the stock price strays away from the earnings line, sooner or later it will come back to the earnings
you can follow only one bit of data, follow the earnings—assuming the company in question has earnings. As you’ll see in this text, I subscribe to the crusty notion that sooner or later earnings make or break an investment in equities. What the stock price does today, tomorrow, or next week is only a distraction. The Internet is far from the first innovation that changed the world.
TURNAROUNDS • Most important, can the company survive a raid by its creditors? How much cash does the company have? How much debt? (Apple Computer had $200 million in cash and no debt at the time of its crisis, so once again you knew it wasn’t going out of business.) What is the debt structure, and how long can it operate in the red while working out its problems without going bankrupt?
Distrust of stocks was the prevailing American attitude throughout the 1950s and into the 1960s, when the market tripled and then doubled again. This period of my childhood, and not the recent 1980s, was truly the greatest bull market in history, but to hear it from my uncles, you’d have thought it was the craps game behind the pool hall. “Never get involved in the market,” people warned. “It’s too risky. You’ll lose all your money.”
Don’t overestimate the skill and wisdom of professionals. • Take advantage of what you already know. • Look for opportunities that haven’t yet been discovered and certified by Wall Street—companies that are “off the radar scope.” • Invest in a house before you invest in a stock. • Invest in companies, not in the stock market. • Ignore short-term fluctuations. • Large profits can be made in common stocks. • Large losses can be made in common stocks.
Same store sales are down 3 percent in the last quarter. • New store results are disappointing. • Two top executives and several key employees leave to join a rival firm. • The company recently returned from a “dog and pony” show, telling an extremely positive story to institutional investors in twelve cities in two weeks. • The stock is selling at a p/e of 30, while the most optimistic projections of earnings growth are 15–20 percent for the next two years.
Buffett, the savviest of investors, decided to close down the New Bedford textile plant that was one of his earliest acquisitions. Management hoped to get something out of selling the loom machinery, which had a book value of $866,000. But at a public auction, looms that were purchased for $5,000 just a few years earlier were sold for $26 each—below the cost of having them hauled away. What was worth $866,000 in book value brought in only $163,000 in actual cash.
I’d rather invest in a company that makes drugs, soft drinks, razor blades, or cigarettes than in a company that makes toys. In the toy industry somebody can make a wonderful doll that every child has to have, but every child gets only one each. Eight months later that product is taken off the shelves to make room for the newest doll the children have to have—manufactured by somebody else. Why take chances on fickle purchases when there’s so much steady business around?
If The Gap has stopped building new stores, and the old stores are beginning to look shabby, and your children complain that The Gap doesn’t carry acid-washed denim apparel, which is the current rage, then it’s probably time to think about selling. If forty Wall Street analysts are giving the stock their highest recommendation, 60 percent of the shares are held by institutions, and three national magazines have fawned over the CEO, then it’s definitely time to think about selling.
Long term, there’s another important benefit. When management owns stock, then rewarding the shareholders becomes a first priority, whereas when management simply collects a paycheck, then increasing salaries becomes a first priority. Since bigger companies tend to pay bigger salaries to executives, there’s a natural tendency for corporate wage-earners to expand the business at any cost, often to the detriment of shareholders. This happens less often when management is heavily invested in shares.
More recently we’ve been warned (in no particular order) that a rise in oil prices is a terrible thing and a fall in oil prices is a terrible thing; that a strong dollar is a bad omen and a weak dollar is a bad omen; that a drop in the money supply is cause for alarm and an increase in the money supply is cause for alarm. A preoccupation with money supply figures has been supplanted with intense fears over budget and trade deficits, and thousands more must have been drummed out of their stocks because of each.
If you plan to hold the stock forever, see how the company has fared during previous recessions and market drops. (McDonald’s did well in the 1977 break, and in the 1984 break it went sideways. In the big Sneeze of 1987, it got blown away with the rest. Overall it’s been a good defensive stock. Bristol-Myers got clobbered in the 1973–74 break, primarily because it was so overpriced. It did well in 1982, 1984, and 1987. Kellogg has survived all the recent debacles, except for ’73–’74, in relatively healthy fashion.)
Every year I talk to the executives of a thousand companies, and I can’t avoid hearing from the various gold bugs, interest-rate disciples, Federal Reserve watchers, and fiscal mystics quoted in the newspapers. Thousands of experts study overbought indicators, oversold indicators, head-and-shoulder patterns, put-call ratios, the Fed’s policy on money supply, foreign investment, the movement of the constellations through the heavens, and the moss on oak trees, and they can’t predict markets with any useful consistency, any more than the gizzard squeezers could tell the Roman emperors when the Huns would attack.
• Predicting the economy is futile. • Predicting the short-term direction of the stock market is futile. • The long-term returns from stocks are both relatively predictable and also far superior to the long-term returns from bonds. • Keeping up with a company in which you own stock is like playing an endless stud-poker hand. • Common stocks aren’t for everyone, nor even for all phases of a person’s life. • The average person is exposed to interesting local companies and products years before the professionals. • Having an edge will help you make money in stocks. • In the stock market, one in the hand is worth ten in the bush.
signs: • The company has lost market share for two consecutive years and is hiring another advertising agency. • No new products are being developed, spending on research and development is curtailed, and the company appears to be resting on its laurels. • Two recent acquisitions of unrelated businesses look like diworseifications, and the company announces it is looking for further acquisitions “at the leading edge of technology.” • The company has paid so much for its acquisitions that the balance sheet has deteriorated from no debt and millions in cash to no cash and millions in debt. There are no surplus funds to buy back stock, even if the price falls sharply.
Since I own 1,400 at present, I suppose they have a point. Certainly I can name plenty of stocks I wish I hadn’t owned. Meanwhile, however, the assets in Fidelity Magellan have grown to $9 billion, which makes this fund as large as the gross national product of half of Greece. In terms of return on investment, Fidelity Magellan has done much better than Greece over the eleven years, although Greece has an enviable record over the preceding 2,500. As for Will Rogers, he may have given the best bit of advice ever uttered about stocks: “Don’t gamble; take all your savings and buy some good stock and hold it till it goes up, then sell it. If it don’t go up, don’t buy it.”
STOCKS IN GENERAL • The p/e ratio. Is it high or low for this particular company and for similar companies in the same industry. • The percentage of institutional ownership. The lower the better. • Whether insiders are buying and whether the company itself is buying back its own shares. Both are positive signs. • The record of earnings growth to date and whether the earnings are sporadic or consistent. (The only category where earnings may not be important is in the asset play.) • Whether the company has a strong balance sheet or a weak balance sheet (debt-to-equity ratio) and how it’s rated for financial strength. • The cash position. With $16 in net cash, I know Ford is unlikely to drop below $16 a share. That’s the floor on the stock.
There was a 16-month recession between July, 1981, and November, 1982. Actually this was the scariest time in my memory. Sensible professionals wondered if they should take up hunting and fishing, because soon we’d all be living in the woods, gathering acorns. This was a period when we had 14 percent unemployment, 15 percent inflation, and a 20-percent prime rate, but I never got a phone call saying any of that was going to happen, either. After the fact a lot of people stood up to announce they’d been expecting it, but nobody mentioned it to me before the fact. Then at the moment of greatest pessimism, when eight out of ten investors would have sworn we were heading into the 1930s, the stock market rebounded with a vengeance, and suddenly all was right with the world. PENULTIMATE
Merck tested everybody’s patience (see chart). This stock went nowhere from 1972 to 1981, even though earnings grew steadily at an average of 14 percent a year. Then what happened? It shot up fourfold in the next five years. Who knows how many unhappy investors got out of Merck because they were tired of waiting, or because they yearned for more “action.” If they had kept up to date on the story, they wouldn’t have sold. The stock of Angelica Corporation, manufacturers of career apparel, hardly budged a nickel from 1974 to 1979. American Greetings was dead for eight years; GAF Corporation for eleven; Brunswick for the entire 1970s; SmithKline (before Tagamet) for half the 1960s and half the 1970s; Harcourt Brace through Nixon, Carter, and the first Reagan administration; and Lukens didn’t move for fourteen years.
After that interlude at Fidelity, I returned to Wharton for my second year of graduate school more skeptical than ever about the value of academic stock-market theory. It seemed to me that most of what I learned at Wharton, which was supposed to help you succeed in the investment business, could only help you fail. I studied statistics, advanced calculus, and quantitative analysis. Quantitative analysis taught me that the things I saw happening at Fidelity couldn’t really be happening. I also found it difficult to integrate the efficient-market hypothesis (that everything in the stock market is “known” and prices are always “rational”) with the random-walk hypothesis (that the ups and downs of the market are irrational and entirely unpredictable). Already I’d seen enough odd fluctuations to doubt the rational part, and the success of the great Fidelity fund managers was hardly unpredictable.
A particularly ominous message is repeated over and over until it’s impossible to get away from it. A couple of years ago there was a drumbeat around the M-1 money supply. When I was in the Army, M-1 was a rifle and I understood it. Suddenly M-1 was this critical digit on which the entire future of Wall Street depended, and I couldn’t tell you what it was. Remember One Hour Martinizing? Nobody can tell you what that is, either, and millions of dry-cleaning patrons have never asked. Maybe M-1 actually stands for Martinizing One, and some guy on the Council of Economic Advisors used to run a dry-cleaning business. Anyway, for months there was something in the news about the M-1’s growing too fast, and people worried that it would sink our economy and threaten the world. What better reason to sell stocks than that “the M-1 is rising”—even if you weren’t sure what the M-1 was. Then suddenly we heard nothing further about the dreaded rise in the M-1 money supply, and our attention was diverted to the discount rate that the Fed charges member banks. How many people know what this is? You can count me out once again. How many people know what the Fed does? William Miller, once Fed chairman, said that 23 percent of the U.S. population thought the Federal Reserve was an Indian reservation, 26 percent thought it was a wildlife preserve, and 51 percent thought it was a brand of whiskey. Yet every Friday afternoon (it used to be Thursday afternoon until too many people jostled into the Fed building to get the number in advance of the Friday stock market opening) half the professional investing population was mesmerized by the news of the latest money supply figures, and stock prices were wafted up and down because of it. How many investors got faked out of good stocks because they heard that a higher money supply growth rate would sink the stock market?