New York Society of Security Analysts
Presents
Strategies of Great Investors
Instructor: John M. Longo, Ph.D., CFA
Finance Department, Rutgers Business School
Chairman of Investment Committee, The MDE Group
November 15, 2005
1
Q: Why Can Using Public
Information (on the Internet or
elsewhere) Add Value Or Help
Result In Superior Investment
Performance?
(* Let’s Have A Picture Reveal The
Answer *)
2
Q: How
Would
You
Describe
The
Woman
In The
Picture?
3
The Human Element In Stock Prices
Two people can look at the same exact
picture (or company) and come to
completely opposite conclusions.
Unlike the laws of physics (e.g. gravity,
motion, etc.) there is no formula that can
consistently forecast security prices –
mainly due to the (irrational?) human
element.
4
Mosaic Theory
Mosaic Theory – Obtain bits and pieces
of public information and weave them
together into a new, unique picture that
others do not clearly see.
5
Program Summary
 No investment strategy works all the
time. Studying the strategies of
successful investors may help you
discover the strategy that works best for
you and may help you avoid costly
mistakes. Find the strategy that best fits
your skill set, resources, and personality
type.
6
Nature Of Investment Strategies
 What is Your Advantage?
 Superior Information
 Receive market-moving material before others
(difficult in the Internet Age and in the presence of
Insider Trading laws.)
 Use of relevant information sources with limited
distribution (e.g. obscure website, bulletin board,
newsgroup, newsletter, etc.)
7
Nature Of Investment Strategies (cont’d)
 What is Your Advantage?
 Superior Execution of Strategy (Very Important With
High Turnover Strategies)
 Low transaction costs.
 Minimal market impact when executing trades.
 Direct access vs. agency execution.
 Market vs. Limit Orders.
8
Nature Of Investment Strategies (cont’d)
 What is Your Advantage?
 Superior
Interpretation of Public Information
(Mosaic Theory)
 Unique insight in interpreting publicly available
information.
 Use of superior technology to aggregate relevant,
disparate information sources (e.g. multiple ECN
and exchange data feeds).
 Superior qualitative or quantitative proprietary
models.
9
Nature Of Investment Strategies (cont’d)
 Length of Strategy Effectiveness (Fleeting vs.





Eternal, Static vs. Dynamic)
Successful strategies often self-destruct.
Successful investors attract attention.
People reverse engineer successful strategies.
Too much money chasing too few investment
opportunities reduces returns.
Make plans for a new strategy before your
existing one begins to falter.
10
Types of Strategies
 Strategy Type: Quantitative vs. Qualitative
 Qualitative: Flexible in dealing with all scenarios,
but difficult to back-test and stress test strategy.
 Quantitative: Easy to back-test and stress test
strategy, but may backfire when operating in a new,
unseen market environment (e.g. trading post 9/11)
 Combination: Quantitative model that can be
overruled or enhanced by human qualitative
judgment.
11
Strategy Complexity
 Strategy Complexity: Univariate vs.
Multivariate


Occam’s Razor Principle: when choosing between
two theories of similar explanatory power, the
simpler method is preferred.
“You cannot earn excess returns unless you obtain
information that is not already discounted in the
market.” – Stephen Ross, renowned MIT Finance
Professor.
12
Strategy Complexity (cont’d)
“The people who profit from the market are
those people who are able to identify the
anomalies not yet seen by the market.”
Sanford Grossman,
Renowned Wharton Finance Professor and
successful hedge fund manager.
13
Benjamin Graham
Q: Who is this person?
A: Benjamin Graham is known as the father of
Value Investing and pioneered a rigorous,
quantitative approach to Security Analysis.
Graham was a successful money manager and
also taught at Columbia University, where he
and fellow faculty member David Dodd wrote
Security Analysis – the “Bible” of Value
Investing, first published in 1934.
14
Benjamin Graham (Cont’d)
Q: Who is this person? (Cont’d)
A: Warren Buffett and John Templeton were
among the many successful investors who took
Graham’s course. Graham was also a founding
member of an organization of professional
security analysts.This organization is now
known as the New York Society of Security
Analysts.
15
Benjamin Graham (Cont’d)
Q: What are the main concepts of his strategy?
A: Value approach with a “margin of safety.”
Focused on quantitative measures of value and
strongly preferred existing assets and current
earnings over promises of future profits/returns.
16
Benjamin Graham (Cont’d)
“To have a true investment, there must be present
a true margin of safety. And a true margin of
safety is one that can be demonstrated by
figures, by persuasive reasoning, and by
reference to a body of actual experience.”
“Investment is most intelligent when it is most
businesslike.”
17
Benjamin Graham (Cont’d)
“Every corporate security may be best
viewed in the first instance as an ownership
in, or a claim against, a specific business
enterprise.”
Over the long-run performance of both
companies and share prices generally revert
to the mean.
18
Benjamin Graham (Cont’d)
Order of preference in determining value:
1) Value of existing assets.
2) Value of current earnings power.
3) Value of potential growth – only in rare cases
and if the growth is within the core competence
or franchise of the firm and benefits from some
sustainable competitive advantage.
19
Benjamin Graham (Cont’d)
“Net-Net” approach was a favorite strategy
 “Net-Net” stocks -> Market Cap < (Current
Assets – Current Liabilities)
 In other words, the stock is trading below net
cash value.
 These stocks are difficult to find in the present
market, but were more abundant during the
Great Depression when Graham and Dodd first
published their seminal work.

20
Benjamin Graham (Cont’d)
 Recognizes the role of psychology in investing.
 “The investor’s chief problem – even his worst
enemy – is likely to be himself.”
 Focuses on investment, not speculation
 “An investment operation is one which, upon
thorough analysis promises safety of principal
and an adequate return. Operations not meeting
the requirements are speculative.”
21
Benjamin Graham (Cont’d)
 Regards growth stocks as a whole as too
uncertain and risky a vehicle for the defensive
investor.
 “Of course, wonders can be accomplished with
the right individual selections … But the
average investor can no more accomplish this
than to find money growing on trees. In
contrast, we think the group of large companies
that are relatively unpopular, and therefore
obtainable at reasonable earnings multipliers,
offers a sound if unspectacular area of choice
by the general public.”
22
Benjamin Graham (Cont’d)
 Seven quality and criteria suggested for the
selection of common stock for the defensive
investor:
 Adequate size of the enterprise (Measured in
sales, $100MM in 1971 dollars.)
 A sufficiently strong financial condition (e.g.
credit rating)
 Earnings stability – positive earnings for 10+
consecutive years.
23
Benjamin Graham (Cont’d)
 Seven quality and criteria suggested for the
selection of common stock for the defensive
investor: (Cont’d)




Dividend record – 20+ years is preferred.
Earnings growth – min increase of at least 1/3 in EPS in past
10 years using 3 years averages at the beginning and end.
Moderate P/E ratio -> current price should not be more than
15x average earnings over the past 3 years.
Moderate ratio of price to Assets
 < 1.5 Book value (unless P/E < 15) or
P/E * Price / Book <22.5 (= <15 P/E *1.5 Book)
24
Benjamin Graham (Cont’d)
 “If you have formed a conclusion from the facts and if
you know your judgment is sound, act on it – even
though others may hesitate or differ.” (Ed. Note: Value
investors are often contrarian, going against the crowd
at large.)
In the world of securities, courage becomes the
supreme virtue after adequate knowledge and a tested
judgment are at hand.”
 “To achieve satisfactory investment results is easier
than most people realize. To achieve superior results is
harder than it looks.”
25
T. Rowe Price, Jr.
Q: Who is this person?
A: T. Rowe Price, Jr. is one of the pioneers of
Growth Investing. He was a successful fund
manager and founded the large mutual fund
company, T. Rowe Price. He is perhaps best
known for his company life cycle approach to
investing.
26
T. Rowe Price, Jr. (Cont’d)
Q: What are the main concepts of his
strategy?
A: Corporations have life cycles. Buy
when earnings are increasing /
accelerating to maximize return and
reduce risk.
27
T. Rowe Price, Jr. (Cont’d)
 Price’s Goal: “To maintain purchasing power of
both income and principal with the minimum
risk of loss of principal and reduction of
income.” (Ed. Note: This goal is somewhat
inconsistent with investing in Growth stocks
since many “blow up” when projections are
missed and/or the expected growth does not
materialize.)
28
T. Rowe Price, Jr. (Cont’d)
“Corporations, like people, have life
cycles. Risks increase when maturity is
reached.”
Three phases of the corporate life cycle:
1)
2)
2)
Growth (growing faster than economy)
Maturity (at or near maximum earnings)
Decadence (experience long-term secular
decline in earnings)
29
T. Rowe Price, Jr. (Cont’d)
 There are greater gain possibilities and less risk
of loss while the earnings trend is growing.
 “Because the economic or business cycle runs
concurrently with a company’s life cycle, it is
difficult to determine in advance when earnings
power is on the decline. Research and an
understanding of social, political, and economic
trends should enable one to recognize the
change in long-term earnings trend of
business.”
30
T. Rowe Price, Jr. (Cont’d)
 Price on measuring industrial life cycles:
 The two best ways of measuring the life
cycle of an industry are:
1) unit volume of sales and
2) net earnings.
31
T. Rowe Price, Jr. (Cont’d)
 According to Price, there are two major types of
growth stocks.
1) Cyclical Growth (tied to economy – e.g. Autos in the
1950’s)
2) Stable Growth (not tied to the economy – e.g.
Healthcare, Beverages, etc.)
 An emphasis on Stable Growth should be preferred
when the market seems expensive (see below on
metrics to assess market valuation) and visa versa.
32
Phillip Fisher
Q: Who is this person?
A: Philip Fisher is one of the pioneers of Growth
Investing. His work (along with Graham’s) has
had a profound impact on Warren Buffett,
arguably the greatest investor ever. Fisher was
one of the first to do traditional fundamental
analysis (beyond looking at a company’s
financials) using his “scuttlebutt” method talking to management, competitors, suppliers,
former employees, etc. His son, Ken Fisher is a
well-known investor and columnist for Forbes.
33
Phillip Fisher
Q: What are the main concepts of his strategy?
A: Identify Growth Stocks with rapidly growing
sales and earnings. Enhance traditional
fundamental analysis (i.e. analyze financial
statements) with legwork or by uncovering
“scuttlebutt” - talking to management,
competitors, suppliers, former employees,
etc.
34
Phillip Fisher
Q: What are the main concepts of his strategy?
A: Identify Growth Stocks with rapidly growing
sales and earnings. Enhance traditional
fundamental analysis (i.e. analyze financial
statements) with legwork or by uncovering
“scuttlebutt” - talking to management,
competitors, suppliers, former employees, etc.
35
Phillip Fisher
 In Fisher’s seminal book on Growth Investing,
Common Stocks and Uncommon Profits, he
identifies 15 factors to look for when buying
common stock: (emphasis added)
1) Does the company have products or services
with sufficient market potential to make
possible a sizeable increase in sales for at least
several years?
36
Phillip Fisher
2) Does management have a determination to continue
to develop products or processes that will still further
increase in total sales potential when the growth
potential of currently attractive product lines have
largely been exploited?
3) How effective are the company’s research and
development efforts in reflection to its size?
4) Does the company have an above average sales
organization?
37
Phillip Fisher
5) Does the company have a worthwhile profit margin?
6) What is the company doing to maintain or improve
profit margins?
7) Does the company have outstanding labor and personal
relations?
8) Does the company have outstanding executive
relations?
9) Does the company have depth to its management?
10) How good are the company’s cost analysis and
accounting controls.
38
Phillip Fisher
11) Are there other aspects of the business, somewhat
peculiar to the industry involved, which will give the
investor important clues as to how outstanding the
company may be in relation to its competition?
12) Does the company have a short-range or long-range
outlook in regards to profits?
13) In the foreseeable future, will the growth of the
company require sufficient equity financing so that the
larger number of shares then outstanding will largely
cancel?
39
Phillip Fisher
14) Does the management talk freely to investors about its
affairs when things are going well, but “clam up” when
troubles and disappointments occur?
15) Does the company have management of
unquestionable integrity?
40
Phillip Fisher
Fisher also discussed three reasons to sell a
stock: (emphasis added)
1) When a mistake has been made in the
original purchase and it becomes
increasingly clear that the factual
background of the particular company, is
by a significant margin, less favorable
than originally believed.
41
Phillip Fisher
2) Sales should always be made of the stock of a company
which, because of changes resulting from the passage
of time no longer qualifies … to about the same degree
it qualified at the time of purchase (e.g. determination
of management, market has changed) (Ed. Note: Sell
when stock does not meet many of the 15 hurdles
discussed above.)
3) Opportunities for attractive investment are extremely
hard to find. (Ed. Note: perhaps suggesting the market
is overvalued)
42
Phillip Fisher
 Fisher advocated a moderately sized portfolio
since owning too many stocks made it
impossible to “watch all the eggs in all the
different baskets.”
 He felt buying a company without a detailed
understanding of the business may be more
risky than having limited diversification.
43
Warren Buffett
Q: Who is this person?
A: Arguably the greatest investor ever. Buffett was a
student of Graham’s at Columbia, worked for Graham,
and later set up his own investment partnership. He
eventually closed his investment partnership in 1969
because he felt the market was overvalued. Since that
time, he has used Berkshire Hathaway as his primary
investment vehicle. Buffett consistently ranks among
the Top 5 on Forbes’ list of the richest people in the
world.
44
Warren Buffett
Q: What are the main concepts of his
strategy?
A: Buffett describes himself as “15%
Fisher and 85% Benjamin Graham.”
He is predominantly known as a Value
Investor who’s “favorite holding period is
forever.”
45
Warren Buffett
 Buffett: Synthesis of Benjamin Graham
and Philip Fisher.


“I’m 15% Fisher and 85% Benjamin
Graham.”
(Ed. Note: Buffett’s long time partner,
Charlie Munger, brought Fisher to his
attention.)
 Buffett: First student of Graham, then
employee of Graham, then collaborator/
peer.
46
Warren Buffett
 Buffett’s approach – combine a qualitative
understanding of the business and its management
(learned from Fisher) with a quantitative understanding
of price and values (learned from Graham).
 Buffett called Graham’s “Net-Net” strategy the “cigar
butt” approach (one or two puffs left, for a cheap price.)
 According to Buffett, the last time it was easy to profit
from Graham’s “Net-Net” strategy was 1973-74.
47
Warren Buffett

Buffett:
 Says he cannot predict short-term market
movements and does not believe that anyone
else can.
 Does not commit any resources to judging
economic cycles (or politics).
 Says there is no difference between buying a
business and shares in a business. (concurs
with Graham)
 Looks for companies selling at attractive
valuations.
48
Warren Buffett

Buffett (cont’d):


Looks for companies he understands with
favorable long-term prospects,
Looks for companies that are operated by
honest and competent people.
49
Warren Buffett
 In
his book, The Warren Buffett Way:
Investment Strategies of the World’s Greatest
Investor, Robert Hagstrom distilled Buffett’s
approach to investing into a number of tenets or
principles. (Ed. Note: Hagstrom did have
access to and conversations with Buffett before
publishing the book. Warren Buffett has never
published a book on his investment philosophy,
but writes a detailed letter to shareholders
annually.)
50
Warren Buffett
Buffett’s Tenets, According To Robert Hagstrom
 Business Tenets - Three basic characteristics of
the business itself.



Management Tenets – Three important qualities that
senior management must display.
Financial Tenets – Four critical financial decisions
that the company must maintain.
Market Tenets – Two interrelated cost guidelines.
51
Warren Buffett
Business Tenets
1) Is the business simple and
understandable?
2) Does the business have a consistent
operating history?
3) Does the business have favorable longterm prospects?
52
Warren Buffett
Management Tenets
1) Is the management rational?
2) Is management candid with the
shareholders?
3) Does management resist the
institutional imperative? (The tendency
of corporate management to imitate the
behavior of other managers)
53
Warren Buffett
Financial Tenets
1) Focus on return on equity, not earnings per
share.
2) Calculate “owner earnings (approx. = net
income + non cash charges – capital
expenditures and any additional working
capital that might be needed) to get a true
reflection of value.
3) Look for companies with high profit
margins.
4) For every dollar retained, make sure the
company has created at least one dollar of
market value.
54
Warren Buffett
Market Tenets
1) What is the value of the business?
2) Can the business be purchased at a
significant discount to its value?
55
Warren Buffett
Hagstrom creates a 4-Step summary of
Buffett’s strategy (The Warren Buffett
Way)




Step 1: Turn off the stock market.
Step 2: Don’t worry about the economy.
Step 3: Buy a business not a stock.
Step 4: Manage a portfolio of businesses.
56
John Templeton
Q: Who is this person?
A: John Templeton was a student of
Graham’s and one of the pioneers of
International Investing. He founded
Templeton funds (now Franklin
Templeton).
57
John Templeton
Q: What are the main concepts of his
strategy?
A: Value investor who said, “If you
search worldwide, you will find
more bargains and better bargains
than by studying only one nation.”
58
John Templeton
Templeton prefers to invest in countries that exhibit the
following characteristics:
 Less government ownership.
 Less government regulation.
 Less quarrelsome unions.
 Lower taxes.
 Higher research budgets.
 People who are honest and reliable.
 People who are farsighted, rather than short sighted.
 Higher rate of savings.
59
John Templeton
In his book, The Templeton Touch, William
Procter listed twenty-two guiding
principles (or maxims) that Templeton said
have been instrumental in his success. I list
those that are most interesting in my
opinion. For the full list of maxims, please
consult Procter’s book.
60
John Templeton
1. For all long-term investors, there is only one
objective. Maximize total return after taxes.
3. It is impossible to produce a superior
performance unless you do something different
from the majority.
4. The time of maximum pessimism is the best
time to buy, and the time of maximum
optimism is the best time to sell.
61
John Templeton
8. If a particular industry or type of security
becomes popular with investors, that popularity
will always prove temporary and when lost,
wont’ return for many years.
9. In the long-run, the stock market indexes
fluctuate around the long-term upward trend of
earnings per share.
62
John Templeton
15. If you search worldwide, you will find more
bargains and better bargains than by studying
only one nation (and provided increased
diversification.)
17. The time to sell an asset is when you have
found a much better bargain to replace it.
18. When any method for selecting stocks
becomes popular, then switch to unpopular
methods.
63
John Templeton
19. Never adopt permanently any type of asset or
any selection method. Try to stay flexible,
open-minded, and skeptical.
20.The best performance is produced by a person,
not a committee.
64
John Neff
Q: Who is this person?
A: John Neff is one of the most celebrated mutual
fund managers in history. He managed
Vanguard’s Windsor Fund for more than 31
years. When Windsor closed its doors to new
investors in 1985, it was the largest mutual fund
in America. During Neff’s 31-year tenure as
the portfolio manager of Windsor, the Fund
increased in value 5,546% vs. a 2,299% gain
for the S&P 500.
65
John Neff (Cont’d)
Q: What are the main concepts of his
strategy?
A: Buy low P/E stocks, watch the
fundamentals, and use common
sense.
66
John Neff (Cont’d)
Further Details on Neff’s Strategy



Assigns great weight to a judgment about the
durability of earnings power under adverse
circumstances.
Tried to create an impact by taking outsized
positions where he saw promising returns.
Conducted exhaustive fundamental analysis (i.e.,
legwork, scuttlebutt, financial statement analysis,
etc).
67
John Neff (Cont’d)
Introduces concept of “Measured Participation”


Measure degree of participation in one stock against
the relative risks and rewards one would expect to find
in other market sectors. (Ed Note: This sounds like an
analysis of benchmark risk + valuation)
Assess firms on the basis of quality, marketability,
growth, and economic characteristics.
68
John Neff (Cont’d)
 Followed a durable investment style whether the market
was up, down, or indifferent:







Low P/E ratio.
Fundamental growth in excess of 7%
Yield protection (and enhancement in most cases).
Superior relationship of total return to P/E (see Neff Formula
For Value below)
No cyclical exposure without compensating P/E multiple.
Solid companies in growing fields.
Strong fundamental case.
69
John Neff (Cont’d)
 Neff Formula For Value:
(Projected Earnings Growth + Dividend
Yield) / (P/E)
The higher the more undervalued.
No solitary measure or pair of measures
should govern a decision to buy a stock.
70
John Neff (Cont’d)
Neff on investing in cyclical (e.g. Autos, Steel,
Paper, etc.) stocks:


Buy after one cycle has decimated its stock price,
but before earnings improvement becomes apparent
to everyone.
A low P/E strategy typically makes maximum
money 6-9 months before cyclical companies report
better earnings.
71
John Neff (Cont’d)
Neff on Investing in Growth stocks:




Projectable growth rates of 12-20%
Single digit earnings multiples of 6-9x Earnings
(Ed. Note: rare to find in today’s market)
Dominance or major participation in definable
growth rates.
Easy industries to understand.
72
John Neff (Cont’d)
Neff on Investing in Growth stocks (cont’d):
 Unblemished record of double-digit historical
earnings growth.
 Outstanding ROE, therein signifying management
accomplishment and capacity to finance growth.
 Significant Market Capitalizations and Net Income
totals thereby qualifying companies for institutional
consideration.
 Prefers (but not essential) some Wall Street
coverage, so “those that needs their hand held will
have a wet nurse.”
 2-3.5% Dividend Yield in most cases.
73
John Neff (Cont’d)
Neff suggests investors watch three areas
of the economy for signs of excess.
1) Capital expenditures
2) Inventories
3) Consumer credit
74
John Neff (Cont’d)
Reasons To Sell:
1) Fundamentals have deteriorated.
2) Price approaches expectations.
75
David Dreman
Q: Who is this person?
A: David Dreman is a successful money manager
and one of the pioneers of examining the
relationship between psychology and the
financial markets. This field of study is now
known as Behavioral Finance. Dreman is also
a columnist for Forbes magazine.
76
David Dreman
Q: What are the main concepts of his strategy?
A: Contrarian, Value investor who favors low P/E stocks.
He is also keenly aware of investor and market
psychology.
Further Details on Dreman’s Strategy:
In his book, Contrarian Investment Strategies: The
Next Generation, Dreman lists over 40 Rules that wise
investors should heed. I list those that are most
interesting in my opinion. For the full list of rules,
please consult Dreman’s book.
77
David Dreman
 Rule 1: Do not use market timing or technical
analysis. These techniques can only cost you
money.
 Rule 2: Respect the difficulty of working with a
mass of information. Few of us can use it
successfully. In-depth profits.
 Rule 5: There are no highly predictable
industries in which you can count on analysts’
forecasts. Relying on these estimates will lead
to trouble.
78
David Dreman
 Rule 6: Analysts’ forecasts are usually
optimistic. Make appropriate downward
adjustments.
 Rule 10: Take advantage of the high rate of
analyst forecast error by simply investing in out
of favor stocks.
 Rule 13: Favored stocks underperform the
market while out of favor companies
outperform the market, but the reappraisal often
happens slowly, even glacially.
79
David Dreman
 Rule 14: Buy solid companies currently out of
market favor, as measured by their low Price /
Earnings, Price / Cash Flow, or Price / Book
value ratios and their high Dividend Yields.
 Rule 18: Invest equally in 20 to 30 stocks,
diversified among 15 or more industries.
 Rule 21: Sell a stock when its P/E Ratio (or
other contrarian indicator) approaches that of
the overall market, regardless of how favorable
prospects may appear. Replace it with another
contrarian stock.
80
David Dreman
 Rule 29: Political and financial crises lead
investors to sell stocks. This is precisely the
wrong reaction. Buy during a panic, don’t sell.
 Rule 41: A given in markets is that perceptions
change rapidly.
81
Peter Lynch
Q: Who is this person?
A: Peter Lynch is arguably the most successful mutual
fund investor ever. During the thirteen years that Lynch
managed the Fidelity Magellan Fund (1977-1990) a
$1,000 investment in the Fund would have grew to
$28,000. At the time of Lynch’s retirement from active
management in 1990, the Magellan Fund was the
largest mutual fund in the world (subsequently passed
by Vanguard’s S&P 500 Index Fund.)
82
Peter Lynch
Q: What are the main concepts of his strategy?
A: Lynch advocates investing in what you
already know in order to make money in the
market. He follows up this common sense with
rigorous fundamental analysis. His investing
philosophy would generally fall in the Value
camp, but he also has had success investing in
Small Cap and Growth stocks.
83
Peter Lynch
Further Details on Lynch’s Strategy
Lynch’s Common Sense Approach:



“Take advantage of what you already know.”
Ex: Lynch bought Dunkin’ Donuts because he liked
the coffee (and subsequent fundamental analysis
confirmed it as a buy)
“The average person is exposed to interesting local
companies and products years before professionals.”
84
Peter Lynch


Don’t overestimate the skill and wisdom of
professionals.
Suggests looking for opportunities that
haven’t yet been discovered by Wall St. –
companies that are “off the radar scope.”
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Peter Lynch
Lynch’s Philosophy is largely consistent
with Graham & Buffett’s.



Invest in companies, not the stock market.
Ignore short-term fluctuations.
Predicting the economy is futile.
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Peter Lynch
Lynch’s Philosophy (Cont’d)



In the stock market, one in the hand is worth ten
in the bush.
However, he appears to be less concerned with
strict valuation measures.
“If the story is still good and earnings keep
growing, then of course it can go higher.”
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Peter Lynch
Lynch’s Suggested Stock Hunting Grounds
He:




Prefers small companies that are already profitable and
have proven that their concept can be replicated.
Is suspicious of companies with growth rates of 50% to
100% a year.
Generally avoids hot stocks in hot industries.
Prefers simple companies that appear dull, mundane, out
of favor, and haven’t caught the fancy of Wall Street.
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Peter Lynch
Lynch’s Suggested Stock Hunting Grounds (Cont.)





Suggests moderately fast growers (20 – 25%) in nongrowth industries are ideal investments.
Looks for companies with niches.
Looks for companies that consistently buy back their own
shares
Looks for companies with little or no institutional
ownership.
Views, insider buying as a positive sign, especially when
several individuals are buying at once.
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Peter Lynch
Lynch on Fundamental Analysis




“Understand the nature of the companies you own and the
specific reasons for holding the stock.”
Suggests carefully consideration of the P/E ratio as a
valuation metric. “If the stock is grossly overpriced, even if
everything goes right, you won’t make any money.”
Distrusts diversifications, which usually turns out to be
what he terms “diworseifications.”
Steers away from long shots since they “almost never pay
off.”
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Peter Lynch
“Companies that have no debt, cannot go
bankrupt.”
Bases his purchases on the company’s
prospects, “not on the president’s resume or
speaking ability.”
Views market declines as an opportunity to
buy stocks in companies he likes.
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Peter Lynch
“Just because a company is doing poorly,
doesn’t mean it can’t do worse.”
“Buying a company with mediocre prospects
just because the stock is cheap is a losing
technique.”
“You won’t improve results by pulling out the
flowers and watering the weeds.” (e.g.
Cutting Winners and holding Losers)
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William O’Neil
Q: Who is this person?
A: William O’Neil is the publisher of Investors
Business Daily – viewed by some as an
investor focused complement to The Wall
Street Journal.
His book, How To Make Money In Stocks is a
bestseller and introduced his Growth
strategy, C-A-N-S-L-I-M.
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William O’Neil
Q: What are the main concepts of his strategy?
A: His main strategy is the C-A-N-S-L-I-M
method, which falls under the Growth
approach. It is also considered by some to be
a trading strategy vs. a long-term buy and
hold strategy.
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William O’Neil (Cont’d)
Further Details on O’Neil’s Strategy


Some critics claim O’Neil is advocating
momentum investing. O’Neil retorts:
“We’re buying companies with strong
fundamentals, large sales and earnings increases
resulting from unique new products or services
and trying to time the purchases at a correct
point as the company emerges from the
consolidation period and before the stock runs up
dramatically in price.”
95
William O’Neil (Cont’d)
C-A-N-S-L-I-M Method For Stock
Selection:
C = Current Quarterly Earnings Per Share
They must be up at least 18%.
A = Annual Earnings Per Share
They should show meaningful growth for at least
the last 5 years.
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William O’Neil (Cont’d)
N = New
Buy companies with new products, new management, or
significant new changes in their industry conditions. Most
importantly, buy stocks as they make new highs in price.
S = Supply and Demand
There should be a small or reasonable number of shares
outstanding, not large capitalization, older companies. And
look for volume increases when a stock starts to move up.
L = Leaders
Buy market leaders, not laggards.
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William O’Neil (Cont’d)
I = Institutional Sponsorship
Buy stocks with at least a few institutional
sponsors with better than average recent
performance records.
M = The General Market
It will determine whether you win or lose, so learn
to interpret the daily general market indexes (price
and volume changes and action of the individual
leaders) to determine the overall market’s current
direction.
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William O’Neil (Cont’d)
 Suggests Setting Stop-Loss Orders:
 Limit your losses to 7% - 8% (Ed Note: This
strategy implies a very high turnover.)
 Trading strategy: Take 20% profits when you
have them (except with the most powerful of all
stocks) and cut losses at 8%.
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Suggestions for Further Reading

I. Textbook
Z. Bodie, A. Kane, and A. Marcus,
Investments. Publisher: McGrawHill/Irwin; 5th edition (July, 2001).
This is the most popular Investments
textbook used by MBA programs.
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Further Reading Cont’d

II. Journal Articles / Investor’s Anthology
J. Vertin and C. Ellis (Editors), Classics: An
Investor's Anthology. Publisher: Richard d Irwin;
(November 1989).
This anthology provides a nice overview of
investing articles published in academia and on
Wall Street.
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Further Reading Cont’d

III. Investor Psychology / Behavioral Finance
H. Shefrin, Beyond Greed and Fear:
Understanding Behavioral Finance and the
Psychology of Investing. Publisher: Oxford
University Press; (January 2000).
This is a very readable and informative book on
the topic of Investor Psychology / Behavioral
Finance.
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Further Reading Cont’d

IV. Strategies of Professional Investors
P. Lynch, with J. Rothchild, One Up on Wall
Street: How to Use What You Already Know to
Make Money in the Market. Publisher: Fireside;
(April 2000).
Peter Lynch, one of the world’s most successful
investors, shares some of his investing secrets.
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Further Reading Cont’d

Benjamin Graham, The Intelligent Investor.
Publisher: Collins Business Essentials;
Updated, revised edition (2005).
This is a good book (originally) written by
the greatest investment advisor of the
twentieth century.
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