The Poor Investor – Investigatory Value Investing

"Faber est suae quisque fortunae" -Appius Claudius Caecus

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The Investing Book You Haven’t Read

As a do-it-yourself investor, I love to read investing books. However, there are only a few books that have really had great educational value, the rest were merely entertainment.

Here are the books which have helped me the most:

  1. One Up on Wall Street, by Peter Lynch
  2. The Intelligent Investor, by Benjamin Graham
  3. Poor Charlie’s Almanack, by Charles Munger
  4. Common Stocks and Uncommon Profits, by Phil Fisher
  5. What Works on Wall Street, by James O’Shaughnessy
  6. See below.

Most of these books you’ve probably heard of or read yourself. If you haven’t read them, I suggest you do if you plan on investing on your own. However, there’s one more book (6) that also goes on this list that most people haven’t read. This book, in my opinion, is essential to the go-it-alone investor. The book is called “100 to 1 in the Stock Market,” by Thomas Phelps. The only problem is the book is out of print and hard to find. Your best bet is borrowing it from your local library.

Thomas Phelps offers some good advice as to what to look for when trying to find a 100- to-1 investment:

  1. Inventions that enable us to do things we have always wanted to do but could never do before. 
  2. New methods or new equipment that helps people do commonplace things easier, faster or at less cost than ever before.
  3. Processes or equipment to improve or maintain the quality of a service while reducing or eliminating the labor required.
  4. New and cheaper sources of energy.
  5. New methods of doing essential jobs with less or no ecological damage.
  6. Improved methods or equipment for recycling the materials used by civilized man instead of making mountains of waste and oceans of sewage.
  7. New methods for delivering the morning newspaper without carriers or waste.
  8. New methods or equipment for transporting people and goods on land without wheels.

He even gives 365 examples of 100-to-1 stocks (from 1932-1971) which could have turned $10,000 into $1,000,000 if bought right and held tight.  Some of  the more familiar of these include:

  • J.C. Penney Co.
  • Deere & Co.
  • Abbott Laboratories
  • Dr. Pepper
  • Lockheed
  • Greyhound Corp.
  • Philip Morris
  • Merck & Co.
  • Goodyear Tire & Rubber
  • Motorola
  • International Business Machines
  • Johnson & Johnson

These stocks all gained at least 100x their original value and some obviously much more.

Let’s say you decided to invest using Mr. Phelps’ method using $10,000 (+any additional money for fees).  Furthermore, say you decide to devote a year to trying to uncover 25 stocks which you thought fit the bill as 100-to-1 type companies.  After this, you divide your money equally into the 25, buying $400 of each company, and hold them for 20 years.  If you only identified 3 out of 25 stocks that went 100-to-1, and say the rest went to zero, even factoring in that year you were looking for the stock, you would have a compound annual growth rate of 12.56%, and $120,000.

Here is the CAGR for identifying 1 out of 25 to 10 out of 25:

  1. 6.82%
  2. 10.41%
  3. 12.56%
  4. 14.11%
  5. 15.33%
  6. 16.34%
  7. 17.20%
  8. 17.94%
  9. 18.61%
  10. 19.20%

Even identifying 2 out of 25 is nothing to scoff at, which beats the average S&P 500 return, including dividends, by ~1%.  Not to mention, this method does not include the dividends you might gain from the companies you invest in.

This method, just like any other, is not fool-proof—and although I don’t know the odds, common sense tells me that they are heavily stacked against you in trying to find 100-to-1 type companies.  Keeping that in mind, I leave you with a parable Mr. Phelps shares with us in the beginning of his book:

“Ask and It Shall Be Given to You”

Five poor Arabs slept on the sand. A bright light woke them. Out of it came an angel.
“Each of you can have one wish,” the angel said.
“Praise be to Allah,” exulted the first Arab to catch his breath. “Give me a donkey.”
Instantly a donkey stood at his side.
“Fool,” thought the second Arab. “He should have asked for more.”
“Give me 10 donkeys,” the second Arab begged.
No sooner said than done. He had ten donkeys.
The third Arab had heard and seen how the first two had fared.
“To Allah all things are possible,” he said. “Give me a caravan with a hundred camels, a hundred donkeys, tents, rugs, food, wine, and servants.”
They came so fast that the third Arab was ashamed to be seen in his rags before such an entourage. But his shame did not last long. Deftly his servants dressed him in robes befitting his new status.
The fourth Arab was more than ready when his turn came.
“Make me a king,” he commanded.
So quickly did the crown appear on his head that he bruised his knuckles from scratching where an instant before there had been nothing but an itch. The palace gardens stretched out before him almost as far as the eye could see, and the palace turrets reached so high their pennants were lost in the desert haze.
Having seen his companions in misery ask too little, the fifth Arab resolved to make no such mistake.
“Make me Allah!” he ordered.
In a flash he found himself in sand, covered with leprous sores.

Who is Kenneth Fisher?

While I am sure many of you have heard of Philip Fisher, how many actually recognize the name Kenneth Fisher?  My guess is Ken will always be hidden, to a large extent, in his father’s shadow.  For us this is a good thing because his method of investing is better off largely hidden from the public eye, just as if you came across an abandoned gold mine you wouldn’t want everyone else knowing about it.

One of the reasons I decided to look into Kenneth Fisher in the first place is because I was sure that his father had taught him plenty about investing.  If you can’t learn anything more from Phil, who better than his son?  In fact, Forbes publishes Fisher’s stock pick performance and has shown he has beaten the S&P 500 11 out of 14 years (Fisher’s record)(full article).  In addition to being an excellent investor, he is also an accomplished businessman, author, and runs his own company, Fisher Investments.  On top of that, he’s a nice guy as well as a moral beacon for those of us in the business and investment world.  He is also on a mission to save the redwood tree.

Kenneth Fisher was the first value investor to use P/S ratios as an analytical tool.  However, instead of just casually glancing at them, Fisher used them almost religiously.  Fisher, today, largely believes that his P/S ratio method may be obsolete because of its widespread use.  However, given the extreme volatility of this market, as of late, I have found this method quite useful in finding undervalued companies.

In Fisher’s book, Superstocks, although he talks mainly about his P/S ratio methodology he also discusses some other important elements of successful investing.  He reiterates the use of scuttlebutt, Phil Fisher’s term for talking to all parties involved with a company from the CEO down to the janitor in order to find out critical information which might influence your investment in said company.  Another important element Fisher addresses is the stability of a company’s profit margin.  Fisher believes a company’s profit margin should be at least 5% and should not deviate significantly from this value in the downward direction.  A high stable profit margin, he believes, reflects that the management is doing its job for investors and always striving to beat competition.  Fisher strongly believes management is the most important aspect of any investment, echoing his father.  This belief has well-served many investors, Warren Buffet included.  The bottom line, if management is not committed and shareholder-friendly, two musts, then your long-term investments are doomed to failure.  He also discusses price-to-research ratios and this has helped me to identify a few stocks I would have normally written off more quickly (one that comes to mind in particular is Nanosphere).

In other writings he talks about how an investor’s worst enemy is largely himself, believing that investors are hard-wired to perform poorly.  Myopic loss aversion so drives investors that they sell too early and permanently lock in losses.  He also refers to the stock market as “The Great Humiliator” as it unabashedly takes money from anyone, rich or poor, without discrimination.  He has studied PE ratios and firmly believes they are utterly useless for investment analysis, a finding that John Neff would surely disagree with.  However, he strongly advocates earnings yields in evaluating the stock market (taking the PE and flipping it) to determine whether it makes sense for companies to borrow money to buy back their own stock. Fisher believes in the American economy and also believes that the trade deficit is nothing to worry about.  He believes an account deficit only indicates that the world thinks America is a better place to invest than any other.

When asked about his investment philosophy Fisher states:

“You’re not going to like what I’m going to tell you here. People have always believed that the kind of equity they invest in is superior to other kinds. ‘I’m a growth guy,’ ‘I’m a value guy,’ ‘I’m a small cap guy,’ ‘I’m an emerging markets guy.’ The fact of the matter is these people share a spiritual core with Osama Bin Laden.  They’re narrow minded fanatics. And, they miss the big picture. In the long term all major categories of equity must have almost identical real risk adjusted returns. Because if you don’t believe that, you believe that a category of equity is more powerful than capitalism itself.”

And with that I will leave you.

——Written by: The Poor Investor

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