Talk:Beating the Street (Book)

Highlights

The text is fortified with liberal doses of Peter’s Principles, such as the two you’ve already had to tolerate. Many of these lessons I’ve learned from experience, which is always an expensive teacher, so you’re getting them here at a discount.

It’s human nature to keep doing something as long as it’s pleasurable and you can succeed at it, which is why the world population continues to increase at a rapid rate.

You should invest in several stocks because out of every five you pick one will be very great, one will be really bad, and three will be OK.

You may never admit to yourself, “I decided to sell my Gap shares because I read an article in the Sunday magazine about the effects of global warming,” but that’s the kind of weekend logic that’s in force, sub rosa, when the sell orders come pouring in on Mondays. It’s no accident that Mondays historically are the biggest down days in stocks and that Decembers are often losing months, when the annual tax-loss selling is combined with an extended holiday during which millions of people have extra time to consider the fate of the world.

This was the perfect scenario for the disciplined stockpicker to search his or her buy lists for likely prospects. The headlines were negative, the Dow Jones average had lost 600 points over the summer and the early fall, cabdrivers were recommending bonds, mutual-fund managers had 12 percent of their fund assets in cash, and at least five of my fellow panelists were predicting a severe recession.

Because the famous Crash was followed by the Depression, we’ve learned to associate stock-market collapses with economic collapses, and we continue to believe that the former will lead to the latter. This misguided conviction persists in the public mind, even though we had an underpublicized crash in 1972 that was almost as severe as the one in 1929 (stocks in wonderful companies such as Taco Bell declined from $15 to $1) and it didn’t lead to an economic collapse, nor did the Great Correction of 1987.

The dividend is such an important factor in the success of many stocks that you could hardly go wrong by making an entire portfolio of companies that have raised their dividends for 10 or 20 years in a row.

In the 1980s, you had massive buyouts of companies that were included in the S&P indexes, which caused the prices of the stocks in the indexes to go up. You had a lot of foreigners investing in our market, and these foreigners preferred to buy large-company stocks with famous names. This added to the upward momentum.

A fourth theory is that the popularity of index funds has created a self-fulfilling prophecy. As more big institutions invest in indexes, more money is poured into index stocks, causing them to rise in price, which results in index funds outperforming the competition.

A value fund, for instance, can be a wonderful performer for three years and awful for the next six.

In fact, when a value fund does better than its rivals in a lousy year for value funds, it’s not necessarily any cause for celebration. (This also applies to growth funds or any other kind of fund.) It may be that the manager has gotten disenchanted with value stocks and has invested some of the money in blue chips or utilities. He or she has gotten frustrated with the value style, especially when it hasn’t been working. The manager’s lack of discipline may produce good results in the short run, but the benefits may be fleeting. When value stocks come back, this manager won’t be fully invested in them, and his or her shareholders won’t be getting what they paid for.

Between 1989 and 1991, the Lipper growth-fund index soared by 98 percent while the value-fund index managed to gain only 36 percent. When value underperforms growth for several years, you might want to add money to the value pot.

The stock market is a fickle business, although it’s difficult to believe that today, after so many years of exciting gains. Severe corrections lead to long stretches when nothing happens, Wall Street is shunned by the magazine editors, nobody is bragging about stocks at cocktail parties, and the investor’s patience is sorely tested.

The fact is that I never had an overall strategy. My stockpicking was entirely empirical, and I went sniffing from one case to another like a bloodhound that’s trained to follow a scent. I cared much more about the details of a particular story—for instance, why a company that owned TV stations was going to earn more money this year than last—than about whether my fund was underweighted or overweighted in broadcasting.

What could happen is that I would meet with one broadcaster who would tell me that business was improving, and then he’d give me the name of his strongest competitor, and I’d check out the details, and often end up buying the second broadcaster’s stock. I followed scents in every direction, proving that a little knowledge about a lot of industries is not necessarily a dangerous thing.

Fidelity began a policy of taking a corporation to lunch. This superseded the old system, under which we had lunch with cronies in the office or with stockbrokers and talked about our golf games or the Boston Red Sox.

I always ended these discussions by asking: which of your competitors do you respect the most?

My methods were not much different from those of an investigative reporter—reading the public documents for clues, talking with intermediaries such as analysts and investor relations people for more clues, and then going directly to the primary sources: the companies themselves.

Knowing that the blame will be passed along to them, the analysts soon learn to protect themselves by not sticking their necks out. Instead of making imaginative recommendations to the fund managers, they prefer to tout acceptable, worn-out companies like IBM. Because they recommend acceptable stocks, they don’t get criticized as much when the fund managers have a lousy quarter.

Later, I presided over these meetings with a small kitchen timer, which I pretended to set at three minutes—the official time limit for any defense or explanation of a pick. In fact, I was setting the timer at progressively shorter intervals, until I got it down to a minute and a half

When you are openly criticized for your ideas, you may tend to hold back the next time.

To avoid undermining one another’s confidence, we allowed no feedback at our presentations—the listeners were free to follow up on the leads or ignore them as they chose.

The first half of 1982 was terrible for the stock market. The prime rate had hit the double digits, as had inflation and unemployment. People who lived in the suburbs were buying gold and shotguns and stocking up on canned soups. Businessmen who hadn’t gone fishing in 20 years were oiling their reels and restocking their tackle boxes, preparing for the shutdown of the grocery stores.

When yields on long-term government bonds exceed the dividend yield of the S&P 500 by 6 percent or more, sell your stocks and buy bonds.

How much time you spend on researching stocks is directly proportional to how many stocks you own. It takes a few hours a year to keep up with each one. This includes reading the annuals and the quarterlies, and calling the companies for periodic updates. An individual with five stocks can do this work as a hobby. A fund manager of a small- to medium-sized fund can do it as a nine-to-five job. In a larger fund, you’re looking at a 60- to 80-hour week.

The publicity I received for having bought 900 stocks, or, later, 1,400 stocks, may have caused some investors to shy away from Magellan. This is unfortunate. Of the 900 stocks in the portfolio in 1983, 700 accounted for less than 10 percent of the fund’s total assets.

I wasn’t convinced they deserved a substantial commitment. Most of the stocks in Magellan fell into this “tune in later” category. It was easier to follow the story when you owned some shares and were put on the mailing list.

The best stock to buy may be the one you already own.

It’s important to get out of a cyclical at the right time. Chrysler is an example of how quickly things can go from good to worse.

When your best-case scenario turns out to look worse than everybody else’s worst-case scenario, you have to worry that the stock is floating on a fantasy.

Never bet on a comeback while they’re playing “Taps.”

Cyclicals are like blackjack: stay in the game too long and it’s bound to take back all your profit.

Yet many investors continue to do this. They want to put their old stocks out of their minds, because an old stock evokes a painful memory. If they didn’t lose money on it by selling too late, then they lost money on it by selling too soon. Either way, it’s something to forget.

With a stock you once owned, especially one that’s gone up since you sold it, it’s human nature to avoid looking at the quote on the business page, the way you might sneak around the aisle to avoid meeting an old flame in a supermarket.

Just because a stock is cheaper than before is no reason to buy it, and just because it’s more expensive is no reason to sell

If you like the store, chances are you’ll love the stock.

A couple of years ago, we were sitting around the kitchen table when Annie asked, “Is Clearly Canadian a public company?,” which is the kind of question our family has been encouraged to pose.

The most fascinating part of any of these fast-growth retailing stories, whether it’s the Body Shop, Wal-Mart, or Toys “R” Us, is how much time you have to catch on to them. You can afford to wait for things to clarify themselves before you invest.

I’ve found that on several occasions over the years, the quiet facts told a much different story than the ones being trumpeted.

A technique that works repeatedly is to wait until the prevailing opinion about a certain industry is that things have gone from bad to worse, and then buy shares in the strongest companies in the group.

while 95 percent of the stylists (they no longer call these people barbers, it seems)

As a place to invest, I’ll take a lousy industry over a great industry anytime. In a lousy industry, one that’s growing slowly if at all, the weak drop out and the survivors get a bigger share of the market. A company that can capture an ever-increasing share of a stagnant market is a lot better off than one that has to struggle to protect a dwindling share of an exciting market. This leads us to Peter’s Principle #16: In business, competition is never as healthy as total domination.

All else being equal, invest in the company with the fewest color photographs in the annual report.

When even the analysts are bored, it’s time to start buying.

Glacier Bancorp used to be called the First Federal Savings and Loan of Kalispell, and I wish they’d kept the old name. It sounded antiquated and parochial, which to me is always reassuring. I’d rather have antiquated and parochial than trendy and sophisticated, which usually means a company is desperate to improve its image.

“We also have a fortress balance sheet. When we get in trouble, other guys are walking the plank.”

I find general gloom in an industry far less bothersome than if a specific company struggles while its competitors thrive.

The popular prescription “Buy at the sound of cannons, sell at the sound of trumpets” can be misguided advice. Buying on the bad news can be a very costly strategy, especially since bad news has a habit of getting worse.

This is a useful year-end review for any stockpicker: go over your portfolio company by company and try to find a reason that the next year will be better than the last. If you can’t find such a reason, the next question is: why do I own this stock?

If Joe Oddlot can’t always speak to the president, he can get the information from the investor relations department. Having the ear of management will not necessarily make you a better investor, any more than having the ear of the owner of a racehorse will make you a better handicapper. Owners can always give you a reason their horses will win, and they are wrong 90 percent of the time.

As a tightfisted operation in a nongrowth industry, capturing a bigger and bigger share of the market as its free-spending competitors fell by the wayside, Sun Distributors deserved to be included in my “blossoms in the desert” category.

In this instance, Sun Distributors had $57 million in goodwill to write off, and this accounting exercise reduced its reported earnings for the two classes of stock to $1.25 a share—when in fact it earned nearly twice that amount. These phantom earnings that the company has but can’t claim as earnings are called the free cash flow.

What confuses the issue is the fund manager’s perpetual itch to get ahead of the competition by returning to the cyclicals before everybody else does.

With most stocks, a low price/earnings ratio is regarded as a good thing, but not with the cyclicals. When the p/e ratios of cyclical companies are very low, it’s usually a sign that they are at the end of a prosperous interlude. Unwary investors are holding on to their cyclicals because business is still good and the companies continue to show high earnings, but this will soon change. Smart investors are already selling their shares to avoid the rush. When a large crowd begins to sell a stock, the price can only go in one direction. When the price drops, the p/e ratio also drops, which to the uninitiated makes a cyclical look more attractive than before. This can be an expensive misconception. Soon the economy will falter, and the earnings of the cyclical will decline at breathtaking speed. As more investors head for the exits, the stock price will plummet. Buying a cyclical after several years of record earnings and when the p/e ratio has hit a low point is a proven method for losing half your money in a short period of time.

Conversely, a high p/e ratio, which with most stocks its regarded as a bad thing, may be good news for a cyclical. Often, it means that a company is passing through the worst of the doldrums, and soon its business will improve, the earnings will exceed the analysts’ expectations, and fund managers will start buying the stock in earnest. Thus, the stock price will go up.

Unless you’re a short seller or a poet looking for a wealthy spouse, it never pays to be pessimistic.

The most important question to ask about a cyclical is whether the company’s balance sheet is strong enough to survive the next downturn.

The autos, often misidentified as blue chips, are classic cyclicals. Buying an auto stock and putting it away for 25 years is like flying over the Alps—you may get something out of it, but not as much as the hiker who experiences all the ups and downs.

One useful indicator for when to buy auto stocks is used-car prices. When used-car dealers lower their prices, it means they’re having trouble selling cars, and a lousy market for them is even lousier for the new-car dealers. But when used-car prices are on the rise, it’s a sign of good times ahead for the automakers.

After four or five years when sales are under the trend, it takes another four or five years of sales above the trend before the car market can catch up to itself. If you didn’t know this, you might sell your auto stocks too soon. For instance, after the boom year of 1983, when car sales increased from 10.5 to 12.3 million vehicles, you might have decided to take your profits in Ford or Chrysler stock because the auto boom was over. But if you followed the trend, you could see that there was still a pent-up demand for more than 7 million vehicles, which wasn’t exhausted until 1988.

In 1991, the popular view was that GM was a weak company with a miserable future. Though I was no fan of GM in the past, my hunch was that this latest popular opinion would prove to be as misguided as the last one.

It was all this negativity about GM that attracted me to it in 1991.

Corporations, like people, change their names for one of two reasons: either they’ve gotten married, or they’ve been involved in some fiasco that they hope the public will forget.

Buy on the omission of the dividend and wait for the good news. Or, buy when the first good news has arrived in the second stage. The problem that some people have with this is that if the stock falls to $4 and then rises to $8, they think they have missed it. A troubled nuke has a long way to go, and you have to forget about the fact that you missed the bottom. There’s a need here to apply some psychological Wite-Out.

When a company is deeply indebted, you want it to be a debt that doesn’t have to be paid in full anytime soon.

Whatever the queen is selling, buy it.