Dedicated to promoting long term investment philosophies

Copyrights © 1997 to 2001 by gpt1001

That's right! Investing is supposed to be boring. You see, our society has conditioned us to seek excitement in everything we do. Unfortunately on Wall Street, this mindset will transfer your assets to the more knowledgeable and more patient investor.

Many people thrive on the challenge of short term trading and the thrill of the occasional big win. "Make some money quick and then get out!" is the refrain I often hear from the inexperienced and uninformed. This is not the way long-term winners play on Wall Street. No, this type of attitude is more appropriate in a casino.

Part of the problem is our background in sports. We thrive on the excitement of the long bomb and yawn about the 80-yard drive even thought both events score a touchdown. How many of us enjoy a prevent defense? We cheer the home run and eat a hot dog during an intentional walk. In tennis, pros are taught that playing not to lose will ensure nothing but a loss. How many shows about skiing feature the novice fearfully snowplowing down a gentle incline? No, we are more excited about watching an extreme skier ski down an impassable cliff or a downhill racer careen madly down the diamond trails.

Or professional sporting events feature the culmination of many years of training without featuring the years of hard work that prepare the athlete for the final event. When there is a human-interest story about training, that is usually the time I go to the kitchen, make a sandwich and grab a Coke. Think about it, if television stations broadcasting the summer Olympics featured only the Olympic events, would you watch? What if the television stations only broadcast athletes training for the Olympics?

Successful investing in business through the stock market is more like playing amateur sports. In tennis, you can do very well just hitting an easy shot down the middle of the court. Softball players can do well just swinging for the easy single. Golfers do very well by swinging easy and staying on the fairway. Remember, there are no mulligans in the investment world.

When investing, the successful professional will take the easy shot by investing in a company where there is a great probability of success. It is only when the amount of money available to invest exceeds the number of easy opportunities available that the investor should venture into the more difficult situations. For most of us, this will never occur. Only mutual funds and other large institutional investors with their limitations on the amount of funds that can be invested in a single company have the need to participate in more difficult situations.

Another problem our society has created in our minds is the desire for instant gratification. We have fast food restaurants and instant breakfasts. There are many books about managing time so we can fit as many activities into our day as possible. We write appointments into our day-timer, and then find we write appointments between appointments until we get to the point where we have two appointments at the same time. (Hope someone doesn't show up!)

Enough examples. On Wall Street, the successful investor will have a boring portfolio. Unfortunately, the people who have the most to gain want you to believe it's supposed to be exciting. This is how they stay in business. Like sharks, many investment advisors think they have to swim to stay alive.

Suppose there was a daily television show about the stock market. Suppose that every day for 5 years a colorful "analyst" spent 30 minutes talking about the same 10 companies. Finally, after 5 years, the analyst suggested you sell one of these companies. Would you watch the shoe every day?

What if every day, the same person came on to talk about investing? What if this person gave a rule of thumb about the percentages of your portfolio that should be invested in equities and the percentages that should be invested in bonds? What if the show was exactly the same every day?

No, the only way we will watch is if new ideas are presented on every show. If the man with the colorful tie doesn't present a new idea several times a day, we will switch to soap operas. If there are not new and exciting ideas about investing, we will watch another show with more variety.

The same thing is true for weekly and monthly investment magazines. Each edition must have new ideas or people will not buy the magazine. Why feature a different mutual fund each month? Aren't we supposed to invest for the long term? Unfortunately, many people define long term as the time it takes to get the confirmation slip from making the trade. Others define long term as the time it takes an investment to qualify for a long-term capital gain. How many of these people would start a small business with the intention of changing businesses after just one year?

When evaluating the media keep the following in mind: Give a choice between selling more advertising space or having your portfolio perform well, which choice do YOU think they will make?

Investing is supposed to be different. It doesn't get exciting until the late innings. Would you be excited if you attended a perfect game in baseball? Probably not until the last couple of innings when you realized the pitcher might get a perfect game. During the first seven innings you would most likely find yourself wishing you had stayed home and watched the grass grow. The seventh inning stretch would be a seventh inning yawn.

In order to perceive why investing is not exciting until late in the game, let's look for a moment at the magic of compound interest. Suppose you invested $10,000 in a mutual fund with a long-term rate of return of 11.7% (the average rate of return of the S&P 500 index since 1924.) The first year, you might only gain $1,170. Of course, you could get less if the market performance was less than average. After 20 years with this return, you would have $91,424. Your return in the 21st year would be $10,696. – a little more than your original investment.

Let's increase the time to 35 years. Not too hard if you just save $10,000 by the time you are 30. After all, don't a lot of 30 year old people buy a car for much more than $10,000? Isn't your secure retirement worth at least as much as a new car?

After 35 years at 11.7%, the 10,000 will have grown to $480,684. In the 36th year, the $10,000 would grow and additional $56,240. This is more than 5 times the original investment. See what I mean by the game becoming more exciting at the end? Unfortunately, the ending is difficult to conceive during the boring beginning of setting aside the first $100. If you want to raise the excitement level, consider that $100 is worth $4,806.85 after 35 years at the average return of the S&P 500 index. Now there is an exciting reason not to blow the money on something that disappears in the short term. (Unfortunately, since I figured out that an item that costs just a few dollars is actually costing my future so much, I've quit spending money on 'trinkets' that have no long-term value.)

I am often amazed at how little time people want to spend planning their financial future compared to how much time they spend purchasing something relatively inexpensive like a car. Yes, the price of an automobile is very small compared to the price of a 20 year retirement. (Yet an investment equal to the price of a car can, if made early enough, provide for your retirement.)

The other day, I scheduled a 2:30 appointment with a teacher. I arrived about 5 minutes early. As we walked down the hall to her classroom, she informed me had scheduled another appointment at 2:30, but that was OK because she knew exactly what she wanted. She wanted to invest $30 a month into something that would grow. Help!!! How does a person deal with someone who can only spend 5 minutes in the hallway planning their future? Do you think she wanted to hear about how $30 a month wouldn't help much? Did she want to listen to how at her age she needed to save over a million dollars for a successful retirement?

If this was the exception, I would feel a little better. Unfortunately, it is a rare person who is willing to take the time to set up a financial plan. Do you have written goals for your financial future? Do you follow a specific road map? Or are you just sailing down wind hoping the wind is blowing the right direction?

Why not take a "financial planning" vacation. Spend an entire week setting specific goals for your future. You will probably only have to do this once in your life. If you take the time to properly plan your investment future, you will only need to do a little maintenance planning as time goes on.

Chip Tucker, who has given me many of my best ideas, suggested that once your plan is in place, you get another hobby besides investing. What a brilliant concept!!! You see, if investing is a hobby, you will always want to tinker with your portfolio. After awhile, it becomes addictive any you will have an unquenchable desire to change something even though your businesses are progressing normally.

Soon you find yourself trading stocks in a quest for the big win. When you reflect on your transactions, you find yourself saying, "If only I had kept that one." Instead of being a bull or a bear, you find yourself becoming a pig. Remember, pigs get eaten. You should be investing for the long-term in businesses with a solid future. Investing for the short term is an oxymoron similar to military intelligence. The terms just don't go together.

Perhaps you should form an investment club that doesn't allow discussions about investing. Or maybe you should only allow speakers who recommend you keep the same investments you had last week. Take your broker to lunch and tall about how great your investments are. Thank your broker for not recommending any changes. Then talk about baseball. A word of caution is in order her. As with any philosophy, this one can be overdone. I am talking about keeping your fractional ownership of companies that are doing well. Don' remain in situations where the future is beginning to look like a day in bankruptcy court. Even if a turn around situation turns around, you have probably wasted several years treading water. Develop a set of rules about when you will sell, and then just follow them.

You may be reading this book in order to discover some new principles of investing that will turn a quick profit. Wrong! If your principles of investing change, then they are not principles. The information I will present is many years old. It has survived the tests of bear markets, bull markets, investment bubbles and depressions. A thorough understanding of these methods should help you avoid significant long- term losses. It will also help you avoid the quick gains. The best advice I can give you is to live a long life and to allow the magic of compound interest to work in your favor. (Living a long life will not help if you don't start investing early.)

Once you have set up your portfolio, sit back and relax. Both good and bad things will happen in the short term. Realize the events of this day, month or year really don't effect where the market will be in 10 or 20 years. If you want to have some fun, read some old copies of the Wall Street Journal. Then read some current copies. See if you can tell the difference. The sky usually doesn't fall. It just temporarily gets a little lower.

The investor's portfolio is like a glacier that gradually moves mountains over the long term. The speculator's portfolio is like a windstorm that makes a lot of noise and raises a lot of dust, but does not really make a lot of permanent change.

Many people have written about the differences between an investor and a speculator. Perhaps the best discussions have been made by Benjamin Graham in his book "The Intelligent Investor." The descriptions that follow are inspired by, but are not a repetition of Benjamin Graham's.

The characteristic that most distinguishes an investor from a speculator is their time horizon. A true investor can see the distant future. Although the investor cannot see what is in the future, the investor realizes the future will come and with it will come the long-term rewards of a well defined and disciplined investment philosophy.

The speculator expects to always have great short-term results, but doesn't have any long-term plans for a portfolio. (usually the speculators don't need long-term plans because their money is transferred to the investor in the short term.) The speculator's portfolio is planned using the latest hot tip, and not by using any type of sound analysis.

An investor has well defined investment philosophies used to identify favorable situations and has developed the discipline and patience to follow through on these philosophies. An investor examines the facts available and determines there is a reasonable opportunity to make a profit with the amount of profit being commensurate with the amount of risk taken. An investor only invests when the probability of profit in a particular situation outweighs the probability for loss and the probability for loss is small. This means investing in sound businesses when the business is offered for sale at a price significantly below its current intrinsic value. When this is done, the opportunities for profit are increased while the possibilities of loss are reduced to the minimum level.

Benjamin Graham makes a further distinction. He classifies investors into two types, "Defensive" and "Enterprising." I would classify a defensive investor as one who invests in relatively simple businesses where there is an abundance of information and where a minimum amount of brainpower is necessary to analyze the situation. The defensive investor should never need to have any doubts if the business is likely to stay in business or if it is likely to make a profit. There are many situations where the defensive investor will make a good profit while still maintaining a large margin of safety.

The enterprising investor will invest in situations that are not readily apparent to the person who lacks the time or expertise to look into unique situations. The defensive investor may only have a couple of easily understood and well-defined investment models and this investor only invests in businesses that can be accurately analyzed by these models. The enterprising investor will likely have more investment models to analyze more types of companies.

The enterprising investor usually has many years of experience, and has learned to easily recognize and avoid the common traps made by less knowledgeable investors. The enterprising investor will still maintain a reasonable margin of safety and will not increase the risk of loss with the investment unless there is an excellent chance of increasing the profit.

The enterprising investor may be rewarded with more profits for his efforts if he is able to recognize a highly profitable situation that would not be apparent to a defensive investor. However, the enterprising investor is not always searching for higher profits. Sometimes, being an enterprising investor merely allows one to make an investment when most other situations appear overvalue.

In my experience, I have found defensive investments are almost always available except when the market is tremendously overvalued. One can have great success by confining your investments to this area. On the other hand, the number of enterprising investments is usually lower than the number of equally profitable defensive investments. In fact, in the last 30 years of investing, I have found only two successful enterprising investments. The first was writing covered calls in the early 80's. This was a period when the time value included in option premiums was high and greatly favored the writer of options. The other situation has been an Investment in Wesco-Financial.

Surely, I could still have had an equally successful investing career without these two opportunities. Usually, when someone claims they are making an enterprising investment, they are actually doing a little bit of closet speculating. In order to justify this speculation, they come up with a unique, untested theory, to explain why the company will prosper. Why not just admit the need for a little fun and go to a casino?

One further distinction in investment philosophy is the definition of a value investor. I am not aware of any clear-cut definition of value investing. Some people think it means buying stocks with a low price earnings ration. Often these people will not even look at the reason the price earnings ration is low. Others define value investing as buying a company for less than its liquidation value. This method has been used very successfully, but it is difficult for today's defensive investor to determine when this situation exists. Still others use the cigar butt theory of investing where they buy a business that is in trouble with the hope that there are a few good puffs left. This doesn't fit into my conception of value investing since these people are not buying a sound business. If this person had to invest their life's savings to purchase this entire business, they would probably decline the opportunity. Some buy a stock that has recently gone down with the hopes that it will go back up with the normal cycles of the market. This person will probably do all right if they invest for the long term in sound companies.

My philosophy of value investing is to first look at the business. You should be convinced the business is sound and it is one you would purchase if you had enough funds to purchase the entire business. Once you have found an outstanding business, then you are merely negotiating price with the current owners. During the "Nifty Fifty" says institutions were willing to buy outstanding businesses at any price. The feeling was the growth of the company would bail them out over time. However, as a patient investor, you are willing to wait until the owners offer their share of the business at a price well below the central value of the business. Anytime you are purchasing a sound business at a price that is well below the central value of the business, that is value investing.

After talking to many mutual fund managers and after talking to other nationally respected investors, I have found many successful money managers follow something similar to this definition. Those that profess to be growth managers still try to make sure they invest in growth businesses at a price below the central value of the business. (This was written in 1997. History has shown many managers now just buy what they think will go up.)

Now, let's define a speculator. The speculator looks around the table wondering who the sucker is, not realizing he is the sucker. A speculator makes an investment without having the pertinent facts and also without applying a sound investment to the facts that are available. The speculator has no core portfolio of easily understood and profitable businesses. The speculator passes by easily understood situations in favor of complicated situations where no reasonable analysis is appropriate. The speculator is trying to score a big profit without regard to the probability of loss equal to or greater than the probable profit.

This person listens to hot tips, or makes an investment in companies that have not even made a profit. Their investments are often preceded by statements such as "Don't you think…", "I think this company will do well in the future" (even though the company has never shown a profit and has only been in existence for two years), "This sector has been really hot…", and other equally uninformed decisions.

The speculator thinks a stock with a price of $2.00 a share is cheap even though the business is losing money. The same person thinks a stock priced at $100/share is expensive even though the company is earning $10.00/share. This type of person has no defined investment philosophies and has made no fundamental analysis of the situation. He is really just making an uneducated guess. This type of person will be very vocal about gains (eve a blind pig finds corn occasionally), and very reticent about losses.

In the long run, most speculators have no concerns about paying taxes because there are no profits. The speculator's main concern is current tax laws only allow one to carry forward $3,000 of losses each year. The speculator tries to take more profit than what the market has to offer while the investor seeks to achieve a reasonable return while maintaining a margin of safety which will protect his principal from the normal investment hazards.

In short, the speculator treats the market like a casino while the investor treats the market like a business. In return, the market will act like a casino to the speculator and the market will act like a business to the investor. Although there is nothing illegal or immoral about speculation, the market forces will, over time, tend to transfer assets from the speculator to the investors who follow a disciplined, long-term investment program.

It is possible for an investor to inadvertently become a speculator by purchasing interests in sound companies when the price is well above the intrinsic value of the companies. During a bull market, many companies will be trading above their intrinsic values, and the temptation will be strong to rationalize the decision to buy because there are few companies trading below their central value. The successful investor will recognize and avoid these tendencies.

Benjamin Graham also stated the profits you make can be increased by the amount of knowledge you apply to the situation, not by the amount of risk you are willing to take. The more I have reflected upon this opinion, the more brilliant I have found this opinion to be. The conventional wisdom is you will receive more reward for taking more risks. This just leads the unknowing into speculative situations without a full realization of the situation. The reality of the market is higher profits are usually available when you strive to reduce the risk to the lowest level for the type of investment you are making, not when you are taking more risk. When you have reduced the risk to the lowest level, the business has the greatest potential to appreciate in price. The amount of knowledge you apply to the situation is what distinguishes the investor from the speculator and the defensive investor from the enterprising investor.

What follows will add to the amount of knowledge you have and by applying this knowledge to the proper situations, you are likely to experience a good degree of investment success over the long term. This knowledge is not likely to provide quick profits in the short term. In fact, one of the characteristics of a value investment philosophy is your portfolio will get off to a slow start. A value investment philosophy is designed to select businesses currently out of favor and selling for low prices. The same people who have driven the price sown must change their views and start to bid the price of the business higher.

The value portfolios I have developed have generally gotten off to a slow start with only one or two businesses in a portfolio of ten companies showing a significant profit in the first few months. In general, the other eight have stayed at approximately the purchase price. After about six months, more companies start to show a steady increase in price. If your portfolio is developed in a rising market, you are likely to be initially disappointed since you will have selected out of favor companies which are not rapidly increasing in price like the glamour sectors that are racing to an overvalued situation.

As a value investor you will not experience large overall gains until your portfolio has had time to mature. This process usually takes about one year. The time you will most likely receive immediate gratification is during declining markets. In a declining market your reward will be that your punishment is likely to be less severe than those who adhere to other investment philosophies. That is why value investing tends to receive more attention during declining markets. Once you have completed a market cycle as defined by the companies you have rotating into and back out of favor, you should find that you have achieved a reasonable profit with a lower volatility than the market as a whole.

By recognizing where the value of your business lies, you will have no concern about price fluctuations of the business. You will instead learn to focus on the cash flows that will be available from the business and be satisfied as long as the cash flows from the business are increasing at a satisfactory rate.

In the case of the dividend discount model, you will focus on the rate of increase of dividends. Later, you will learn to evaluate other cash flows. You will also come to look at your portfolio as a business, which is essentially a holding company that purchases fractional interests of other companies. When you report your profits each year, you will report the combined results of all your companies without focusing too strongly on any individual company.

What follows is the development of a long-term investment plan. You should learn a philosophy that will lead the investor to buy when a business is undervalued, and if desired, sell when a business is overvalued. The main critique will be there is an implication of mathematical precision that is clearly not present in the investment world.

Back in 1979, I got my first lesson on margin of safety, long before I ever heard of Benjamin Graham. I was investing as a blind sheep back then.

At the time I was a co-pilot in the Air Force, flying KC-135's. Another base had just had a crash where the crew died. Our Wing Commander came in to talk to the crews who were sitting alert. He was Col. Harry Johnson. He probably saved my life.

Col. Johnson came in the room visibly upset. You see, the crew probably died unnecessarily. They didn't use a margin of safety.

He said "Look guys, I know you don't like me much…but listen to me now. If you listen to nothing else, listen to this."

He held his right hand about chest high and said "This is your flying ability." He held his left hand about stomach high and said "This is where I want you to fly." The difference is your margin of safety. The distance between the two hands is what keeps you alive.

"Sometimes things will happen that will use up your margin of safety. These are generally unforeseen events. Bad weather. Broken airplane, or a fight with your wife. I never want you to intentionally use any of this margin of safety to complete the mission. I'd rather you came home alive so you can complete the next mission."

I distinctly remember a crewmember laughing on the way out about the speech. He later died in a crash in Ohio. A spectacular crash where the aircraft came apart in the air. Instead of pilots, two of the crewmember's wives were in the seats. Not a single pilot had access to the controls. I'd suggest they used up their margin of safety.

How did he save my life? One night, I was on final approach at Plattsburgh AFB in upstate New York. The wind was calm on the ground. But in the air, our groundspeed was 70 knots faster than our airspeed. This indicated a loss of 70 knots of tailwind on final. This is a very dangerous situation because to land safely it requires a great increase in power as you lose the tailwind to slow your rate of descent. Nothing else was wrong.

I wasn't that great a pilot. I didn't have the stick and rudder skills of most other people. So my margin of safety was always large. I elected to take the approach around. On the radios I announced that I suspected there was a severe windshear on final. This causes planes to crash. The supervisor of flying publically chastised me on the radios for taking around a perfect approach while the winds were calm.

Rich came in right behind me. He was an excellent pilot. An instructor in stan eval (Which means he gave checkrides to other pilots.) The runway probably still bears the imprints from the landing. You see, it was a somewhat controlled crash. The landing gear was pushed a bit into the wings. The crew was ok, thanks to the stick and rudder skills of the pilot in averting a worse crash.

What does this have to do with investing? Ben discussed margin of safety. The distance between your hands. It is what keeps you alive when you encounter unforeseen events. Use it in driving, flying, everything you do, even investing.

Take a company like HD. They are probably fairly valued if everything goes perfectly for the next 15 years. But most likely there are other companies that are undervalued even if a few things go wrong.

An old pilot saying. "Use your superior knowledge and wisdom to avoid situations that require the use of your superior skill and cunning."

Have you ever watched the actions of a mouse as it is being chased by a cat? Usually the cat isn't especially hungry and is more interested in the sport of chasing the mouse. But the mouse exhibits some truly irrational behavior.

A cat will normally only chase the mouse when it is running and sit and stare when the mouse sits still. Soon the mouse figures this out and sits quietly right in front of the cat's nose hoping the cat will tire of the game and go away. Eventually the cat tires of the lack of inactivity and starts to toss the mouse in the air. Does the mouse respond by running away? No, it will usually just lay there again. After all, a running mouse gets chased. Eventually, the cat tires of the game and eats the mouse.

Sometimes in the early stages, the mouse runs to a safe haven. The cat will lay there patiently until the mouse decides not running doesn't make the cat go away. So it tries to outrun the cat. The cat, thinking this is great fun, will chase the mouse a few times to another safe haven. And wait patiently again until the mouse runs again. Eventually, the mouse becomes cornered and becomes like the first mouse who just sits still waiting to get eaten.

What does this have to do with investing?

Many people will sit on their ass when they are in a bad stock because they fear getting out of it. What if the stock goes up? What if what they buy after they sell the bad stock goes down? People rationalize all sorts of reasons for sitting in front of the cat's nose.

After finding a safe haven, many people don't just sit in it while the cat waits patiently. If nothing seems to be happening to the price even while intrinsic value is moving up, they will chance a run in front of the cat instead of waiting in their safe haven.

Sit on your ass investing is fine if you are sitting in the safe haven and not in front of the cat.

We used to go camping at the Boy Scout Camp about 35 miles west of Enid. At the campground, there was a pond we affectionately called "The Doughnut." It was a circular pond about 50 yards in diameter and in the center of the pond was a circular island.

The enticing aspect of this pond was that you could catch as many wide-mouth bass as you desired. Just about every time you threw in the lure, you reeled in a fish. In fact, it was annoying at times to interrupt the relaxation of communing with nature to take the fish off the hook.

Being a novice fisherman, I only had one type of lure in my tackle box - a beetle spinner. I didn't see any incentive to possess any other types. They were economical and they caught fish. I used to enjoy fishing with Terry Polwart. His father was a world class bass fisherman and he had assimilated a lot of his father's expertise. Terry used to catch a lot of fish with a lot of different types of lures, but at the end of the day, we seemed to have the same number of fish. Terry was always recommending different lures to me, but I never saw the point. I was catching plenty of fish. My lures cost about $.49 apiece and his were about $3.00.

There were some advantages to fishing the Doughnut. The only species of fish I ever caught was wide-mouth bass. They are fun to catch because they don't have teeth. Also, because their mouth is big, it is easy to remove the hook. I didn't care how they tasted since I always threw them back. Once, while fishing at Lake Watonga, I caught a northern Pike. Small mouth, big teeth - bad. I never went fishing there again.

John Keith, the scoutmaster, once suggested we fish at Lake Hoover. At Lake Hoover, the only species of fish you could catch were catfish - and there weren't too many of those. There were a lot of water moccasins swimming in the lake and hiding in the grass around the shore. John couldn't understand why I always liked to fish the Doughnut instead of Lake Hoover. I told him it was because it was where I caught fish.

Now, what does all this have to do with investing? Your investment philosophy should be one where you catch fish. Which would you prefer? Fishing in a small pond where you catch fish? Or fishing where there are lots of snakes and where you only catch scum-sucking bottom feeders? Many successful investors have a narrowly defined written philosophy to define their own small pond. Her are some highlights of mind.

THINGS THAT ARE MEANINGFUL:

1. Making money. This is the primary objective of my investments. Since I am saving for retirement, all my money is serious money. My objective is to make enough money over the next 20 years to retire.

 

2. Earnings Per Share (EPS). If you gave me just the history of EPS and nothing else, I would let you have everything else. You can be quite successful investing in a group of 10 to 15 companies with a ten year history of increasing earnings per share.

 

3. Sales. If sales are increasing, profits will go up if the profit margin is a positive number. If a company makes $1.00 for every widget it sells, then it becomes very important if more widgets are sold each year. If a company loses $1.00 for every widget sold, then perhaps they can lose less money if they go out of business.

 

4. The Annual Report. This is perhaps your best source of information about a business. These are the only certified numbers available for a company. Everything else is subject to the injection of someone's opinion. Why look at everything else and not look at the annual report? You can also get some idea of the company's strategic plans. One advantage about the annual report is that it is only published once a year. There is no need to evaluate a truly outstanding company more frequently.

 

5. What elderly people with money say. They've been successful. Their advice is worth taking

 

6. Long term portfolio performance. I ought to make money over time. I evaluate this number very accurately to make sure I am mot deceiving myself with optimistic estimates of performance. Matching my performance against the investment philosophies I have used, I will know which philosophies are best.

 

7. Written goals. Unless you know where you are going, you will not know when you get there. Written goals are essential for evaluating your long term progress.

 

8. Compound interest. This formula was created by God to make it possible for us to succeed financially. Failure to understand compound interest will almost certainly result in failure to meet your goals.

 

9. A written investment philosophy. Writing down your investment philosophy will help clarify your thoughts and etch them into your brain. Looking back at your ideas, you will see how much you have grown over time. This will help give you the confidence to move forward.

 

10. An investment support group. Find someone you can share ideas with. CT has given me many of my best ideas. He has openly ridiculed my most ridiculous ideas. I still wish I could convince him that chaos theory is applicable to the investment world. Dave R. has kept me intereste in large companies that seem to keep increasing in value.

THINGS THAT ARE NOT MEANINGFUL

1. The economy. I once heard Peter Lynch say "If you spend 13 minutes a year studying the economy, you have wasted 10 minutes." I feel he was off by about 3 minutes. Since I tend to remain fully invested at all times, what difference does it make what is happening to the economy? Besides, they keep revising the numbers for many months after they are issued, so how can you keep track? Why should I trust the government to publish accurate economic figures? If I have money to invest, my personal economy is good and I invest.
2. Management I have never been capable of accurately evaluating the managers I work for. How could I possibly evaluate the management of a large company? Whose opinion would I use? Who would evaluate the expertise of the people giving these opinions? Over the long term, good management will produce good results if they are in a good business. Over the long term, all managers produce poor results in a poor business. Over the long term, bad management will disappear from any business. So why concern yourself with something you can't evaluate? If the numbers are good, then I don't care if the management is good. I don't care to investigate situations where good management tries to turn around a bad business. If a bad manager is turning around a good business, it will be readily apparent in the numbers.
3. Interest Rates. Interest rates fluctuate. When they go up, most stocks will go down. When the go down, most stocks will go up. Over the long term, the effects of the business's growth will outweigh any short term fluctuations in interest rates. Anytime I have heard a prediction about interest rates, I have usually heard the opposite prediction within about 15 minutes. Since interest rates are unpredictable, why wory?
4. "New Exciting Widgets." A new industry is very difficult to analyze because there is no basis for making anything buy a qualitative analysis. You find yourself saying "I think" instead of "I know." In other words, you are speculating instead of investing.
5. Cyclicals. Why try to guess when a cyclical will cycle? You have to make two correct decisions for every company - when to buy and when to sell. To make these decisions, you have to make guesses about the economy. For a company in the steady state growth phase, you only need to make one correct long term decision.
6. Trading. (Well actually I do a little closet trading in my own account, but like other bad habits, it is one I am trying to break.) Why give up your best companies for an inferior company
7. Having fun. Although it is more fun to learn about exotic industries, I have been much more successful investing in mundane industries. The mundane industries are easier to analyze. Naturally, I do consider making money to be fun.
8. Glossy pages. I don't invest in companies where the back part of the annual report has glossy pages. The glare hurts my eyes. This is one area where I have chosen to be unfair and irrational. It doesn't hurt my results since nobody ever lost any money by not purchasing a business. The best annual reports have no glossy pages. Why invest in a company that wastes a lot of money producing a flashy annual report?
9. Today's news. What is important are principles of investing. Not today's hot news. What difference does it make what the Crisis of the Day is. I know that over the next 20 years, the economists will predict 15 of the next 2 recessions. The analysts will predict 23 of the next 6 corrections. There will be a revolution in about 1 country a year. We will become involved in 10 military conflicts. These are recurring cycles that won't affect the long term performance of the market. A perfect example of the simple-mindedness of watching today's news was the market decline during the Cuban Missile Crisis. Apparently people thought the trumpet was going to sound and God only took cash.
10. Dow Jones Industrial Average. Although it is intellectually stimulating to monitor, the DJIA has only a fleeting interest for those purchasing an individual business. If you were opening a small business, would you check the paper to see the level of the DJIA? Why then should you check the DJIA when you are purchasing a large business. (I do note the average when purchasing a diversified portfolio through a mutual fund.)
11. One of my stocks is going down If the fundamentals are still satisfactory, then what difference does it make if my stock declines? After all, it is only one piece of a diversified portfolio. It can't possibly go to less than zero, and it won't get there while the EPS are increasing. In a portfolio of 10 stocks, it is probably the majority will be less than their previous highs. In the short term three of them will probably be less than what I paid for them. In the long term, one will refuse to go up just as some fish never get caught. So why worry? These are the natural results of owning an investment portfolio.
12. Short term portfolio performance. The performance of a portfolio should be considered in light of the investment strategy. If my largecap stocks are underperforming another sector of the market, it doesn't matter. Every sector will at times outperform other sectors. Even cash outperforms the S&P 500 index one month out of two.
13. Technical analysis. I am not cognizant of a single study that shows technical analysis works. The only benefit I see is it provides brokers with an excuse to recommend frequent trades. In this sense, it is beneficial for the brokers.
14. The stock I didn't buy. Did you ever go fishing? Did you ever catch all the fish in the pond? Enough said.

I limit myself to carefully following 23 stocks. This is my small pond with lots of fish that are easily caught. Anytime I come across a new idea, I compare it to the group of 23. If after careful consideration I like the stock better than one of the 23 I will replace one of the group. The reason I picked the number 23 is that my computer only has enough memory to track 23 stocks. (you can see this part is dated a little.) By forcing myself to eliminate a company every time I add a company, I constantly upgrade the quality of the companies I track. If I could add an unlimited number of companies to my universe, I would end up with a lot of trash in my universe.

Take some time to define your small pond. By having written criteria for your selections, and by refining these criteria over time, you will become a more astute and successful investor. Remember, we all enjoy fishing in different ponds. The fact that we agree or disagree does not mean either one of us is right or wrong. Just evaluate your criteria based on the long term success of your particular portfolio.