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Notes from John Neff on Investing
April 16, 2007, 9:57 am
Filed under: investments/finance/economics

Here are some notes, quotes and ideas from John Neff on Investing  by John Neff and S.L. Mintz.

John Neff was the legendary manager of Vanguard’s Windsor and Gemini Funds for 31 years. He beat the market 22 times while posting a 57-fold increase in an initial stake.

From the Prologue:

“Investment success does not require glamour stocks or bull markets. Judgement and fortitude were our prerequisites. Judgement singles out opportunities, fortitude enables you to live with them while the rest of the world scrambles in another direction… To us, ugly stocks were often beautiful.”

From Part 2, Chapter 7:

“We followed one durable investment style whether the market was up, down, or indifferent. These were its principal elements:

  • Low price/earnings (p/e) ratio
  • Fundamental growth in excess of 7 percent.
  • Yield protection (and enhancement, in most cases).
  • Superior relationship of total return to p/e paid.
  • No cyclical exposure without compensating p/e multiple.
  • Solid companies in growing fields.
  • Strong fundamental case.”

“Because stock prices nearly always sell on the basis of expected earnings growth rates, shareholders collect the dividend income for free.”

Go for good companies with solid market positions and evidence of room to grow. Sometimes, great companies stumble when bad news happen and the resulting fall in P/E might signal a buy.

Operating margins gives an indication of a company’s earnings margin of error to untoward events; a company with high profit margins is more able to weather a storm.

Keep tabs of stock prices posting new lows. Scan stock tables for stocks trading at a 52-week low. Low prices should never signal a buy automatically. The goal is to find earnings growth capable of capturing the market’s attention once the climate shifts, if it ever shifts for the company in question. When scanning for stocks, look out for stocks that bear further investigation, like stocks from familiar, well-established companies.

Unfavourable news signal opportunities. Read the news with an eye to finding particular companies or industries on hard times. When one is found, decide whether the underlying business is sound and fears have been overblown.

Betting a stock’s P/E to reach stratospheric heights is betting against the odds. Keep the odds in your favour.

Don’t be contrarian just for the sake of it. You have to be right on fundamentals to be rewarded.

Neff’s approach of “Measured Participation”. It established four broad investment categories:

  1. Highly recognised growth
  2. Less recognised growth
  3. Moderate growth
  4. Cyclical growth

Don’t chase highly recognised growth stocks.

Weigh the values of less recognised growth. Some stocks are fundamentally weak. Opportunities can be characterised by the following:

  • Projectable growth rates of 12-20 percent.
  • Single digit multiples of 6-9 earnings.
  • Dominance or major participation in definable growth areas.
  • Easy industries to understand.
  • Unblemished record of double-digit historical earnings growth.
  • Outstanding returns on equity, therein signifying management accomplishment, not to mention the internal capacity to finance growth.
  • Significant capitalisation and net income totals therein qualify companies for institutional consideration.
  • Ideally, some Wall Street coverage.
  • A 2-3.5 percent yields in most cases.

Moderate growers supply heavy yields.

Cyclicals will rise again. Timing is critical in cyclicals. They usually follow the same pattern. As earnings pick up, investors flock to them. When earnings begin to peak, investors abandon them. Buy them six to nine months before earnings swing upwards, then sell into rising demand. The trick is to anticipate increase in pricing. Start with knowledge of an industry’s capacity, and then make some judgements about sources and timing of demand increases. Don’t be too greedy on the upside. Have a notion of normal earnings and sell on the right side of the slope.

Attack stock-picking from both top-down and bottom-up perspectives. Look out for sectors long overdue for recognition and keep an eye on companies.

Learn what makes an industry tick. A wise investor studies industries, its products, and its economic structure. Industry trade magazines supply very valuable information long before it finds its way into the general consciousness. Prudent investors stay abreast of developments, before the stock prices adjust.

Top-down investors keep track of inflation. Growth of the economy is affected by inflation. It supplies the yardstick that reveals whether the industries in your portfolio actually measure up. The companies should at least match overarching economic growth if you plan to beat the market.

Watch three areas of the economy for signs of excess: 1) capital expenditure 2) inventories 3) consumer credit.

Reasons to sell: fundamentals deteriorated or price approached expectations.

Stick to a firm selling strategy. Don’t fall in love with stocks.

Always take note of prevailing opinion, but never let it sway investment decisions.

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