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Money Masters of Our Time
July 1, 2007, 5:02 am
Filed under: investments/finance/economics

Personal notes from John Train’s Money Masters of Our Time

I read this book before; I am rereading it now because it is really very well-written and it offers concise summaries of the investing philosophies of top investors.

T. Rowe Price

  • Mr. Growth Stock
  • Seeking the “fertile fields of growth” and holding those stocks for long periods of time.
  • He defined a growth company as one which shos “long-term growth of earnings, reaching a new high level per share at the peak of each succeeding major business cycle and which gives indications of reaching new high earnings at the peak of future business cycles.”
  • The most profitable and least risky time to own a share is during the early stages of growth.
  • To be a great investor, one must be a contrarian, a loner.
  • “Even the amateur investor who lacks training and time to devote to managing his investments can be reasonably successful by selecting the best-managed companies in fertile fields for growth, buying their shares and retaining them until it becomes obvious that they no longer meet the definition of a growth stock.”
  • Two aspects of capitalizing on the “fertile fields of growth”: identifying an industry that is still enjoying its growth phase and settling o9n the most promising company or companies within that industry.
  • The two best indicators of a growth industry are unit volume of sales and net earnings.
  • Price doesn’t believe in specific predictions of a company’s future.

Price’s requirements for growth companies

  • Superior research to develop products and markets
  • Lack of cutthroat competition
  • Comparative immunity from government regulation
  • Low total labour costs, but well-paid employees
  • At least a 10 percent return on invested capital, sustained high profit margins, and a superior growth of earnings per share

Buying Points – fix a price, buying on a scale

  • Valuation
    • A record of earnings growth
    • Buy when a stock is out of fashion
    • Blue chips with a record of rising dividends are worth a higher multiple than secondary stocks without dividend growth
    • Stable growth stocks are worth more than cyclical stocks; cyclicals are worth a higher multiple of their recession earnings than of their boom earnings
    • Pay a lower multiple of earnings for growth stocks if bonds are available at high yields
    • Total return on growth stocks has to compete with that available from bonds or stocks in general
  • Scale buying
    • As a stock falls into buying range, buy vigorously.
  • Selling
    • Beware of a decline in the return on invested capital
    • Business cycles create confusing background against which to study performance.
    • Some industries have their own cycles.

Warren Buffett

What makes a great investor

  • You must be animated by controlled greed, and fascinated by the investment process.
  • You must have patience.
  • You must think independently.
  • You must have the security and self-confidence that comes from knowledge, without being rash or headstrong.
  • Accept it when you don’t know something.
  • Be flexible as to the types of businesses you buy, but never pay more than what the business is worth.
  • Have ten or fifteen years of intensive theoretical and practicial training beofre you start in yourself.
  • Be a genius of sorts.
  • Possess a high degree of intellectual honesty.
  • Avoid any significant distractions.

Wonderful Businesses

  • Good return on capital
  • Understandable
  • See their profits in cash
  • Strong franchises and thus freedom to raise prices
  • Doesn’t take a genius to run
  • Earnings are predictable
  • Not natural targets of regulation
  • Low inventories and high turnover
  • Management is owner-oriented
  • High rate of return on total inventories plus plant
  • A royalty on the growth of others, requiring little capital itself

Bad Businesses

  • Retailing
  • Companies that put the whole company on the line just to stay in business
  • Farm-related enterprises
  • Businesses heavily dependent on research
  • Debt-burdened companies
  • Chain-letter businesses
  • Managements that don’t tell the truth
  • Long-term service contracts
  • Beware of smokestack industries – heavy industries requiring continuous massive investments

Buffett buys companies that produces strong cashflow, which allows him to use cash to buy more cash. Examples include insurance companies and banks.

Develop an understanding of accounting.

Charlie Munger’s Principles

  • Specialisation in the business world often produces very good business economics
  • Advantages of scale are important
  • Technology can either help you or kill you
  • Investors should figure out where they have an edge and stay there. Stay in your circle of competence.
  • Winners bet big when they have odds- otherwise, never.
  • A significant discount means greater upside and greater margin of safety.
  • Buy quality businesses even if you have to pay up.
  • Low turnover reduces tax and increases return.

John Templeton

  • Templeton insists on only buying what is thrown away.
  • The best bargains are in stocks that are neglected.
  • Search many markets for bargain stocks.
  • The investor needs the ability to recognise unfamiliar values.
  • A flexible viewpoint is the professional investor’s greatest need.
  • Ask if a company is a natural candidate for regulation
  • Deal with inflation.

Questions to ask

  • Does the company have a long-term plan?
  • What will be the average annual growth rate?
  • Why should the future be different from the past?
  • What are the problems?
  • Who is the ablest competitor?
  • Why?

Templeton seeks to unearth the intrinsic value of a company – 4 important factors

  • Price earnings ratio
  • Operating profit margins
  • Liquidating value
  • The growth rate, particularly the consistency of earnings growth

Templeton has the prodigious ability to discern the most important 2 or 3 factors that affects the buying decision.

Richard Rainwater

  • Activist investing – being a consultant/adviser/shareholder at the same time.
  • To succeed you must specialise.

Rainwater’s strategy

  • Target a major industry in disrepute that’s due for a change. Find opportunity and value and think on a global scale.
  • Find a partuclarly attractive company or a sector within the industry.
  • Find a company with a long-erm, sustainable competitive advantage, or a impregnable business franchise.
  • Find a “world-class” player to run the show- consult and engage experts
  • Never enter an investment alone
  • Improve the risk-reward ratio through financial engineering.

Paul Cabot

  • First get all the facts. Then face the facts.

Philip Fisher

  • Buy outstanding companies- outstanding management with strong technological lead
  • Sell a stock only if you made a mistake or if there is a decay in fundamentals
  • One should not sell a stock because one thinks it’s too highly priced or the market is due for a correction
  • Use scuttlebutt- the business grapevine- trade shows, management, industry association executives
  • Characteristics of an attractive business- growth from existing and new products, high profit margins and return on capital, effective research, superior sales organisation, a leading industry position and a valid franchise.
  • Management characteristics include intergrity, conservative accounting, accessibility, orientation towards the long term, a recognition of the pervasiveness of change, excellent financial control, multidisciplinary skills, special skills of industry and good personnel policies.

Fisher’s material – annual reports, printed material, business sources and company visits

Buying Points

  • Buy when the start-up period of a substantial new plant has depressed earnings and discouraged investors
  • Buy on bad corporate news- temporary misfortune.
  • In a capital-intensive industry where an unusually large investment on plant is required, buy when engineers figure out how to increase their output substantially by spending a relatively modest amount of additional capital.
  • Buy on a war scare- war leads to inflation which reduces the value of cash

Benjamin Graham

  • Real earnings consist of dividends paid plus the increase in the net assets per share.

Graham-Newman’s investment techniques

  • Buying stocks for 2/3 or less of their net current assets- usually more than a hundred different issues at a time.
  • Buying companies in liquidation, where there seems an 80% or better chance of making at least a 20% annual return.
  • Risk arbitrage: buying stock of one company and simultaneously selling the stock of another that it it merging with.
  • The “convertible hedge”: buying a convertible bond or preferred stock, and at the same time selling short the common it converts into. The convertible should be bought close to conversion parity, so that if the position is closed out by converting little is lost. The farther the common and convertible pull apart, the more the profit.
  • Buying control of a company selling for less than it is worth, to force realisation of the assets.
  • “Hedged” investing: being long one stock and short another

Graham’s criterion – a stock should be bought for lesst han 2/3 of its net current assets giving no weight to fixed assets and deducting all liabilities in full, and sold at 100 percent of net current assets

Added criterion- debt to tangible equity ratio should be less than 1, earnings yield should be twice the prevailing AAA bond yield

Mark Lightbown

Good Companies

  • First step in company analysis- calculate its value based on its present stock capitalisation, both including its debt and without. Then compare these totals with the similarly calculated capitalisation of other such enterprises and with your own appraisal of the company’s intrinsic value. Set an attractive price range to conduct buying.
  • To calculate true worth, first determine the free cash flow generated by the enterprise. Take the operating profit plus depreciation and amortization and then subtract the amounts required in plant and equipment and additional working capital to maintain the expected growth rate. This calculation should reveal whether the company will still spin off cash in hand to owners or instead demand fresh equity to support growth. It shows also the rate of return on incremental cash reinvested.
  • Lightbown’s third tool derives from his contention that the aim of every business is to create economic goodwill. He defines this as the amount above and beyonf what you have invested that you could sell the business for.
  • The fourth step is to determine at what stage of the business that added value arises. This gives one an idea of the sustainability of the company’s profit margins.
  • Lightbown’s ideal is a business requiring almost no incremental cash to grow. Alternatively he looks for a management particularly adept at creating high rates of return on incremental invested capital.
  • A company that does not visualise its future evolution is all too likely to stagnate. One must look at how a company develops its capacity to compete by recognising changes in its market and adapting to those changes.

Good Countries

  • Check if the president and the congress are in alignment.
  • A country with abundant natural resources may well have trouble developing consistently, since it may focus its attention on extracting and redistributing what is already there, instead of creating wealth.
  • The agent of change in a country must come from within an existing political grouping, but be quite different from that grouping’s traditional policies.
  • The people in a good country must want to save and reinvest. The country employs a large trade surplus.
  • The educational level of a country must be high.
  • A good country has mechanisms to stimulate and channel domestic savings to build infrastructure for economic growth.
  • A system to permit capital movement should already be in place and there must be a banking system that at least knows how to take deposits and possesses credit analysis skills.
  • The culture should accept entrepreneurship as a complex creative effort in which all concerned are going to share.
  • The government must keep its hands off business.
  • The country should have low, stable tax rates.
  • Labour must be deregulated.
  • One must wait for the right person with the right ideas to come to power, with the ability to implement those ideas too.

To get a good feeling of the country, travel by bus.

The ultimate prize in emerging market investing is the medium-sized company with a solid position in its economy that is on the way to becoming a big company and eventually a regional or world-class company through a combination of organised growth and intelligent allocation of cash flows. Don’t spend too much time looking for minor opportunities.

Patience is the central trait of the good investor. Don’t worry if the stock hasn’t gone up yet, as long as the business continues to thrive.

John Neff

  • Value investor
  • Only buys when a stock is cheap and acting badly
  • Sells when it is too expensive, always when it is acting strongly in the market.
  • The market usually overpays for the prospect of growth
  • Stick to your conclusion, be patient.
  • Neff looks at unpopular industry groups, stocks with low P/E and high yields.

A good company

  • A sound balance sheet
  • Satisfactory cash flow
  • An above-average return on equity
  • Able management

The prospect of continue growth

  • An attractive product or an attractive service
  • A strong market in which to operate

Julian Robertson

  • Look for companies that dominate industries, monopolistic or oligopolisitc companies.
  • Management must be dedicated to the bottom line.

Themes in stockpicking

  • Quality of management, a disciplined corporate strategy and solid growth
  • Wonderful management- attention to bottom line, have a long term plan
  • Monopoly or oligopoly
  • Great value, based on careful examination of company books
  • Regulation
  • Upstream needs- look for companies that will supply the whole growing industry
  • Grwoth
  • Big core positions

Jim Rogers

Four tests of a good country to invest in

  • It must now be doing much better than previously.
  • It must also be better off han is generally realised.
  • The currency must be convertible.
  • There must be liquidity for the investor.

Investing in change – Look out for major secular changes independent of the business cycle

  • Disasters- Usually when the entire industry is in a crisis, the whole industry is ready for a bounce, as long as there is something in the situation that should change the fundamentals.
  • Changes for the worse- When an industry is so popular that investing institutions own 80% of the shares of its top companies, one can be reasonably confident that the stocks are overvalued in the market.
  • New trends
  • When the government decides to act- government intervention causes change

The trick to getting rich is correctly sizing up supply and demand.

The investing process

  • Rpgers never talks to brokers or security analysts.
  • Develop a way to think independently.
  • Observe the everday world around us for ideas. Be inquisitive.
  • The stock must be so cheap that the worse that can happen when everything goes wrong is that your capital will be sterile for a while.
  • Don’t lose money. If you don’t know the facts, don’t play.
  • Rogers love accounting sheets.
  • Rogers pays more attention to the balance sheet than the income statement.
  • He gives great weight to the depreciation account and likes to buy companies on the verge of bankruptcy.
  • He tracks capital expenditures in absolute terms, as a percentage of depreciation, as a percentage of gross plant and equipment and as a percentage of net plant and equipment.
  • Then he looks at the ratios of sales to receivables, debt to equity, and the other- when there is almost no inventory, when receivables are low, when the profit margin is 20% and the pretax ROE is 25%, when capital expenditures are growing at 40%-50% a year, Rogers begins to smell a classic top, a promising time to go short.
  • Rogers look at tried and true ratios to shee how bad things can get, and when they reach the lower limit, he assumes they will start to go the other way.
  • When you see several major companies losing money, and capital expenditures coming to a stop, then look for an industry recovery.

Always bet against the central banks and with the real world.

George Soros

  • Avoid a stock that is facing a difficult test, and buy after it has survived the test.
  • Short-term volatility is greatest at turning points and diminishes as a trend becomes established.
  • By time all the participants have adjusted, the rules of the game will change again.
  • The best time to buy long-term bonds is when short-term rates are higher than long-term rates… when the yield curve is inverted.
  • The usual bull market successfully weathers a number of tests until it is considered invulnerable, whereupon it is ripe for a bust.

Investment techniques

  • Start small. If things work out, build a larger position. In a world of floating currencies, trends get steadier and more determinable as they develop.
  • The market is dumb, so don’t try to be omniscient. As along as an investor understands something better than others, he has an edge.
  • The speculator has to define from the first the level of risk that he dares assume.

Market theories

  • The falsity of the efficient market theory.
  • Technical analysis has a feeble theoretical foundation and doews not work consistently.
  • Fundamental analysis holds that value, defined in terms of earning power and assets, determines stock prices. But stock prices also change fundamental values, by permitting the sale or repurchase of shares, or mergers and acquisitions, and the like.

Soro’s theory of reflexivity- perception changes events which in turn changes perceptions

Equilibrium

  • Soros rejects the concept of equilibrium in classical economics.
  • Decisions to buy and sell are based on expectations.

Boom/bust seqeuence

  • A little-recognised trend
  • The beginning ofthe self-reinforcing process
  • A successful test of the market’s direction
  • A growing conviction
  • A resulting divergence between reality and perception
  • The climax
  • Then the start of a mirror-image self-reinforcing sequence in the opposite direction.

One of Soro’s most important traits is his ability to reverse field instantly when he realises he has made a mistake.

Philip Carret

  • Carret likes over the counter stocks.
  • Carret looks for no log term debt, and a current ratio of better than 2.

Philip Carret’s Principles

  • Never hold fewer than ten different securities covering five different fields of business.
  • At least once in six months reappraise every security held.
  • Keep at least half the tototal fund in income-producing securities.
  • Consider yield the least important factor in analysing any stock.
  • Be quick to take losses, reluctant to take profits.
  • Never put more than 25 percent of a given fund into securities about which detailed information is not readily and regularly available.
  • Avoide “inside information” like the plague.
  • Seek facts diligently, advice never.

Ignore mechanical formulas for valuing securities.

  • When stocks are high, money rates rising, and business prosperous, at least half a given fund should be placed in short-term bonds.
  • Borrow money sparingly and only when stocks are low, money rates low or falling and business depressed.
  • Set aside a moderate proportion of available funds for the purchase of long-term options on stocks of promising companies whenever available.

Michael Steinhardt

  • A strategic trader- he forms large and general conceptions like those that we all derive from reading the papers. Having them, he looks for specifics.
  • Ask “what will change?”
  • “You will never make big money in the market without getting in the way of danger.”
  • Steinhardt likes stocks of companies with a share repurchase scheme.
  • On the long side, look for lower-multiple dull stocks. On the short side, be in the best-known companies of America, the ares of speculative focus.

Ralph Wanger

Investing philosophy

  • Look for good small companies
  • Identify a major trend, then buy companies that will benefit from the trend: “downstream” beneficiaries

Criteria of a good company

  • Growth potential- a growing market for the products, good design, efficient manufacturing, sound marketing, and healthy profit margins.
  • Strong financial position- low debt, adequate working capital, and conservative accounting. A strong balance sheet allows growth without the need to dilute existing shareholder’s capital.
  • The price must be attractive.

Wanger identifies attractive investment areas that have favourable characteristics that lasts five years or longer.

Wanger likes small companies- managers respond faster to change and they tend to be overlooked.

Recognise a transforming technology and invest downstream from it.

Robert Wilson

  • Any successful approach in investing is bound to fail in due course.
  • Wilson insists on stocks in which there is a major risk. Unless there is fear in a stock, it probably doesn’t haev a great capital gains potential.
  • ¬†Buy companies that are doing something new and different or doing it in a different way.
  • Don’t try to anticipate how fast competition will undercut an established company.
  • Companies are often destroyed not by the competition but by themselves.

Investing philosophy

  • Find intelligent brokers that work for you.
  • Look for the fundamental idea in a stock.
  • Then, watch the script!
  • Seek uncommon insights.
  • Look forward to pleasant surprises.
  • Kick a dog when it’s down- short stumbling companies, trends last longer and further than they are expected.
  • Don’t act too soon, even if you know you are right.
  • Beware of falling in love with a company.
  • Watch the forest, beware of getting lost in the trees- keep track of larger trends while scrutinising companies.
  • Beware heavily-researched stocks.
  • Beware popular stocks.
  • Don’t worry about a healthy company’s competition.
  • Neither good management nor market potential can by themselves create success.
  • Beware of management’s encouraging comments.
  • Beware of windfall companies.
  • Accept taxes
  • In bad times, collect clues for good times.
  • Ignore advice based on institutional ownership of stock.
  • Heed managerial motivation.

Peter Lynch

  • To make money, you must find something that nobody else knows, or do something that others won’t do because they have rigid mind-sets.
  • Lynch seeks to catch the turn in a company’s fortunes- often there is a one-to-twelve month interval between a material change in a company and the corresponding movement in its stock.
  • 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 that groups.
  • Lynch insists on firsthand contact with his sources.
  • A key Lynch feature is fluency: he allows his portfolio to flow easily from one idea to another, without extensive analysis.
  • Lynch believed in an old trader’s rule: If you buy a stock because you hope something will happen, and it doesn’t happen, sell the stock.
  • You don’t get hurt by things that you don’t own that go up. It ‘s what you do own that kills you.
  • Inside buying is almost always a good sign; Lynch observes that a company rarely goes bust in the face of heavy insider buying.
  • One of the worst trap is to buy exciting companies without earnings.
  • Lynch suggests looking at companies selling at a low P/E that earns 15 to 20 percent ROE and 10 percent or so on revenues. It should also have a strong and understandable business franchise.
  • Lynch loves simple businesses.
  • Lynch looks at unit growth of sales volume.
  • “The very best way to make money in a market is in a small growth company that has been profitable for a couple of years and simply goes on growing.”
  • The inefficiencies of international investing can be astonishing.
  • Lynch entirely avoids conscious “asset allocation”, either between stocks and reserves or between industrial sectors- he doesn’t believe in modern portfolio theory and gives little weight to a company’s dividend policy.

Lynch’s holdings categories

  • Growth companies on which he would hope to make 2 or 3 times his cost over time.
  • Underpriced asset plays, “value” stocks or smaller blue chips. He would look for rapid gain of a third of so after which he would likely move on promptly.
  • Special situations and depressed cyclicals.
  • Defensive stocks, which he would hold in preference to cash. Lynch never holds actual cash or cash equivalents; instead he buys conservative stocks with substantial yields in stable industries.

Lynch makes it a point to look for great companies in lousy industries, and avoids the hottest companies in the hottest industries.

Sizing up how to invest in a thrift, low-cost operators in small cities taking in deposits from neighbours and making residential mortgage loans.

  • It should be profitable.
  • It should have a high equity-to-assets ratio and a solid balance sheet and should not be saddled with problem loans.
  • You should see insiders buying shares and paying the same price you are.
  • The amount raised in the offering should roughly correspond to the company’s value before the offering.
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