WHY RULE #1 WORKS

I got this message from Jim yesterday. He wants to get started with Rule #1, but he has some concerns about taking risks. Our exchange below is a good, broad intro to what we're doing here on the site and in my book.

[edited for length]

Dear Phil,

I saw you last week in Omaha and was energized.  I was inspired to hear your story and so desperately want to make forward progress in mine.  I have had a number of setbacks including a failed business, a brain tumor & then nearly a year with no work.

I am thrilled to be alive, proud to be an American and Thank God every day that I am a Christian who had faith enough to "just keep working and hoping for a better day tomorrow."  (I may sound like a space cowboy, but I am not.  3.0 GPA from Nebraska, All-American Swimmer at NU, outside sales rep in 6 industries over the last 20 years that required intense crash course learning.)

I am writing because my wife is a total skeptic.  I don't blame her after some of my poor decisions.  She will freak out if I tell her I am gathering money to invest in the stock market. 

I KNOW I need to get started investing for some type of future for my 3 kids & my wife.  I am frozen in my tracks, clueless and again, so desperately want to believe in something that will help me advance my finances.  YOU COULD BE THE SOLUTION!?

You said you were on-stage to help others.  I believe you. I would so greatly appreciate a sign, an email, a letter, a voice mail explaining to my wife that your methods would be helpful to our future. 

I promise you if I figure it out, I will pass it on.

I know you are swamped with letters like this.  I hope & pray you might answer this.

God Bless you on your mission.

Jim

Here's my response:

Hi Jim,

I'm impressed with what you've accomplished in your life.  Anyone who has the discipline to become a great swimmer can do anything!  I'm still trying to figure out how to make a mile without expiring. 

Second, I truly believe that the most important key to success is to thank God for being alive in His world and then get out there and do everything you can do to be the man God made you to be.  I hope what I can teach you will help you on that journey but truthfully, all that having financial liberation does is give you options.  That said, it's better to be rich than poor if God wants you to be rich!

So here's how to start, Jim.  You don't need money.  You need a little discipline, time and knowledge.  Internet tools help with the time thing or we wouldn't even be talking.  Knowledge is the easy part.  And discipline to do the work comes easier with some success.

Read my blog starting with the oldest stuff first and work forward. You'll see that the businesses I bought this year have done well, as have some that my readers found and bought.  If we can do it so can you.  We stay really focused on a few things and watch those businesses carefully.  So when Whole Foods goes from $90 to $150 and Google goes from $200 to $400, a huge portion of our net worth goes along for the ride up.  So we don't diversify across lots of businesses.  We learn a few and hopefully own them for a long time.

But which ones?  We have only two requirements. The first requirement is easy and the second one is even easier. 

The first requirement is that it be a wonderful business. Just that.  Nothing else.  We never buy anything that we don't know is wonderful. And I mean something very specific and easy to figure out when I say "wonderful."  I mean a business that will continue growing at a predictable rate for 20 years.  That means a wonderful business first and foremost has a PREDICTABLE rate of growth.  Here is an example of a  wonderful business with a wonderfully predictable rate of growth:  Walgreens.  WAG.  Take a look at the last 25 years of equity and earnings growth rates.

But here's the catch: In order to know that a business's growth is wonderfully predictable, you have to know something about it.  It has to MEAN something to you because if it does you will understand it more easily and more quickly.  And it should not violate your values (because that makes you a hypocrite).  And understand the business enough to know that they are the best at what they do (we only go with the best).

You need to know that it has a lot of automatic protection against competition.  I call this a MOAT. 

And you need to know that the MANAGEMENT, in particular the CEO, are intent on building this business for the benefit of all the stakeholders - including and most especially the owners.  You and me. 

These three M's are quite simple to figure out and you will find that in a year or so you have too many wonderful businesses that you would like to own.

The second thing is easier than knowing the business is wonderful and tends to narrow the number of wonderful businesses we can buy.  The second thing is that we need to buy the business at an attractive price. By "attractive price" I mean a price that is so good that I am certain that I am going to make money.  This is not a difficult concept.  We simply wait for what we want to buy to go on sale. 

The key to this idea is the rather shocking notion that in the stock market, the price of a stock is not always the same as what it is worth.  This is a revolutionary idea for some reason.  Your mutual fund manager does not believe this idea.  He thinks that price and value are the same - which is why he lost 40% of your money in your 401k and why your retirement, if you leave it in his hands, will not be nearly what you hope.  Even a 6% annual return is out of reach for your fund managers if the stock market does not go up for the next 15 years, a probability rather than a mere possibility.

Knowing the value of a business is quite easy.  Remember that its growth is predictable?  So we just grow it at that predictable rate, figure out what it will be worth in ten years and then figure what we have to pay for it today to make 15%.  I call that the Sticker Price, like the sticker price on the window of the new car.

Then comes the three most important words in investing:  Margin of Safety (MOS). Since I'm a river guide and since since things can change even for a really wonderful predictable business, I need a big discount off of the Sticker Price.  A big discount.  BIG.  50%.  The amazing thing about the stock market is that with patience I can buy wonderful businesses at 50% off all the time.  Try that in real estate!

Wonderful business, attractive price.  The key to good investing for the last hundred years and it will continue to be the key for the next hundred.

So can YOU do it?  Why not?  You won't get rich quick, probably, but you'll get rich eventually. If all you do is invest $300 a month, you'll be able to retire comfortably in 20 years starting with nothing.

So here's a few questions for your wife: Why not learn to invest like the best, like Buffett, Graham, Nygren, Ruane?  Why not make 15% to 20% a year no matter what the market does?  Why not be skeptical about the mutual fund industry and their claims that the market always goes up and that you'll always get an 8% return?  Why not take control of your financial future instead of leaving it in the hands of people who have proven they are clueless? 

And one final question:  What else would you suggest you do?

I hope this helps you guys,

Now go play!

Phil Town