Rule #1: Phil Town on Investing

War of the Worlds, Part Two: Good Biz, Bad Biz

To recap: I got in a battle with a guy from Kiplinger on Maria Bartiromo’s show, Closing Bell. He said that individual investors can only succeed if they diversify (easily done with mutual funds) and hold through the drops in the market because the little guy can’t pick wonderful businesses that are on sale, nor know when to get out.  Maria was also skeptical that the little guy could successfully use technical tools to get in and out when the Big Guys get in and out.  Let’s see if we can convince our doubters, shall we?

The first step of knowing when to buy and when to sell is to know the business that you are buying well enough to be able to put a value on it.  It is absolutely basic to Rule #1 investing that the business is wonderful. 

Wonderful businesses are easily found, but you do have to know what "wonderful" looks like.  I could write a book about it.  Oh, wait.  I did write a book about it.  So read it.  But I’ll cover the main points here for you anyway.  I call the main points "The Four M’s”, the first 3 of which are all about "wonderfulness".

War of the Worlds, Part One

Last Friday I fought a brief skirmish in the war of independence of investor thinking.  I was on Maria Bartiromo’s show, Closing Bell.  Maria asked me to come on the show to talk about how the week’s massive volatility would affect the small investor.  It was the end of a really bouncy week.  The Dow peaked at 14,000 and dropped to 12,800 or so and Maria was interviewing a lot of different kinds of investors to get their opinions about what it meant and what to do. 

I climbed up the steps of the Federal Building across from the New York Stock Exchange and was taken to a room to get some makeup on, and then back outside to wait while Maria finished up the previous segment.  They put on a lapel microphone and led me to my director’s chair next to Maria.  She was going through notes and just said a quick "Hi" and went back to it while one of the crew hooked my mike up to the sound system and stuck an earbud in my left ear.  I was on live with ------- , a guy from Kiplinger.  As soon as I heard that I knew I was in for a battle.

HOW TO AVOID BECOMING ONE OF THE BIG GUYS

Rob has a pretty sizeable nest egg to invest on his own and wants to make sure he does it right.  Several Rule #1 readers have written in with similar concerns. Read on:

Hi Phil,

Studied your book and have been using your philosophy and tools for about 3 months now. I have an IRA with approximately 4 million in it which is being managed by a money managing firm.  I would like to take over the management myself using your book and tools as a guide.

Do the same rules apply using this much money?  Would I invest all of the money in 4 or 5 stocks? Would I have to buy each company in stages (ie. $100,000 at a time) in order not to affect the price and then trade these companies according to the three charts you use as tools or could I buy $800,000 of each stock when all 3 charts cross their lines?

When I go on vacation would I place a stop loss order and sell out completely if they meet that price and then buy back again when I return? 

Thanks for your advice.  I have given copies of your book to everyone in my family and now we are all engaged looking for those few pearls.

Thanks again for my financial education.

Rob

OWNING 2 COMPANIES IN THE SAME INDUSTRY... PLUS, SHOULD YOU LOWER YOUR MINIMUM RATE OF RETURN WHEN YOU CAN'T FIND A COMPANY ON SALE?

Doree has a few questions. Read on:

Hello Phil,

I have run numbers on a lot of companies (using Excel and Investools, I can do this in about 5 minutes). Like many others, I am having a tough time finding stocks that both meet the 4M's and that are selling at or below their MOS. In fact, most of what I find that is investment worthy is trading well above the Sticker Price. I supect this is because the market is generally strong and prices are relatively high.

My question is, why not lower the accpetable ROR from 15% to say 12%? Wouldn't it be better to get this return and buy stocks at a somewhat higher price than keep funds in cash equivalents (short term T-Bills and Money Market Funds) earning a much lower ROR? Then, when market conditions change and better deals are available, take advantage of them. I would really appreciate your insight on this.

Another question I have relates to one of your Blog posts wherein you state only own 1 stock (the best) in the same industry. I am guessing you mean only one where the companies compete head-to-head as companies can be in the same industry but not competitors - e.g. Oracle and Adobe - in the same industry but not direct competitors. I would also appreciate clarification on this.

Thank you so much for your book and your web-site, especially the Blogs which are a real font of information! I am just loving doing the analysis so currently this is play!

Thanks for everything.

Warm regards,

Doree

QUESTION OF THE WEEK: THE MOS IS GOOD BUT THE TOOLS SAY "SELL"... NOW WHAT?

A lot of Rule #1 readers are writing in with variations on the same question:   if the MOS is good but the tools say Sell, now what?

Here's how Steve worded it:

Question:

Hi Phil,

Great book. I'm still going thru it and have a question about when two factors collide. For example, I'm running the Big 5 numbers for NBR and they all look really good. Using your calculator, the MOS is really, really high, but I think my last calculation had the MOS around $450+ and the stock is under $40. This seems like a really good buy, but when I look at the chart tools, many of the signals are saying SELL (e.g. MACD just turned negative, RSI is approaching the 50 mark, moving averages are about to cross, STO going below the 80 line).

So my questions:

Is my MOS incorrect?

What to do when two factors collide?

Thanks for any input,

Steve

Answer:

The big guys -- the institutional investors -- control 85% of the money in the stock market, and they don't play the game the way we do.  The game they play is "How did I do this quarter compared to my peers?"

For that reason, they may sell a stock that is well under the Sticker simply because others are selling it... and someone started the run just because they wanted to take profits to make the quarter look better.

YOUR HOMEWORK: EBAY

Here's one from Kevin in St. Peter, Minnesota. As a reminder, Homework posts aren't intended to be stock picks -- they're examples of the Rule in action.  This particular post gets into why it's important to come up with your own growth rate in addition to looking at what the analysts think.

Hello Phil,

I just finished reading your book (I devoured it in under two days!) and am hoping to use The Rule to help my wife and I be able to retire early (I'm 33, she's 32). I am planning on doing some paper trading for a bit first, and I went to Investopedia.com to open an account for practice. The first thing I did was buy 1000 shares of eBay, just for a test.

I then figured I should put eBay through the ringer. Here goes:

Meaning: I've been using eBay for years, and teach community ed classes on how to buy and sell on eBay.

Moat: I believe that eBay definitely has a Brand Moat, and possibly a Switching Moat as well -- once you're established on eBay you have a high "Feedback Rating", going to a new site would reduce the years of goodwill that you've accumulated.

Management: Pierre Omidyar is the Founder of eBay, and is also Chairman of the Board. The CEO is Meg Whitman, who joined the company in 1998 when it consisted of 30 employees. She has overseen the growth of eBay from a "Beanie Baby swap meet" to a global force that sells big revenue items like cars, houses and islands.

Margin of Safety: I ran the numbers on eBay, and here's the Big Five numbers:

YOUR HOMEWORK: RESMED, INC. (RMD)

Every once in a while someone gets the hang of Rule #1 Homework on the first try. Read on.

Phil,

"Knowledge is power"  Francis Bacon

My 17 year old son and I heard you at a Get Motivated seminar in Corpus Christi, TX earlier this year.  He had wanted to learn about stocks since he was very small and I had put it off since they scared me--lack of knowledge breeds fear.  I had placed my faith in mutual funds. 

You opened my eyes and I took my son with me to the Investools seminar and they opened our minds to consider investing.

You emphasized practicing our trading before we invested REAL money.  Investools pushes you to move quickly.  I chose to follow your advice.  I pre-ordered your book and audiobook. While waiting for the book and CD to arrive, my son and I practiced with paper trading.  It didn't go very well and we were puzzled.  We thoroughly enjoyed the Investools seminar and using their website but we weren't getting the results we wanted or expected.  (Thank you again for the recommendation of practice, practice, practice!)

Okay, my favorite Icon on Investment,  I think I have found my first wonderful company and I want the teacher's approval or re-direction.

YOUR HOMEWORK: JABIL (JBL)

Here's another homework, from long time reader Michael L.

Phil,

Thank you for the audio version of your book.  It has been wonderful to listen to it over the past two days. 

Although I attended the seminar and have been a subscriber to Investools I have made some trades that were not Rule #1 trades and did lose money.  In one case, 30% in one open!  Check out DESC and look at the day it dropped significantly.  I have a fellow co-worker who has been in the stock since it was at 2 dollars.  He convinced me to buy the afternoon before they were to give their 1st quarter results.  The con-call was after the market closed and needless to say, it was not good and I lost 30% of my total value at the open.  Fortunately it was not 100% as I pulled out, licked my wounds and kept my cash until I followed the Rule, all the way or no way.

Then your book came.  I had some stocks on the radar, but being very trepidations about trading I wanted to read/listen first to figure out what I had been missing.  One particular stock I did the 4 M's on is Jabil JBL and I was hoping you could check out my information and if you had the time, let me know what you think?

Jabil-JBL

Basic information- Jabil is an electronic products solution company providing basically electronics products to the market faster and more cost efficient by providing complete electronics products supply chain.  In short, they make electronic components for items I know I use every day.

YOUR HOMEWORK: PHARMACEUTICAL PRODUCT DEVELOPMENT, INC. (PPDI)

Here's a homework submitted by one of my long-time readers, Tom from Grand Rapids.

Hey Phil,

It's been a while since we last chatted, mostly because my wife and I were busy welcoming the newest and (hopefully) FINAL addition into our family this past November!

At any rate, now that I've got yet ANOTHER college tuition to fund it's time to get back into the swing of things. Panera (PNRA) has become one of my best "friends" over the past few months and I'm gonna stick with it for the foreseeable future. However, I realize that I need to have a few other options available in case the bottom drops out - not to mention the fact that I want to continue to sharpen and hone my "skills" so I can become an Investment Superhero someday too!

Here goes my latest catch:

Pharmaceutical Product Development Inc. (PPDI)

APPLYING RULE #1 TO INTERNATIONAL INVESTING

Every once in a while people ask about foreign companies and commodities, like Chris does below. Read on.

Phil,

I've been reading (very dangerous) about Iran's plans to start trading its oil in Euros and not dollars - they plan to start doing this some time around 03/23 - 03/28 of 2006.  This information got me thinking (also very dangerous) about the Rule # 1 principles and investing/trading in other markets.

1. Do you trade in international securities or do only trade in U.S. markets?
2. Generally speaking, does Rule # 1 and associated investment strategies and principles apply to international trading or just to U.S. exchanges?

I'm still very new to these investment principles and not yet ready to involve myself with international trading, but out of academic curiosity, I thought I'd run this question by you and ask.

Thanks again Phil!

Christopher

Here's what I think:

Rule #1 is a universal strategy for investing.  We're not prevented from finding a wonderful business at an attractive price by a national border.