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100 To 1 in The Stock Market Summary
100 To 1 in The Stock Market Summary
One of the best ways to learn any domain deeply is to look at the actions of the experts in
that domain and clone it. Cloning is not blind copying but instead it is rediscovering the
reasons behind those actions and learning from it. This way we increase our odds of
becoming an expert one day. I have seen this working in (1)Investments in the form of
13Fs (2) Programming; reading the code written by engineers better than us (3)Reading
books which are read by people better than us. I follow few experts when it comes to
reading books. I purchased the book 100 to 1 in the stock market by Thomas W. Phelps as
soon as I saw the recommendation given below. In this post I will be summarizing some of
the key ideas from it.
pretty much the same material things in life good food, good clothes, a home on the right
side of the railroad tracks, good schools for our children. To get more than the average we
must be able to do more than the average, or do what we do better than the average. If all
we can do is take in washing there will always be someone down the street ready to take it
for two cents a pound less than our price.
Thousands of investors have owned one or another of these 100-to-one high-gate stocks
at sometime or other in the last forty years. Probably not one in a thousand has held his
winner until it increased one hundredfold in value. All of course wish they had done so. Yet it
would be just as great a mistake to assume that what has been will continue to be forever
and ever. Or to pay now for all the growth that can be foreseen.
The total number of years and the rate of return required to increase the stock price to
increase by 100 times is given below. Albert Einstein is absolutely right when he said
that compounding is the eighth wonder of the world.
worst that can be seen for it, there is no downside risk. And since the soup is rarely eaten as
hot as it is cooked, the buyer is likely to get more than he is paying for.
Buffets purchase of Coke falls into the first category and his purchase of American
Express falls into the second category. But how can we measure what millions of other
investors are expecting? Phelps gives a logical solution for this with three simple
rules (1) The value of any security is the discounted present worth of all future
payments (2) A dollar of income from one fully taxable source is worth as much as dollar of
income from any other fully taxable source (3) Hence it follows that when investors pay
more for a dollar of income from one source more than they need to pay to get an
equivalent dollar of income from another source they are expressing implicitly the opinion
that the income stream from the first source will rise faster or dry up more slowly than the
income stream from the second source. Otherwise what they do makes no sense.
Stock price has two components to it. One of them is the actual earnings per share and the
other one is the multiple people are willing to pay for $1 of earnings. Multiple is commonly
referred as p/e ratio.
Price = Earnings per share * Multiple
Imagine you bought a stock for $10 which is earning $1 and has a multiple of $10. The
business is doing really well and the expectations of the market is exuberant and they bid up
the multiple to 40. For this stock to become a 100 bagger your earnings needs to increase
by 25 times. The math is given below.
Old Earnings = $1
Old Multiple = 10
Old Price
On the other hand if you bought the stock for $100 which is earning $1 and has a multiple of
100. If the multiple stays constant (which is very rare) then the earnings should grow by 100
times for you to make a 100 bagger. The math is given below.
Old Earnings = $1
Old Multiple = 100
Old Price
The moral of the story is simple. If you pay too much for the stock then for the price to go up
all the heavy lifting should be done by growing the earnings. Multiple reflects
market psychology and it oscillates between extreme fear and greed. One has to be
extremely careful to not pay too much for the stock. But this simple fact is often forgotten.
Peter Lynch explained this concept beautifully which I have given below.
Excerpt from: One up on wall street
If you remember nothing else about p/e ratios, remember to avoid stocks with excessively
high ones. Youll save yourself a lot of grief and a lot of money if you do. With few
exceptions, an extremely high p/e ratio is a handicap to a stock, in the same way that extra
weight in the saddle is a handicap to a racehorse.
A company with a high p/e must have incredible earnings growth to justify the high price
thats been put on the stock. In 1972, McDonalds was the same great company it had
always been, but the stock was bid up to $75 a share, which gave it a p/e of 50. There was
no way that McDonalds could live up to those expectations, and the stock price fell from
$75 to $25, sending the p/e back to a more realistic 13. There wasnt anything wrong with
McDonalds. It was simply overpriced at $75 in 1972.
And if McDonalds was overpriced, look at what happened to Ross Perots company,
Electronic Data Systems (EDS), a hot stock in the late 1960s. I couldnt believe it when I saw
a brokerage report on the company. This company had a p/e of 500! It would take five
centuries to make back your investment in EDS if the earnings stayed constant. Not only
that, but the analyst who wrote the report was suggesting that the p/e was conservative,
because EDS ought to have a p/e of 1,000.
If you had invested in a company with a p/e of 1,000 when King Arthur roamed
England, and the earnings stayed constant, youd just be breaking even today.
You cannot assign the same multiple to both of them. Why? I have not given you the
complete information. Now take a look at the complete information. It should be very clear
that Johns earnings should receive higher multiple than Peter. Why? John spends a lot of
money in educating himself. Also he pays higher rent which suggests that he is living in a
better community and he is spending more on eating healthy foods. But Peter spends half
his income on gambling and drinks and none on education. Given these facts it should be
obvious that John is likely to earn more in future and it will result in his earnings growing at a
faster rate.
What is the takeaway lesson? Companies are like people and their earnings vary so much in
quality. Hence comparing them blindly is like comparing cows and horses on the basis of
how fast they can run. Phelps talks about two kinds of earnings accounting and
conceptual. Buffett fans should immediately recognize this as nothing but owners earnings.
Here are few things every investor should consider when looking at earnings (1) Does the
company manipulate earnings by cutting down its spending on R & D (2) Does the company
sells a lot of items using credit which increases accounts receivable and earnings (3) Do
they build up inventory by running its plants more than its allowed capacity which results in
reducing unit of cost of production and increases earnings (4) Do they squeeze their
employees to increase earnings (5) Do they pollute their environment by cutting corners. If
you answer yes to any of these questions then the quality of earnings is strained. The reason
is because all these items might boost earnings in the short term but they are awful in the
long term. Remember we are in the long term game for 40 years.
Never do business with a man you do not trust. If the management is not trustworthy then
avoid it like a plague. Phelps explains why using an analogy from biology.
Excerpt from: 100 to 1 in the stock market
Suppose you meet today an old friend whom you have not seen for fifteen years. Biologists
tell us that there is probably not a single cell in either of you that was there when you last
met. Yet you have no trouble recognizing each other and recalling matters which interested
you both when you last met. This is possible only because each dying cell is so faithfully
replaced by a like cell. So it is with corporations. No matter how broad-minded we are, how
dedicated to equal opportunity, we tend to hire and promote our kind of people.
When morally derelict men get to the top of great corporations and stay there for a period of
years, the evil they do does indeed live after them. Inevitably they bring into the
organization and promote to higher levels men like themselves. The moral cancer thus
introduced cannot be extirpated simply by removing the evil genius at the top. It may take a
generation under a good management to purge the organization of the unprincipled sharpshooters brought in by a bad management. Hence it is unwise to look for a quick turnaround
in any organization whose management has demonstrated a lack of moral principle.
Earning Power
Stocks go up and down for many reasons. Even their earnings may go up or down for many
reasons. As an investor what we should think about is earning power. What is the difference
between earnings and earning power? One of the best explanation given by Phelps.
Excerpt from: 100 to 1 in the stock market
Earnings are simply reported profits no matter how obtained. As we have already seem,
earnings may rise because of a sudden, non-recurring surge in demand, because of a price
advance, because of a change in accounting practices, because of improvement in business
generally which permits utilization of what previously was excess productive capacity. None
of those reasons reflects earning power any more than the movement of a cork downstream
attests its motive power.
Earning power is competitive strength. It is reflected in above averages rates of return
on invested capital, above average profit margins of sales, above average rates of sales
growth. It shows to best advantage in new or expanding markets.
Failure to distinguish between ephemeral earnings fluctuations and basic changes in earning
power accounts for much over trading, many lost opportunities to make 100 for one in the
stock market.
To check if the firm has earning power every investor should see 10 year trends for (1) Sales
growth (2) Profit margins (3) Return on equity (4) Return on invested capital (5) Ratio of
sales to invested capital (6) Buildup of book value. We should make sure that they are not
showing signs of weakness. Read the paragraph given below several times. To me this is the
secret of hundredfold returns.
Excerpt from: 100 to 1 in the stock market
Real growth is as simple and certain as arithmetic if the book value of a stock is increased by
retained earnings while the rate of return on invested capital remains constant. To illustrate,
let us assume our company has a book value of $10 a share, with no senior securities, and is
earning 15 percent on its invested capital. In this example, book value and invested capital
per share are the same. Let us assume further that our company pays no dividends.
At the end of the first year per share book value will be $10 plus 15 percent of $10, or $
11.50. At the end of the fifth year book value will be $20, and at the end of the tenth year
$40. If our company can continue to earn at the same rate on this invested capital, its
earnings in ten years will be four times the starting figure.
If our company pays out a third of its earnings in dividends, the amount plowed back each
year will be 10 percent per share book value. At that rate it will take nearly fifteen years,
instead of ten, for book value and earnings to quadruple.
Earning at 15 percent and paying no dividends, our stock would grow one hundredfold in
thirty-three years. Earning 15 percent and paying a third of earnings in dividends, out stock
would take more than forty-eight years to multiply its assets and earnings by 100.
Chipotle Mexican Grill is a chain of restaurants, specializing in burritos and tacos. I have
been eating burritos there since 2006 and the restaurant is always crowded. I never
bothered to read their annual report once and now I am sucking my thumb after looking at
its earning power which is given below. Its return on invested capital is very solid and
improved over the years. Book, Revenue, and Earnings all trending up. Look at the P/E in
2006. It was 45 and an uncritical mind would have rejected the stock stating that it is
expensive. A critical investor would have asked (1) How many new stores can they open
before saturating in the US (2) Are they expanding internationally (3) Are the stores
crowded (4) Do they have a moat. By doing that he would have seen the enormous growth
potential in the stock.
From 2006 to 2013 earnings increased by 30.06% and P/E stayed almost flat thus earnings
growth contributing to stock price increase from $57 to $530.75. This represents a
compounded growth of 32.17%.
Closing Thoughts
Buying right will do little good unless you hold on. But holding on will do you little good and
may do you great harm unless you have bought right. 100 to 1 in the stock market is one
of the best investing books I have read. The book ends with the following statement.
In Alice in Wonderland one had to run fast in order to stand still. In the stock market, the
evidence suggests, one who buys right must stand still in order to run fast.
1.
Those of us who ask little of life, get little. Those who ask much, get much, but those
who ask for too much get nothing.
2.
If you dont buy what has to be sold, you never really need to sell anything.
3.
2.
3.
It must be a unique product that does an essential job better, cheaper and/or
faster than before or provide a new service with great and long continued sale
increases.
4.
4.
Look for stocks that professional managers like, but are not sure of.
5.
6.
Stay with your most successful stock investments as long as they are increasing their
earnings.
7.
Try to be associated with people whose self interests are almost parallel to yours.
Therefore it is probably more important to see who is talking, rather than what he is
talking.
8.
To make money in stocks, you need to have vision to see them, courage to buy them
and patience to hold them. Patience is the rarest of the three.
9.
Far more money can be made by good stock selection, than by good market timing.
10.
Many stocks could have been bought at 52 week highs for many years and still turn
out 100 to one winners. All one has to do is identify them and stick to them.
11.
12.
13.
When looking for the biggest game, never ever, shoot at anything small.
14.
15.
Do not count losses in trading opportunities as loss in profits. The shorter the time
one has to hold the stock before it is sold, the more palpable the error in buying it.
16.
17.
In bull markets, correcting mistakes often means taking profits, despite the STCG tax.
The biggest problem in correcting errors in the market is that stocks look best when
they are at the peak and not so great when they are at the bottom.
18.
The ability to foresee is rare and the ability to continue to hold the same buying
rational when the stock drops for no apparent reason, is much rarer. Therefore we find it
less attractive than before, though it should appear more attractive.
19.
A great deal of investing is one par with a fish biting an inedible spinner simply
because it is moving.
20.
All good stocks rise and keep rising, but not everything that is rising is a good stock.
21.
The notion that cash is safe and stocks are unsafe is a fallacy. Inflation loss is real.
22.
Another fallacy is that avoidance of risk is more important that seizure of opportunity.
Opportunity can reward you 100 fold, risk on the other hand can only make you loose 1x
of your capital.
23.
Never for a non-investment reason should one take an investment action. Such as:
1.
2.
3.
4.
New management.
5.
New competition.
6.
24.
If you think something is attractive in the market, buy it. If it falls lower buy more.
These differences may be the ones that make 60x instead of 40x, but it is not worth
missing the opportunities all-together.
25.
Even if one knew what the stock market is going to do, it will still be more profitable
in just keeping your head down and continue to stock pick.
26.
The more successful one is at market timing, the greater is the temptation to rely on
it and thus miss much greater opportunities of buying right and holding on.
27.
Most deception is bad, but self deception is worse because it is done to such a nice
guy :)
28.
The shortest route to making money in the market is to buy gold stocks when nobody
likes it. The only problem is that good stocks seldom have friends.
29.
When you say good stock, most people think of earnings, but the company can also
have assets that are earning nothing at the moment. Great assets are potential earning
power.
30.
Rather than current ratios, use statistics to back up vision and foresight. Do your
research and have faith in it.
31.
Patience is a virtue, have it if you can, seldom found in a woman, almost never in a
man.
32.
33.
What one buys in the stock market is 3/4 times more important that when one buys
in the market.
34.
Sometimes some stocks are just triumphs of lethargy and nothing else. Here
foresight has no relevance.
35.
Even if the near term outlook is bad, just continue to hold on.
36.
A man does not have to be able to lay an egg to tell a good one from a bad one.
37.
The only way to make more money than the going rate of return on capital is to buy
stocks whose values are not that apparent to people. The past is there for every one to
see and when a stock has performed in the past, and is likely to do so in the future, you
can make money off it, but outstanding returns are unlikely.
38.
39.
If a company grows at 20% for the next 6 years, it will grow 6x in the next 10 years,
and 9,100x in the next 50 years. Try to imagine if the company can grow that big. A large
factor is also the current size of the company, which will help determine that.
40.
When you pay for a stock you are not only paying for average growth, but more
importantly for superior growth over the future. Therefore you have to evaluate the
company in a size 5-6 times its current size, after 6-8 years and check if it still makes
sense.
41.
You can almost win any argument, if you are allowed to make any assumptions.
42.
Dont listen to opinions, unless you are also given an insight into the assumptions
made for making those opinions.
43.
44.
In investing one always deals with probabilities and possibilities, and no certainties.
Risk is an essential element in the quest for capital gain. Dont be dismayed by a
loss. Recognise it as one of your costs on the way to a net gain.
45.
A perfect track record can almost certainly mean that you are also letting a lot of
good opportunities pass you.
46.
There is no system, philosophy that will keep an investor from making mistakes or
keep him harmless when he is wrong. We never risk our money, unless the odds are
largely in our favour, our inescapable losses should therefore look small compared to our
profits.
47.
One of the most persistent illusions of the business of investing is that information is
absolutely vital. Given that assumption, every trade needs a buyer and seller, and if both
relied on the same information that the company is giving out, there will hardly be the
quantum of trades that persist in the market today. Therefore, assuming that both sides
of the trades are made by institutions, its almost certain that opinions on the stock matter
way more than common or rather secret information.
48.
49.
When you read a paper in the morning, never forget that your homework has only
just begun.
50.
Look at opportunity ratio while evaluating. If you can gain 100 points by risking a loss
of 10, the odds are 10:1. This again isnt the complete story, its just the payoff. Equally
important is the chance that of the relative gain to the loss.
51.
In the stock market as in poker, one must only bet when the odds are heavily in your
favour.
52.
If the price is already down by discounting the worst, there is very limited downside
risk, focus on the upside and take a call.
53.
All values are relative in all aspects. In a kingdom of the blind, a one-eyed man is a
king.
54.
Dont scoff at dividends when you are looking at capital gains as, the route through
highest capital gains is often though valuation based on dividends.
55.
Wise investors dont buy stocks just because they are going up, they buy is because
the current cost will seem extremely cheap in the years to come, and dividends yields of
the future prices may still be 1-2%, but will be large on the investment price.
56.
The greatest gains in the market have been made by simultaneous increase of
earnings along with increase in PE.
57.
58.
1.
2.
If a PE grew 4x, the company would only have to increase earnings 25x.
3.
The same is also a double edged sword when PE falls, in fact it is much worse
as if the PE halves, the earnings have to double just to keep the prices constant.
59.
There is no such thing as a correct PE or a correct relative PE. The story, assumptions
and risk reward are the most important.
60.
If a stock has gone up 50x after you bought it and with a significant risk, if it can
double, it will yield a 100x return. You can run incredible amounts of risk for a reward of
that size.
61.
In the stock market as in poker, the money tends to move from stupid to intelligent
hands.
62.
1.
2.
3.
63.
The best safeguard against the sleigh of hand booking keeping is to have nothing to
do with it or with the men who practise it.
65.
The greatest mistake of the public is to pay attention to the prices instead of the
value.
66.
67.
But for the gullible, there would be no manipulators. In Africa, where there are no
antelopes, there are no lions.
68.
Stocks are bought and sold on the market because both, the buyer and seller hope to
benefit by their actions.Neither are there to do another a favour.
69.
70.
1.
2.
All laws made by men, can be changed by men, will be changed by men ass
soon as people decide that they would be better off if the laws are changed.
3.
No ones title or right to property is worth anymore than his fellow creatures
willingness to defend it.
4.
71.
1.
Psychological
2.
Statistical
3.
Spiritual
72.
Remember that a man who will steal from you, will steal from you.
73.
Ask yourself if the company you plan to invest into is going to make the world a
better place. If no, avoid it like the plague.
74.
No matter how profitable, stay away from men, companies and ventures that are
based on defrauding rather than helping their customers.
75.
Most fraudsters are not so selfish as myopic, not so much greedy as stupid.
76.
When morally derelict men reach the top of corporations, and stay there for a a few
years, the evil done by them lives on.
77.
78.
When you invest into a selling to a bigger fool venture, you might be the biggest
fool, and just dont know it yet.
79.
In racing there is a huge difference between the 1st, 2nd and 3rd prize. Investment
returns are no different.
80.
Bet on individuals and organisations fired by the zeal to meet human wants and
needs, imbued with enthusiasm over solving mankinds problems. Not just ones that are
there for the profit.
81.
The corporate economist thinks of making the company bigger than more
profitable.When you see a company delivering a low return on capital and continuing
capital expenditure year on year to improve market share you probably are dealing with
a corporate economist.
82.
83.
Check if the Main man has people smarter than him or is he always hogging the
limelight. Generally people who share limelight with CFOs and other heads tend not to be
egomaniacs.
84.
85.
If ones head is held under water until he agrees, it is extortion, not an agreement.
86.
87.
88.
89.
Debt is never bad. What one does with it determines the goodness or the badness of
the debt.
90.
1.
Inventions that can make you do what you always wanted to, but could
do in the past. Cars, Airplanes, Televisions, Smart phones etc.
2.
Things that simplify or make existing tasks easier, faster or at a lower cost
Computers, earth moving machinery.
3.
4.
5.
Doing old essential jobs organically. using neem as pest control instead of
pesticides.
6.
7.
91.
1.
2.
3.
4.
92.
The basic reason very few of us have made 100-1 on an investment is that most of us
havent even tried to do so.
93.
1.
Sales growth
2.
Profit Margins
3.
RoE
4.
RoCE
5.
94.
95.
In Alice in Wonderland one had to run fast to stand still, in the stock markets, one
who stands still can really make money fast.
by Chetan Parikh
Back
by Thomas
1. The moral, of course, is that those of us who ask little of life get little. Those
who ask much get much. Those who ask too much gets nothing.
3. Mr. Garretts first goal was to increase his capital in order to increase his
power to help others. Having no children he was not heir-selfish. He decided the
way to increase his savings fast enough to count at his age was to invest in a
fast-growing company. He began his search for one that met these four criteria:
1. It must be small. Sheer size militates against great growth.
2. It must be relatively unknown. Popular growth stocks may keep on
growing but too often one has to pay for expected growth too many years
in advance. Probably to meet this criterion the stock he wanted would be
traded over the-counter rather than on any stock exchange.
3. It must have a unique product that would do an essential job better,
cheaper, and/or faster than before, or provide a new service with
prospects of great and long-continued sales increases.
4.
5. Except to learn from experience, one should never waste time looking back,
Mr. Pettit replied. In 1925 I personally owned 6500 shares of ComputingTabulating-Recording (now IBM). At that time there were only 120000 shares
outstanding. I sold mine for more than a million dollars-a lot of money in those
days. Today they would be worth two billion dollars.
6. To make money in stocks you must have the vision to see them, the courage
to buy them and the patience to hold them. Patience is the rarest of the three.
8. For the individual or institution really out to make a fortune in the stock
market it can be argued that every sale is a confession of error. I write this fully
realizing that err is human. I do not mean to criticize anyone for making a few
errors of the kind I have been making for forty-five years. But a problem welldefined is half solved. Just as I garnered no ivory by counting guinea hens as
elephants, so shall I gather no fortune in the stock market by counting lost
opportunities as trading profits. The shorter the time a stock has been held
before it is sold, the more palpable the error in buying it go-go funds managers
to the contrary notwithstanding.
10. In a bull market correcting mistakes often means taking profits. But when
we do so let us not kid ourselves we are making money. The truth is we are
acknowledging missing vastly bigger opportunities and incurring a capital gains
tax liability to boot.
Josh Billings
11. Josh Billings once said of a man he admired with great restraint: The
trouble with him aint that he is ignorant, but that he knows so much that aint
so.
12. As the saying goes, Patience is a virtue, have it if you can. Seldom found in
women, never found in man.
13. Again and again this survey of the big winners in the stock market
emphasizes that it is more important to be right than to be quick.
14. The conclusion seems inescapable that what one buys in the stock market is
much more important than when he buys it.
15. Wall Street has its fad and fashions just as Paris does. A stock that is in
vogue may do a great job for its owners without attracting much speculative
attention.
16. Fortunes made that way are what my old friend and colleague Dwight
Rogers calls triumphs of lethargy. In the same vein Decatur Higgins of
Scudder, Stevens & Clark quotes a former associate as noting sadly, I suffer
Patrick Henry
18. Patrick Henry met that one head-on in a speech to the Virginia convention in
St. Johns Episcopal Church, Richmond, Virginia, on March 23, 1775: I have but
one lamp by which my feet are guided, and that is the lamp of experience. I know
of no way of judging the future but by the past.
19 Because every stock buyer wants to make money, it is almost a truism that
nothing kills a money-making opportunity faster than its widespread
popularity. This applies just as surely to growth stocks as it does to Florida real
estate. What shall it profit a man to buy a sock whose earnings quadruple in the
next ten years if he has to pay for four times the current earnings now?.
20. Incontestably, growth stocks are highly attractive if they continue to grow
as fast as or faster than they have been growing and if buyers continue to expect
them to continue to grow as fast or faster and if the rate at which future earnings
and dividends must be discounted does not increase materially.
21. The mere fact that a stock has been a growth stock for ten or fifteen years is
no warranty that it will continue to grow even one more year.
22. Unlike dogs, not every stock has its day. In Wall Street a stock that does not
have its day is called a dog.
23. Even when a stock does have its day, there is no assurance that the stock
will be a leader forever.
24. How do I reconcile that statement with my advice to buy right and hold on?
Thats easy. As we have seen, hundreds of stocks have risen more than one
hundredfold. A few have risen one hundredfold, and then have gone on to double
or triple in price after that. But tomorrow is a new day for every company, every
security. Eternal vigilance is the price not only of liberty but if solvency. My
advice to buy right and hold on is intended to counter unproductive activity, not
to recommend putting them away and forgetting them.
25. The point I am trying to make is not how rich you and I could be if our
foresight was as good as our hindsight. To think that way is an unpleasant as
well as unprofitable way to spend time.
Norris Darrell
26. Does this mean that one should never sell anything? Mankind has made so
many amusing and pathetic errors in underestimating the future of the human
race that it is tempting to adopt the policy of Mr. Darrells client who never sold
anything. But let us fall back on the principle that when any rule or formula
becomes a substitute for thought rather than an aid to thinking, it is dangerous
and should be discarded. As we have seen, and shall see again and again, the
tree does not grow to the sky.
27. To grow at the rate of 20 percent compounded annually for fifty years, a
company must be 9100 times as big at the end of the period as it was at the
beginning. If you project that kind of growth of the company with $100 million of
annual sales, you must expect those sales to reach $910 million annually by the
year 2021. If you start with a company whose sales already are a billion dollars a
year, to count on 20 percent compounded annual growth for the next half
century, you must foresee the sales of 9 trillion 100 billion dollars in the year
2021.
Ridiculous, you say. No practical man tries to look ahead that far. But 20 percent
growth compounded annually will increase a companys size by more than six
times in the next ten years. The significance of this, in a book advocating buy
right and hold on, is twofold:
2. When you pay in advance for the earnings of a stock to triple or quadruple,
as you do when you buy it at three or four times the price-earnings ratio of
the Dow-Jones Industrial Average, you should foresee not only the growth
you are paying for but further above average growth beyond that. This
means that you must evaluate the competitive status of the company not
as it is today but as it will be six to eight years from now, when it is three
or four times bigger.
28. No one buys a stock to do someone else a favor. No one sells a stock to let
someone else in on a good thing. Most trades are result of head-on collisions
between diametrically opposite opinions about the same security at the same
instant in time.
29. Often both the buyer and the seller are well informed. How can two wellinformed people come to opposite conclusions about the same stock at the same
price? Usually it is because they have made different assumptions about its
future. One may assume that its earnings will grow at the compounded annual
rate of 15 percent for years to come. The other may apprehend a slowing down in
the growth rate. Or one may be convinced that inflation in America is
uncontrollable. The other may assume that while the American people act slowly
they act wisely and courageously when the peril becomes clear.
30. Never mind opinions. They are not worth a dime a dozen. Try to get the
reasons for them, the assumptions underlying them.
No one knows or ever can know for sure what the future holds. If the Almighty
had intended us to know that, he would have equipped us with another sense
which none of us has. The Irishman highlighted the matter when he said, Sure
and I wish I knew where I was going to die. Id never go near the place. If we
have no certainty as to when or where our own life will end, how can we
presume to be sure of future developments with regard to matters not nearly so
close to us?
31. Hardwick Stires has been a partner in Scudder, Stevens & Clark, probably
the worlds oldest and largest investment counsel firm, for 40 years, the period
covered by this book. For almost that many years he has been a member of the
Business Council, one of the prime links between business and the
Administration in Washington. His investments philosophy has been developed
and tempered by two major depressions, the Second World War and the still
unresolved battle against inflation. Risk, he says, is an essential element in
the investment quest for capital gain. Dont be dismayed by a loss. Recognize it
as one of the costs without which you could not have net gain.
There is a legend that the founder of the Morris Plan banks once called a
manager to account for having no losses.
To make such a record, the founder said, you must have been turning down
good loans. Next year I want to see some loses not too many, mind you, but
enough to show that you have been risking something on your judgement.
32. This is not to say that risk must always be commensurate with the profit.
The art of speculation in one sense is the ability to recognize when a seeming
risk is not a real risk or when a real risk is not nearly as great as the stock
market anticipates. Even so an investor would have to be starry-eyed indeed to
think that he could turn $10000 into a million dollars without taking any chances
of losing his money.
33. One of the most persistent illusions of the business of investing is that
information is all you need to make money. Organizations that sell information
foster that illusion. It is good for their business.
If one just stops to think about the two parties to every trade, the fallacy in this
notion that information is tantamount to money-making investment decisions
become painfully apparent. For every buyer there must be a seller. For every
seller there must be a buyer. Sometimes an informed buyer has the good luck to
meet an uninformed seller and vice versa. But it is a good guess that most of the
time practically all of the time where institutions are on both sides of the trade
both buyer and seller are informed. If information is everything, how can two
informed professionals come to opposite conclusions about the same security at
the same price at the same instant in time?
34. A second reason why one informed investor may sell what another informed
investor is buying is that no one can be informed about the future. Since all the
decisions as to the future must be based on assumptions, informed investors
may make different assumptions and hence come to opposite conclusions about
buying or selling a particular stock at a particular moment.
35. A third reason for difference of opinion among informed investors is that no
one ever is or can be fully informed. The investor who is 98 percent informed
may come to the opposite conclusion from that reached by one who is 99 percent
informed.
36. The illusion that information is the be all and end all the investments
business logically leads to the imposition of penalties on those will seek to
benefit from sure thing inside information. It you believe that information leads
you in a straight line to correct investment decisions it follows that anyone who
gets information ahead of you has an advantage which should not be allowed.
Joseph P. Kennedy
37. In 1961 when I was writing an article for the Atlantic Monthly entitled The
Hazards of the Stock Market I asked Joseph P. Kennedy for an interview. I had
first met him twenty-five years earlier when he was chairman of the Securities
Exchange Commission and I was chief of the Wall Street Journals Washington
Bureau. Ours then was the first news gathering organization to assign a reporter
full-time to the SEC.
Mr. Kennedy agreed to see me, but because his son was President of the United
States the interview had to go off the record. Now that both father and son are
gone, however, and ten years have elapsed since the interview I think I have
historical license to report these two points:
bought it back.
38. Even if ones information is complete and accurate, it can still misleading
investment wise if it is late. A lemon that has been flattened by a steam roller
has more juice in it that a piece of information the stock market has already
discounted. To use another analogy, the difference between soda water that has
just been uncapped, and soda water that has been left all night. Just as uncapped
soda water soon loses its fizz, so uncorked news fades into history or oblivion.
39. How can one tell whether his information is fresh or stale? As is true of so
many aspects of the investments business, there is no way to be sure. Even if
10000 investors have heard the news ahead of you, it may still prove profitable
to you if 10 million investors are going to hear it and act on it after you.
40. Really fresh news news to which the stock market has not reacted can
indeed be golden. News that comes as no surprise to substantial market interests
may yet have enough kick in it to be silver to the remainder. News that has been
fully discounted is lead and those who act on it are dead.