By Thomas W. Phelps
|Original Publication Date||1972|
|Topics||Stocks, Value Investing, Classics|
|Similar Titles||100 Baggers|
|Works from Same Author||N/A|
The central theme of this book can be captured in 5 simple words: “Buy right and hold on”. The author’s view is that the big money in investing is made by finding good companies at bargain prices, buying them and letting compounding work for you by holding on tight.
The first 8-10 chapters of the book are filled with statistics and examples of how well an investor could have done if they’d purchased $10K worth some company shares in <19XX> and held on for <N> years (where XX is often in the 1930’s or 1940’s and N is generally around 40 years). Phelps is careful to point out that the hardest part, by far, is the “holding on” as he takes the reader through the rollercoaster that is buy-and-hold investing. In some cases, you would have had to sit through declines of 75% or more in order to realize gains of 100X. Phelps also presents sensible and logical reasons (many of them tax related) as to why trading in and out stocks, or replacing existing stocks with “better” ones might not make sense.
In terms of “buying right”, the author talks about some standard value concepts:
- Look for good companies that are solving known problems in a better, more efficient way, or who are doing something that nobody else is capable of doing
- Focus on quality – quality of company and quality of product. As the author puts it (paraphrasing): People who appreciate quality generally tend to have money, so companies that produce quality will always have customers and as such often have the best prospects over the long term
- Look for quality in earnings too! He has various hypothetical comparisons between “Company A” and “Company B”. As a simple example, assume A & B are similar companies and, on the surface, appear to produce identical earnings. Digging deeper, we find that A could actually have higher earnings, however, they’re investing heavily in technology to reduce their environmental impact, whereas B is ignoring environmental impact and dumping waste into a local river. Despite equal earnings, Company A is clearly superior to Company B, who is, in all likelihood, accruing an environmental liability and just generally being a bad corporate citizen. As an aside, I was surprised at the forward-thinking nature (e.g., environmental concerns) of some of the examples presented given that the book was originally published in 1972.
- Companies at low historical multiples are often a better buy than companies at high historical multiples. A low multiple might mean that a stock or sector is currently out of favor and may thus represent better value. For example, if a company is currently selling at a P/E of 8 against a normal historical range of 7 – 35, provided the business remains sound, it might be a good opportunity.
- The author is a big proponent of normalizing price (or P/E, or whatever) of individual stocks vs the index to get a sense for relative performance and help gauge value. He specifically uses the Dow 30 as a point of comparison but the proliferation of ETFs in recent times means that the modern investor could use any number of indicies.
I find myself in total agreement with the general premise of this book – I believe (and the data generally supports) that riding winners is probably the single most important thing the average trader / investor can do increase their odds of long-term success. I also cannot disagree with the simple tag-line “buy right and hold on” though I suspect that if it was easy, more people would do it.
The fact that the book was originally published in 1972 allows for evaluation with the benefit of hindsight. Particularly ironic is the chapter where the author lauds the then head of Arthur Andersen, the accounting firm at the center of the Enron Scandal, for his opposition to off balance sheet trickery such as “leasebacks”. To be fair, the world changed a lot between publication and 2001 when Enron finally exploded.
Enron irony aside, while many of the companies discussed in the book are still going concerns today (IBM and Occidental Petroleum as two examples), a surprising number of the stocks he highlights as 100-1 winners have since imploded.
The point here is absolutely not to pick on the author for highlighting the wrong stocks in his book, as these were all majorly successful companies in their day. I’m more interested in providing a two-item addendum to the book – additional lessons can be inferred based on the benefit of hindsight:
1. It’s not clear to what extent the author dealt with survivorship bias in compiling his list of 100-1 stocks. He does talk about time period dependence a little bit in the book (i.e., the idea that the time-window considered will have a great impact on the outcomes observed), however, I suspect cases of stocks that produced 100-1 gains, then subsequently went to zero may not have been considered in his historical analysis. The reader should be aware that it can, and will happen as shown in the examples below.
2. Strongly linked to the first item is the idea that “buying right and holding on” does not excuse the reader from constant re-evaluation of the businesses they own. A few of the fallen stocks discussed in the book are Kodak, Polaroid and AIG.
In hindsight, it seems obvious that digital photography would supplant Kodak and Polaroid, but would it have been obvious to the average investor in the late 1990s, when both of these stocks were hitting their what would ultimately turn out to be their all time highs? (Hint: no, it would not). The first real smart-phone (iPhone) didn’t launch until late 2007 and the term “selfie” didn’t make it into the dictionary until 2013 – by this time, holder of either of these stocks would have seen all of their money disappear.
Another example is former insurance giant AIG. While AIG still exists today, it is a shadow of it’s former self, having declined about 95% during the 2008 financial crisis and never recovering. An investor willing to periodically re-examine their holdings might have noticed that AIG had an ever-increasing exposure to credit-derivatives (a deviation from their former business) and pre-emptively sold – easy to say with the benefit of hindsight, but admittedly unlikely. More likely is that an investor could have been attuned to the slow drift in AIGs business, recognized the significance of the crisis to the company while it was unfolding and thus mitigated some of the damage to their portfolio. The chart below shows the swiftness of the decline; likely only avoided by the well-prepared and the lucky.
If you’re looking for a book that reinforces the possibilities and benefits of buy-and-hold style value investing, then this book is as good as any. There are many great example of how fortunes could have been made via stock selection, followed by sitting tight. It contains various important value concepts intended to assist the reader in making good selections, but no specific, actionable advice. And as I point out, it completely fails to acknowledge that, just because a stock rises 100-fold, it doesn’t mean that it can’t come right back down again.