Rules of Engagement Redux
Cover Story, by Mark Robertson, Managing Partner December 1st, 2008
After several months of the nastiest markets seen in most people’s lifetimes, we were drawn to a down-to-earth set of Rules of Engagement shared by Charles Carlson back in 1998 after another particularly bad episode.
This month, we revisit a theme attached to last month’s message: “We hold these truths to be self-evident: That all investors are created equal.” After several months of the nastiest markets seen in most people’s lifetimes, we were drawn to a down-to-earth set of Rules of Engagement shared by Charles Carlson back in 1998 after another particularly bad (albeit brief in the rear view mirror) episode. I wrote the original version back in December 1998 fairly soon after joining the Better Investing staff … it’s time to spend a few more moments with Mr. Carlson and the Individual Investor Revolution.
Charles Carlson is the individual investor’s champion and author of 1998’s comprehensive guide, The Individual Investor Revolution — an arsenal of weapons guaranteed to get you into the game and on the road to success in investing. The book became the most popular tome back in 1999-2000 in surveys of our huge Community of long-term investors.
Carlson often makes references to investment clubs. In fact, he refers to clubs as the “Armies of the Revolution” and often shares experiences at NAIC events, or to things that he’s learned while making visits to investment clubs.
Patience, Discipline & Sticking to a Strategy. The 2008 stock market has inspired some retrospective on what really works and a look back at this 1998 best seller by Charles B. Carlson, CFA.
As part of the “Army of the Revolution,” we have an opportunity and responsibility to better guide those around us tempted to stray from the mission. Still others are inhibited by the mystery, fear, and the gloom and doom that seems to dominate the media and stock market averages.
What are the most effective ways to get (and remain) involved in investing?
As an individual investor, the power is in your hands. In short, you’re in the perfect position to seize investment opportunities and high returns that can transform your life.
10 Rules of Engagement: Winning the Individual Investor Revolution
Successful investors suggest that anyone is better off with a strategy than without. After all, you can’t win a battle without a battle plan. Make no mistake — the individual investor revolution is all of that, a real battle. If you disagree, Carlson suggests that “you’ve never met an investment banker, fund manager, or stockbroker.”
Rule #1 — If You’re Not in The Game, Get in The Game Now.
There’s never a bad time to start, and there’s never a good excuse for not starting. The reason that getting in the game is important is because your biggest success factor is the power of time. The beauty of time is that it doesn’t care how smart you are, how much money you have, or how well-connected you are. Time is the great equalizer. If time is the most influential factor, it follows that it’s important to get started as soon as possible.
If you’re not in the market, there’s never a bad time to start.
Rule #2 — If You’re in The Game, Stay in The Game.
Markets move in bursts, and you have to be in the market to capture these bursts. Last month, we explored the massive volume of cash “on the sidelines.” This is the fuel for a market burst.
Bottom line: NOBODY knows for sure if, and when, stocks are “too high” or “too low.” What we do know is that corporate earnings, which are ultimately the most important long-term driver of stock prices, will be higher 5-10-15 years from now. Higher corporate profits mean higher stock prices over time.
Heed the words of Warren Buffett and his recent “Buy America. Now.” dissertation. Look beyond the malaise of today’s news and discover companies likely to be solid 5-10-15 years from now.
If you’re in the market, stay in the market.
Rule #3 — Keep Your Battle Plan Simple and Efficient.
Having a simple strategy has a variety of benefits. First, it’s easier to implement and manage. Here are some ways to keep it simple:
(1) Diversify — to a point. Investors achieve adequate diversification with [12-20] stocks, so long as they’re selected from different industries with a sufficiently high overall growth forecast.
(2) Be a reluctant seller. Warren Buffett has less than two dozen stocks, and he holds on to them for decades. If Mr. Buffett is convinced that he will have a limited number of great ideas during a lifetime, who am I to argue? The reality is that you really only uncover a handful of genuine investment opportunities each year. When you do, buy them, hold them and be a reluctant seller.
NAIC founder George Nicholson urged our legions to buy and hold for as long as it makes sense to do so. If you’ve chosen leadership companies carefully, opportunities to sell will be less frequent.
The Role of EPS Stability During Recessions and Market Corrections? We’ve noticed that the leaders in our Groundhog 2008 stockpicking contest generally tend to have portfolios with higher overall EPS Stability rankings. We explored stocks with recession-proof characteristics and tendencies in our June 2006 cover story where we introduced and explained our EPS Stability ranking. It’s hard to ignore the cluster of participating Groundhogs with low overall EPS Stability and their underperforming account balances vs. the total stock market. Note the number of points to the right of the vertical stock market line. The majority of participants continue to outperform. We like that.
Rule #4 — Play to Your Strengths.
Use whatever advantages you have. One advantage that you bring is special expertise and awareness of a particular industry. This advantage should be evident in your portfolio.
Another advantage that you have is the ability to invest for the long haul. Most professionals exhibit high, in some cases, frenzied, turnover rates of continuously buying and selling stocks. Choose immunity from this.
Buy stocks that are out of favor, with higher projected annual returns and high quality ratings, with excellent long-term prospects.
Rule #5 — Take What Your Opponent Gives You.
How? One way is by taking advantage of the huge price declines that hit stocks when they miss their quarterly earnings estimates. I’m sure that some of you have owned good quality companies whose stock prices were blown out of the water when the earnings reports were just a shade below Wall Street’s expectations. Think about it. Does the fact that the company missed its earnings estimate by one or two pennies mean that its long-term prospects are in danger? Probably not.
This month’s Solomon Select features Stryker. The company recently reported $0.66 when Wall Street was expecting $0.67. You guessed it. The stock price was hammered.
We are NOT suggesting that investors should jump in immediately into the fray every time that a stock gets clobbered. Every time the rhino’s nearsightedness hands you a potential long-term opportunity, update your studies, assumptions and forecasts, and consider this “gift” in the proper perspective.
Rule #6 — Avoid Battles You Can’t Win.
It’s foolhardy to start a battle that you can’t win. Unfortunately, the very fact that Las Vegas, and lotteries, exist proves that people ignore this advice. Wall Street has its share of long-shot players as well, especially in the futures and options markets.
Bottom line: The playing field in the futures and options market is far from level for the average individual investor. The biggest difference is that with options, that powerful advantage of time is no longer on your side. In most cases, time becomes just one more adversary.
Rule #7 — Don’t Claim Your Victories Prematurely.
“You’ll never go broke taking a profit” may be the worst investment advice ever given. Yes, you’ll never go broke, but you’ll never get rich either. Carlson grimaces at the thought of investors claiming victories early by selling stocks after they rise 25 percent, 50 percent, or for that matter, 100%.
Rule #8 — Have the Courage to Act on Your Conviction, BUT, Do Not Confuse Conviction with Stubbornness.
Wall Street is the only place where the merchandise gets more popular as it gets more expensive. That’s because the “herd” mentality is that rising prices mean that it must be worth buying. Invariably, the “herd” gets trampled when the promise fails to materialize.
Those that have the courage to act on convictions that may run counter to Wall Street’s “herd” can find substantial rewards.
Be brave. Not foolish.
One reason to stick with your own conviction is that you can make the choice that it be unbiased. Form YOUR own opinion.
Rule #9 — Engage on All Fronts, Foreign and Domestic
As an investor, you must be willing to go wherever value can be found. That may include investing beyond the borders of the United States.
For a refresher, go back and re-read our tribute to Sir John Templeton from mid-2008. Opportunity knocks.
Rule #10 — Develop Future Leaders of the Individual Investor Revolution
The most important responsibility of any leader is to educate and train the “next generation.” Carlson strongly suggests that part of the “wisdom package” that parents and grandparents impart on children and young adults must include knowledge about investing. After all, kids have the most of one ingredient so important to investment success — time.
They’re curious, they’re listening, and they’re capable of so very much.
The upshot is that if we instill good investing disciplines in a youngster today, we will change his or her life tomorrow.
Reflections on Revolutions
Better days ahead. We know many young-at-heart investors who have discovered the virtues of patience and discipline in the realm of investing.
Chronological age has nothing to do with it, although I’ll confess that the passing of a recent 50th birthday does seem to deliver more reflective moments. The “wisdom package” mentioned by Carlson does seem to expand with experience and the rate of expansion is often proportional to the amount of listening and thinking.
I remain convinced that all markets (even this one) are best handled by sticking to some basic core principles:
1. Invest regularly. We do this for returns, so our emphasis should be on routine acquisition of high-return opportunities. It necessarily includes maintaining the projected return levels of our portfolios at suitable levels.
2. Stay in the game. Take advantage of selling opportunities but patiently seek replacements for our portfolios.
3. Invest in high-quality leadership companies. As the Groundhog graphic suggested, heeding the lessons of history and seeking high-quality companies with relatively high (and stable) profitability trends is a pretty good idea.
4. Prudently diversify. Build enough growth, return and quality into your portfolios. Maintain as necessary.
Revolt patiently, with discipline.
Mark Robertson
Mark Robertson is founder and managing partner of Manifest Investing, a source for research and portfolio management focusing on strategic long term investors.