Phil Town's “Rule #1” investing book – my summary.

Adrian is a great fan of this book, so I was excited when it arrived recently.

Having now studied it carefully, I would suggest that the key part of the strategy is not at the beginning, but at the end of the book.

Weird, I know, but I say this because towards the back of the book he recommends that you use three tools which summarise recent stock price action. These effectively tell you not to buy until all three indicate that the stock price is rising; and also they tell you to sell when all three are pointing to a stock price decline.

This is very heartening because it's indicating that he is not advocating a “buy and forget” approach to investing. And he highlights the good news connected with using these tools, that it shouldn't take you more than 15 minutes per week to check them.

Given that he only wants you to get in when it looks likely that the stock price will continue to rise, and he wants you to get out when it looks like its going to fall, this proves what Rule #1 is:

Don't lose money.

So if you're holding a stock with a falling stock price, then you are not following Rule #1.

Now follows my potted summary of what Phil Town is suggesting that you should do, including the reasons why you should it.

I encourage you to read the book, as its a good read in itself, and many of his examples and asides are most illuminating. And bear in mind it was written in mid-2005 so the examples are only examples from that time – things are very different now.

Anyway, here's my summary.

Why bother yourself with learning and operating this Rule #1 method?

1) Anybody can. A stay-at-home mom attended a Phil Town seminar and although disliking maths, she increased the family portfolio from $45k to $72k in a few months.

2) You will regret letting other people handle your money for you. Since 1985, 96% of mutual fund managers failed to beat the S&P 500 Index, and the successful 4% only beat it slightly. You'll be better off doing it yourself.

3) Dollar cost averaging (DCA) insists you put your money into a falling stock – are you crazy? Rule #1 investors seek a 15% return – that's impossible to achieve if you keep putting equal amounts at equal intervals into a falling stock: forget it.

4) Real estate is too much work for too little return. Real estate grew at 4% per annum over 30 years, its a lot of work, and has lots of costs. Rule #1 investors seek 15% p.a. for 15 minutes work a week: no contest.


What do I have to do?

In a nutshell:
- find great businesses;
- determine their true value;
- buy it if its at a 50% discount;
- repeat.

Every potential business has to be assessed using the four M's.

1) Get personal: only invest in a business which has Meaning for you. Assess this by answering these questions:
- do you understand what they do?
- are you interested in what they do?

2) Will inflation or competitors be a problem: do they have a Moat? In inflationary times, strong businesses can increase their prices without adverse consequences. Competitors are kept at bay because of a trade secret (Coca-Cola), massive market dominance (Microsoft), or patents (pfizer).

5 clues to a big Moat are reflected in certain financial figures. These should all be at 10% or more:
- Return on capital (ROIC, ROC, ROI)
- Sales growth rate
- Earnings per share (EPS) growth rate
- Equity growth rate (BVPS)
- Free cash flow (FCF or Cash) growth rate

These can all be found for free (with some additional calculations) on MSN Money website; and all are set out on subscription websites like:
- Investors Business Daily (www.investors.com)
- Zacks (www.zacks.com)
- Morningstar (www.morningstar.com)
- Success (www.success.investools.com)

3) Who's running the show? (Management)
You must trust the people in charge; they must have a high personal financial stake in the company; and they should have drive. Check out the people by
- reading statements made by the CEO to see if they're honest or mealy-mouthed;
- see what's being written about them in Forbes and such places;
- see if they're selling their own stock; and
- see how much he's paid, and how it varies with the success or decline of the company.

4) Current stock price does not reflect its true value (Margin of safety)
We want to buy a “$100 stock” for an actual price of $50, so we need to determine the true, higher “sticker price”.
Determine the sticker price using these figures:
- Current EPS;
- Estimated future EPS growth rate;
- Estimated future PE; and
- minimum acceptable rate of return from this investment (15%).

When do you buy? When do you sell? (The 3 tools)

Three indicators (available on MSN Money) all have to be in agreement before you buy; and they will also indicate when to sell. They are:

- 8-17-9 MACD;
- 14-5 stochastic; and
- 10-day moving average

Other times to consider selling are when:
- a competitor breaches the Moat;
- the CEO goes bad; or
- the market stock price exceeds the sticker price.

Phil Town insists that you should never buy a stock simply because these 3 tools suggest a Buy – the previous checks of your personal interest; of the Moat; of the CEO; and of the various earnings figures must be undertaken first.

So there we are: that's how Phil Town claims you can do better than the mutual fund managers.

For myself, given the downturn and Credit Crunch, I wonder how many stocks would pass just the 3 tools test – indeed, are there any stocks today that are consistently rising? For if no stocks are showing that type of stock price action, then the 3 tools can't possibly indicate a Buy, so you can comfortably sit on the sidelines for now without fear that you're missing anything.

Phil's website is at: www.ruleoneinvestor.com

and there's a really clever online stock screener that does all the sums for you at:
stock2own.com - StockAnalyzer

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