Every investor needs to find the strategy that suits them best. A good way to educate yourself is, obviously, to read books. Here are four classics from acclaimed investors that explain their methods of picking stocks and analysing companies.
One Up On Wall Street
Peter Lynch, who managed Fidelity’s Magellan Fund between 1977 and 1990, had an eye for “ten-baggers”: stocks that would multiply in value by ten times or more in the space of a few years. This helped his fund return an average of just under 30% a year. In One Up On Wall Street, he aims to show ordinary investors how to emulate his eye-popping returns. His core message is to “buy what you know”.
Lynch argues that individual investors have one crucial advantage over professionals. Wall Street primarily focuses on backward-looking metrics, while the ordinary investor can get a good idea of how a firm is doing through experiencing their goods and service.
Of course, identifying whether a successful company is a good investment is more complicated than that, and Lynch walks the reader through the other things that you need to know as well before you decide the company is worth investing in. These include an introduction to the key ratios for valuing a stock, as well as his view on when to take profits on a successful investment.
• One Up On Wall Street: How To Use What You Already Know To Make Money In The Market by Peter Lynch (Simon and Schuster, £10.99)
The Zulu Principle
Jim Slater was one of the most flamboyant figures of British business during the 1960s and 1970s. He first came to public attention as a share tipster – his tips for his column in The Daily Telegraph returned nearly 70% over two years, compared with less than 4% for the market as a whole. He then built up a £200m business empire called Slater Walker with Peter Walker, which had to be bailed out by the Bank of England during the 1973-74 banking crisis. Undeterred by this setback, he used his share picking and entrepreneurial talents to rebuild his fortune.
In The Zulu Principle, Slater revealed how he consistently picked winners. His insight was that the best way to beat the market was to develop a deep understanding of a particular sector. In his case he focused on small companies with a track record of earnings growth that have the potential to keep on growing. He also explains the special formula (the price-to-earnings-growth ratio) that he used to spot whether a firm was worth investigating further.
• The Zulu Principle: Making Extraordinary Profits from Ordinary Shares by Jim Slater (Harriman House, £20)
Common Stocks And Uncommon Profits
Finding a company that you can buy and hold for a long period while seeing its value soar is the holy grail of growth investing. In Common Stocks And Uncommon Profits, Philip Fisher details his strategy for finding firms that can perform over an extended period. The core of this book is a 15-point checklist detailing the key things that he looked for in all the stocks he bought. These focused on three areas: strategy, operations and management.
Fisher preferred firms that were outstanding in all respects and was willing to pay a premium price for them. Warren Buffett has credited Fisher’s book with helping him understand the value of a “moat”: a barrier or advantage that keeps competitors at bay, allowing the company to protect both its market share and its profit margins. While many of the specific companies that he recommends have either disappeared or have merged with others, the principles behind his advice are timeless.
• Common Stocks And Uncommon Profits and Other Writings by Philip Fisher (John Wiley & Sons, £19.99)
The Intelligent Investor
Many successful investors have made money buying growth companies. However, most studies suggest that the best long-term returns come from value investing – buying companies at a cheap price and then selling them when they become expensive. The definitive book on value investing is The Intelligent Investor by Benjamin Graham, Warren Buffett’s mentor. In it, Graham introduces two key concepts that have had a big impact on generations of investors: “Mr Market” and the “margin of safety”.
Thinking of Mr Market helps one understand the idea that the stockmarket veers between extreme optimism and pessimism, but over time its valuation of a particular stock will eventually regress to fair value. Hence investors should focus on those companies that are trading below their intrinsic value, based on a reasonable appraisal of their present and future earnings.
The margin of safety is the idea that all valuation methods are only an approximation, since it’s impossible to know what will happen in the future, so investors should concentrate on those that look extremely cheap compared with the estimate of its intrinsic value.
• The Intelligent Investor: The Classic Text On Value Investing by Benjamin Graham (HarperBusiness, £18.99)