T. Rowe Price knew how to make really big money on the stock market by using a simple three-step system that anyone can take advantage of. You don't need an MBA, a big corner office or an expensive computer. It is based on common sense and discipline -- meaning that the same basic skills you use to feed quarters into a parking meter can be applied to discovering incredible stocks.
Price's system was inspired by a job that he landed after graduating from college, where he studied chemistry. At DuPont, he was required to learn about the chemical giant's finances...and he discovered his true calling in the spreadsheets, reports and analysis that crossed his desk. Over the years, he held jobs at companies that went bankrupt or used unsavory hardball sales tactics. But for a man like Price, even disappointment and despair became lessons in success.
It was during those tough times that he began to actually formulate an investing philosophy based on his own observations, principles and appreciation of business practices that caused companies either to rise or fall. Price's investment philosophy has two supporting pillars...
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The first maintains that the successful investor is intimate with the companies that he or she invests in. The familiarity reaches into the company's management, line of business and potential.
The second pillar supports the notion that change is the only certainty in the investment world and that the best investors know how to exploit economic, social and political changes to extract the most profit from the stock market.
From Price's perspective, the best company to invest in would be managed by executives who are resilient and progressive, in order to avoid or sustain and even capitalize on the inevitable shockwaves that ripple through the marketplace.
While this philosophy laid the groundwork for the formation of the multibillion-dollar global financial services firm that bears his name -- it also led to the creation of his easy three-step system for beating Wall Street.
The three steps to Price's system are (1) gather information, (2) evaluate the information and (3) make the decision.
When it comes to gathering information, Price stayed current on breaking news, product announcements, industry trends, proxy statements, annual reports and government data. Eventually, Price attained the financial clout to speak with the management of a company under consideration.
In the second step of Price's system, the investor evaluates the information gathered. Some of the investment criteria most important to Price were...
> Management's track record, reputation and sufficient ownership stak> Industry leadership and sustainable competitive advantag> The ability to attract and retain world-class talent for ongoing growt> Product innovation, high quality and robust marketplace deman> Potential dividend growt> Attractive profit margins, return on investment and return on equit> Affordable stock price relative to future earnings and historical P/E.
The P/E ratio (price of stock divided by earnings per share) was critical to Price. It is one of the best ways to avoid overpaying for stocks when they are in high demand. If an investor is enamored with a stock, he should have the discipline to wait for a down cycle, when the P/E ratio is low.
Another opportunity to find a good company with a low P/E ratio is when it's relatively unknown -- a time when research, flexibility and discipline play important roles. In this case, potential may outweigh all other factors. But when it comes to new companies, for example, cash flow, growing sales and experienced management become more important than in a mature company.
Now that all the information has been gathered and analyzed, it's time for the third and final step in Price's system: making the decision.
Before submitting a buy order, Price revisited his data -- evaluating it against the latest developments, such as...
> A downward trending of sales, earnings and profit margin> Eroding marketplace leadershi> Increased cost of doing busines> Management changes that could damage the company.
The trick to evaluating the above criteria is in determining whether they are the result of a bear market or poor management. A declining market might present a bargain buying opportunity, assuming that the stock will rebound when the market returns to a bull cycle.
On the other hand, if management has turned bad, the company could find itself in a fatal nose dive.
Price's system presents guidelines for finding companies with profit potential. Investors must then find their own comfort level when it comes to flexibility and discipline -- two extremely important attributes regardless of which system is used. An investor's flexibility and discipline should be determined by his risk tolerance, profitability goals and time horizon.
In other words, are you willing to bet that time will run out on the meter before you move your car?
Happy investing,
Irwin Greenstein for Penny Sleuth
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