If you want to make a success of your investments, you would be well advised to follow the experts. Here we look at the strategies of five legendary investors.
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While Peter Lynch was in charge of Fidelity's Magellan fund between 1977 and 1990 it posted an average annual return of 29%. No fund manager in history has ever run a fund of its size (by the end of the period it was worth $14bn) so successfully for such a long time. He puts this achievement down to a few simple things, mainly the skill of finding investment opportunities in areas you are already familiar with. He made a point, for example, of looking closely at stocks for which he or his family had "positive personal experiences as consumers", says Peter Temple in the FT. He also looked for the simplest of businesses to invest in, famously suggesting that one should, "Go for a business that any idiot can run because, sooner or later, any idiot probably is going to run it."
Having spotted a possible company, Lynch looks at three criteria: profitability, price, and whether or not it has a good business model. He likes companies with strong assets backing them and forward p/e ratios well below forecast earnings per share. He prefers firms with strong growth potential, but at the same time is wary of those with unsustainable growth rates. "As a rule of thumb, he generally looked for earnings growth of between 15% and 30%," says Debiprasad Nayak in The Economic Times Online. To Lynch, however, financial fundamentals were a secondary thing to look at. First, he liked to understand the company thoroughly. He visited shopping malls to see how shops were doing, check which brands were selling and at what kind of prices. Then he looked at the balance sheet.
Lynch's book on investing, One Up On Wall Street, was published in 1989.But that doesn't diminish its relevance today. The book introduces the idea of "ten-baggers", the Holy Grail of investing, says Luke Johnson in The Sunday Telegraph. Ten-baggers are shares that investors can make ten times their money on within about five years. Finding these meant that, on the whole, Lynch avoided investing in large, well-established businesses and opted for less well-known ones or turnaround stories. He was also a contrarian investor like many other great investors, he sought out stocks that everyone else was ignoring.
One final piece of Lynch advice to retail investors. You should think of your stocks as you would your children: you have limited time, so you can't keep an eye on too many of them at once. Lynch thinks that five stocks is enough for most of us to keep track of.
Eddie Lampert: the next Warren Buffett?
Eddie Lampert takes security seriously. He was kidnapped at gunpoint as he left work in 2003 and held hostage for two days. However, his mental resourcefulness is such that he managed to talk his way out of trouble and be back at his desk just two days later. But there's more to Lampert than resilience alone: he's currently being touted as the new Warren Buffett.
His private investment fund, ESL Investments, which takes its name from his initials, has grown from $28m in 1988 to a mammoth $9bn today, returning an average 29% a year compared to the 25% a year Berkshire Hathaway has made since Buffett took over in 1965 (though over a much longer period). One huge success for Lampert has been his 53% stake in Kmart. Once bankrupt, the retail giant has now merged with Sears and is a veritable cash cow, throwing off more than it can use in the business. It has $3bn in hand.
Lampert has always had powerful mentors, working with the likes of Robin Rubin, former boss of Goldman Sachs, and economics Nobel winner James Tobin at Yale. The person who first sparked his interest in investing, though, was his grandmother, who would read the ten-year-old Eddie Lampert stock quotes from the paper. He has also paid close attention to Warren Buffett, dissecting his reasons for making each investment. Lampert tends to go for mature, easy-to-understand businesses with strong cash flows, long-term returns being much more important than short-term bumps and rises (sound familiar?). He is also starting to turn minority stakes into larger plays where he has the majority and can control a firm as he did with Kmart. "There is nothing Lampert likes to control more than how money is spent," says BusinessWeek. Every dollar must earn as much as possible, and his companies will often use cash to buy back shares rather than boost capital spending.
But for all these similarities, "Lampert is no Buffett clone".He is more assertive with management, for one thing, and is more willing to target poorly run companies as they produce greater returns when turned around. Unsurprisingly, he can be tough at ESL too, where, with just 15 employees, "he runs a tight ship". Former workers talk about his understanding of risk, and his "uncanny ability to see how the pieces of an investment fit together".
If, at its inception in 1954, an investor had placed $10,000 in Sir John Templeton's flagship Templeton Growth fund, it would now be worth nearly $7m, which is nice, and qualifies him as an investing guru (the same money in an S&P tracker would have returned you $500,000). But if, 11 years later, you had put the same $10,000 into Berkshire Hathaway just after Warren Buffett took it over you would now be sitting on a nest egg of over $50m.
Buffett is a patient investor and a cautious one. He ignored the tech-bubble entirely, and still doesn't hold a single tech or internet stock, not even Microsoft. He would, he says, bet it will do well, but as he points out, why should he "have to bet"? He likes stocks he can "see", and therefore understand, such as Coca-Cola: he believes it's "much easier to predict the relative strength that Coke will have in the soft-drink world than Microsoft will in the software world".
Unlike Templeton, he seems to think that he can still find value in the American market earlier this year, for example, he bought PacifiCorp from Scottish Power, in what is seen as his new investment technique to "buy entire companies, rather than simply taking a stake", says SmartMoney. In April, he also bought a significant stake in Anheuser-Busch, the world's largest brewer and the maker of Budweiser beer. Buffett's reputation goes before him as soon as his purchase was announced, the share price went up 6%.
As well as being able to see his stocks, Buffett likes to know them intimately.He once likened over-diversifying a portfolio to having a harem of 40 women "you never get to know any of them very well". His stocks are more like friends: he knows them well and holds onto them for the long term, or as long as they pass his growth tests without becoming over-priced. "The key, he says, is to think of yourselfas part-owner of the business," says Graham Searjeant in The Times.
He is very sceptical about the future of the dollar last year, he bet $21bn against the dollar. With his other currency plays, this earned him $2.6bn last year but with the dollar's recent rally, he has been hit, and could have lost "as much as $1bn", says SmartMoney. But the world's second-richest man and best-known investment guru is "undeterred and continues to position Berkshire Hathaway, his investment company, for dollar weakness", say Patrick Hosking and Gabriel Rozenberg in The Times. Still, he can't find much to invest in at all, be it a dollar asset or not. At Berkshire Hathaway's AGM in May, he said, "We'd love to have one [an acquisition] in the $5bn to$10bn range. At the moment, we've got more money than brains, and we hope to do something about that."
From 1936 to 1956, Benjamin Graham had a "remarkable record as a stock picker", say Pablo Galarza and Stephen Gandel in Money. Over the 20-year period, his mutual fund had a compounded average return of at least 14.7%, compared to 12% for the overall market. That may not sound like much of a difference, but, as Galarza and Gandel point out, a $10,000 investment in Graham's fund would have earned roughly $60,000 more than the average in the space of two decades.
So how did he know which stocks to pick? He was the ultimate valueinvestor. His net current asset value (NCAV) approach is "relatively unknown to individual investors", says Harry Domash's Winning Investing, but it was clearly successful for him. It is a system that calls for buying stocks trading below their calculated value. Instead of using the more usual book value (assets minus liabilities), Graham wanted to know what the company would be worth if it were liquidated tomorrow. In order to work this out, he would only include current assets (ie, cash, inventories and accounts receivable), while ignoring long-term assets, such as buildings and patents. He would delete from this both long and short-term liabilities, giving him the NCAV. His aim was to find and buy companies trading at two-thirds or less of their net current asset value.
He insisted on such a heavy discount because he believed that you needed a margin of safety "a price so low that you can make money even if some part of your analysis turns out to be wrong", say Galarza and Gandel. This gave him leeway to carry out less research than many of his colleagues, as a lot of it would be redundant if the shares were cheap enough. For example, if a company has current assets worth $12 per share and no debt, you would have a nice margin of safety if you bought its shares at $7, however dodgy its business.
"A true Graham follower has to be resigned to buying companies that the rest of the market think are lousy," say Galarza and Gandel. Like Templeton and Lynch, he focused on companies the rest of the market were ignoring, so that he could pick them up cheaply while knowing that the real value was there to back up the investment, even if the company went bust. Graham discovered the hard way that this was a good investment strategy. One of his early picks was Savold Tire, which he bought on its first day of trading making an impressive 250% in a short period of time. But instead of reaping his profit, he held onto the stock. Six months later, corporate fraud was exposed at the firm and its shares became totally worthless. His response was his NCAV strategy, designed to ensure that even if companies went into receivership, there would still be money left for investors.
Sir John Templeto
Fortune: estimated at over $1bn
He may be 92 years old and have sold his family of mutual funds (for $913m, in 1992), but that doesn't mean Sir John Templeton doesn't still knowa thing or two about investing. Described as "arguably the greatest global stock picker of the century" in Money magazine, he continues to keep an active eye on what's happening in the markets. Right now, that's not something he finds very comforting: in recent years he has been very worried about the quality of investments in the market and he has repeatedly warned that the US housing boom is more of a bubble, and that it will soon burst.
Nowadays, Templeton works full-time as a philanthropist; donating about $40m a year to "discovering how religion can influence the physical world", says Lyford Cay in Financial Intelligence Report. However, he remains dedicated to his first vocation: "the study of investments", says Cay. And thanks to his close study of the markets, his "timing has been impeccable".Templeton took short positions in dotcom and tech stocks at the very height of the 1990s boom and managed to make himself another fortune in the process.
So how does he choose which stocks are going to make him money? Templeton's first rule is to do the opposite of the crowd. He moved to the Bahamas 32 years ago, and found that not being in the middle of the market buzz meant that he didn't accidentally follow everyone else's investment ideas.
Unpopular stocks aren't necessarily bad stocks, says Templeton; they may just be unfashionable, and therefore cheap (unlike the dotcoms in 1999). Finding this kind of value is his main criteria. By looking at companies' market capitalisation (share price times number of shares in issue) and then calculating the intrinsic value (what he believes the company's assets and the market are really worth), he spots ones that are trading too cheaply. As Templeton's foundation website points out, "standard stock-buying advice is buy low, sell high'". But he followed the advice to the extreme picking companies, industries and even nations that were at rock bottom levels, or "points of maximum pessimism", as he puts it.
Templeton's next step was to assess the risk. Stocks might be at bargain prices, but the risk that "somebody might do something stupid" may be too high, he told Cay. Over the years, his combined interest in value and risk has lead him to invest all over the world if he were to make one criticism of Warren Buffett, it would be that he is "small-sighted. If he had spent more time in foreign nations, he would be better off," he told Cay. Templeton, on the other hand, loves to invest abroad. At present, for its combination of good value and low risk, Templeton's favourite country is South Korea but he is also looking around in China, Russia and Canada.
His advice to smaller investors is to take the same approach. "Invest in a well-managed mutual fund focusing on nations and industries where share prices are not so high," he told SmartMoney. One place that doesn't currently fit the bill? The US. Indeed, Templeton told Cay that he doesn't "remember a time when you had to search so diligently to find anything that was a bargain" in America.
What the gurus might buy now
If you followed Peter Lynch's strategy, what might you invest in now?In America, the answer might be debt-collection firm Portfolio Recovery Associates (NASDAQ: PRAA), says the Motley Fool website. In the UK, it might be recruitment company Northern Recruitment (LSE: NRG), saysPeter Temple in the FT. And in China, it might be Sinopec Shanghai Petrochemical Co (NYSE: SHI), one of China's largest producers of ethylene, according to a stock screening done by Validea.com.
Buffett has recently bought a "significant" stake in Anheuser-Busch (NYSE: BUD), the world's largest brewer, and the price has risen as a result. But given that he has as ever invested for the very long term, the shares may still be worth a look. Otherwise, Validea.com's screens suggest that those using his investment strategy would like Factset Research Systems (NYSE: FDS), which provides global financial information, as well as insurance brokerage firm, Hilb, Rogal & Hobbs Co (NYSE: HRH).
Graham's much-followed techniques would suggest that Cooper Tire & Rubber (NYSE: CTB), which designs and makes tyres, would have caught his eye, as would the car manufacturer Nissan (NASDAQ: NSANY), says the Motley Fool website. The stock screen on Validea.com suggests that Graham might have considered buying into the steel boom via Mittal Steel (NYSE: MT).
Sir John Templeton
Templeton recently recommended the Korean car manufacturer Kia Motors to Lyford Cay in the Financial Intelligence Report as one day being bigger than General Motors, so we know that he likes that, at least. Otherwise, Fortune magazine recently followed his strategy and identified Vodafone Group (LSE: VOD), the world's number-two wireless phone company, as suiting his criteria. He himself suggested that an investment fund he likes is the Matthews Asia-Pacific fund, which invests more broadly across Asia than most of the funds that focus on that region, says SmartMoney.
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