Jim Slater, who died last week aged 86, was a well-liked, if controversial, figure in the investment world. As a corporate raider in the 1960s and 1970s he grew his investment vehicle Slater Walker to be worth more than £200m, only to see his empire implode during the mid-1970s property and banking crash. He went on to rebuild his fortune (for more, see our recent profile).
But among private investors, he was best known as a stockmarket guru, both as a spectacularly successful share tipster for The Times (in the two years from the launch of his column in 1963, his tips gained nearly 70%, compared to less than 4% for the wider market, reports The Daily Telegraph) and as a writer of several books on investing, most notably The Zulu Principle: Making Extraordinary Profits from Ordinary Shares.
Slater used a range of indicators to guide his decisions. As the Monevator blog puts it, "Slater was a self-made man back when the City was still dominated by old school ties, and he was systematic about his stockpicking when the culture was still to buy on tips from those supposedly in the know'". His rules boil down to four broad core principles. The first is "growth at a reasonable price" which you find using his PEG ratio (see below). The other three are listed below.
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Elephants don't gallop
One of Slater's best-known quotes was "elephants don't gallop". In his very first article for The Times, he warned readers that there would be "no blue chips" tipped in his column. His reasoning was that it was far easier for a small company to deliver rapid growth: "Mammoth companies rarely double their market capitalisation in a year. By contrast, small companies often do this and more."
Many studies have confirmed the "small cap" effect JP Morgan, for example, recently found that small caps have outperformed across virtually every global market over the last ten years. However, it's worth remembering that smaller firms tend to be less liquid and have higher trading costs. Slater himself suggested that at least 20% of an investor's portfolio should be in bigger firms because of this.
Concentration matters
Slater also urged investors to specialise in a few companies and avoid over-diversification. This was "The Zulu Principle" the idea that an investor can gain an edge simply by knowing more on a specific topic than most of their peers. And on this front, the data backs Slater.
As we've pointed out several times (most recently here), studies suggest that most of the gains from diversifying within an equity portfolio come from the first 15 to 20 shares. Adding more shares over and above this only reduces volatility by a small amount, while diluting your portfolio with low-conviction stocks. Indeed, one 2012 study by Danny Yeung suggested that if fund managers simply invested in their 20 largest, presumably highest-conviction, holdings and ditched the rest, they would have beaten the market by 4% a year on average.
This also echoes Warren Buffett's admonition that investors should act as if they can only buy 20 stocks in their entire lifetime as much as anything else, it's a strong reminder to understand what you're buying and do your research before you invest in anything.
Watch what the bosses are doing
Slater also felt it was important to look at whether directors are investing in their own company, or selling up fast. This makes sense. Directors are better informed than most private investors, and while there are many legitimate reasons for insiders to sell holdings such as a need for cash to pay divorce bills it is generally a sign that things aren't going well.
Similarly, if directors are putting their own money into the company, then it is a sign that things may be about to pick up. One 2001 study found that between 1975 and 2001, small stocks with at least three insiders buying shares outperformed the wider market. However, this effect didn't work for larger companies.
The PEG ratio does it work?
Slater liked fast-growing companies, but didn't want to pay too much for them. So he devised his own measure the PEG ratio. This divides the price/earnings (p/e) ratio by the stock's expected percentage growth rate (so a firm with a p/e of ten, growing at 10% a year, would have a PEG of one). The idea was to find stocks that were cheap relative to their rate of growth.
But as we have noted before, the PEG's utility as a predictor of future returns is shaky evidence suggests it's no better than the p/e on its own. That said, other well-known managers,such as Peter Lynch and Warren Buffett, have had tremendoussuccess with the "growth at a reasonable price" approach. It'salso worth noting, says The Daily Telegraph's Richard Evans,that Slater included the caveat that "the company should alsobe able to show consistent growth in profits in at least four outof five years".
Other rules such as cash flow being higher thanprofits would also have helped to winnow out stocks likelyto run into trouble. But perhaps it's better to view the PEG asa useful reminder to consider both momentum (growth) andvalue (cheapness) when picking stocks to investigate further.
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