To make money in the stock market, you must have “the vision to see them, a courage to buy them and the patience to hold them. Patience is rarest of the three.
The author Thomas Phelps was a private investor, columnist and financial advisor. His illustrious career began just before stock market crash of 1929 lasted into 1970’s. He wrote this books – in 1972, based on his experience and observation about stock market returns. Many of his observation relevant today, even after 40 + years he wrote them first.
There are very powerful wisdom in this book (published in 1972) packed in very few sentences. I have tried to pick up these snippets here, as they are.
Overarching theme of the book
This is a story – fact, not fiction- of hundreds of opportunities to make a millions dollar in stock market by investing in stock market by investing $10000 in just one stock and holding on.
Starting with 1932 anyone could have made a millions dollar on $10000 investment in a different stock in each of 32 different years, of which 1967 was the latest. To do it would have required neither the luck nor the skill to sell out at the right time. Every one of the more than 360 different stocks that could have been bought for $10000 in 32 of the last 40 years was worth a million dollar or more in 1971. All that was required was to pick one of the hundreds of the right one and hold on.
Stock Selection and market timing:
Investor tend to look for the right time to buy/sell stocks . Looking at historic prices, it is tempting to think that shares can be bought at low price and sell at high price- but waiting for the market timing is a mirage. Here is apt advice from the author:
Some will argue, as I have argued for many years, that good timing plus good selection is better than either alone. But bear market smoke gets into one’s eyes and blind him to buying opportunities if he too intent on making timings and more successful one is at market timing, the greater the temptation to rely on it and this miss the greater market opportunities in buying right and holding on.
To clinch the argument, it is readily demonstrable that far more money can be made by good stock selection than by good stock market timing.
Warren buffet has advised to focus on stock selection and he not to worry about macroeconomic development in the world. When asked about how he and Charlie Munger, his business partner, choose investments, Buffett responded, “Charlie and I don’t pay attention to macro forecasts. We’ve worked together for 50+ years, and I can’t think of a time when they influenced a decision about stock or a company.” Buffett has also referred to macroeconomic literature as “the funny papers.”
Eternal truth about stock’s attractiveness
The big risk in correcting errors in the stock market is that stocks look best to so many of us when the prices are highest, and worst when their prices are lowest.
The ability to foresee the future is rare, the ability to rationalize the present too common. Hence when the stock we bought after careful investigations declines in price we often find it less attractive than before.
Sound advice for achieving superior return:
Wise investor do not buy a stock just because it is going up or it expected to go up. Wise investor buy because they foresee an increase in earning and dividend that will make today’s price look cheap in years to come. Even the wisest sometimes misjudge the future of earning and dividend. Only fools- and perhaps some professional short term trader- buy without giving that future a thought.
Virtue of PATIENCE
As a saying goes – Patience is a virtue, have it if you can, seldom found in women, never found in man.
Anyone who can hold on in the face of all the advise and temptation to make sure of a profit demonstrate a quality of mind quite out of ordinary.
Trading Vs Buy and hold
If one can buy right, no amount of trading or switching thereafter is likely to produce results equal to what he can have by simply holding on . By doing so he avoids the paperwork, brokerage commission, and capital gain taxes. He loses the fun of trading, of matching his hunches about what the market will do tomorrow against the hunches of everyone else who is trading, the self satisfaction of making a fast buck out of thin air
Catching swing in the market, even when one is reasonably successful at it, makes pennies compared with dollars garnered by those who buy right and hold on.
Buying Growth stocks
There are various snippets across the book talking about investing in growth stock. Here are few:
- Money is made buying anything that is going to worth more in the future than one has to pay for it now. Since the past is visible to all, th4ere is seldom much capital gain in buying stocks that continue to earn in future what they have earned in the past. Everyone can see the past. Hence the stock that faithfully earn nest year what they have earned last year tend to be fully priced. That can also be stocks whose earning continue to grow if the prospect of that continued growth is apparent to all. The only way to make more than the going rate of return on your capital is to buy value not apparent to most people at the time you buy.
- Because of every stock buyer wants to make money, it is almost a truism that nothing kills a money making opportunity faster than its widespread popularity. This applies just as surely to growth stock as it does to Florida real estate.
- It is true that time is on the side of the growth stock buyer if the growth and the expectation of the growth continues.
- Growth stock are highly attractive if they continue to grow as fast as or faster than they have been growing and if the buyer continue to expect them to continue to grow as fast or faster and if the rate at which future earning and dividend must be discounted does not increase materially. There are three if’s
- When you pay in advance for the earning of a stock to triple or quadruple, as you do when you buy it at three to four time PE ratio of DJIA, you should foresee not only the growth you are paying for but further above average growth beyond that. This means you must evaluate the competitive states of the company not as it today as it will be six to eight years from now, when it is three to four times bigger.
- But one does not have to be a financial geniuses to realize that when he buys a stock at a very high relative PE he is paying someone hard cash now for what is hoped for in the rather distinct future.
Hope and Expectations
Of times more than half of the rise in price of stock is due to a change in investor psychology .Paying attention to the psychological content of any stock price advance is important for two reasons:
- What goes up on a rise in investor expectations can do down on a fall in those expectations. Both can occur without any change in reported earning.
- It is rare for a PE ratio much more than 4 time DJIA. Hence, when a stock sells at PE of 60 when DJIA is selling at PE of 15, the prospective buyer is on notice
a- That his optimism about the stock future is widely shared
b- that the changes of a further rise in the price of the stock due to further rise in it’s relative e PE rations are relatively slim.
There has been lot of research on after the book was written on the role of psychology of the market participants on the market, it is called Behavioural Science/Behavioural finance. But his observation about people’s behaviour is as relevant today as it was 50 years back.
Importance of Buying right
Buying right will do you little good unless you hold on. But holding on will do you little good- any may do you a great harm- unless you have bought right.
Example- Wipro is a Indian IT company listed in Indian stock exchanges and NYSE. It has been a huge beneficiary of shifting trend of offshoring in IT support and services. Following table provide information about few data point in 2000 and 2015.
|Year 2000||Year ending 31 March 2015|
|Share price||678 (on 21 Feb 2000)||545 (as on 8 Feb 2016)|
|Net Profit (Cr)||248||8652|
After 2000, Wipro sales increased by 15 times, net profit by 35 times, but the share price has not moved up, in fact it is down. This is because WIPRO had a very high PE of 123 in 2000, which has come down over the years to 14 PE. It is another example of Warren Buffett quotes “Market is a voting machine in a short term but a weighing machine in a long term.”
Mathematics of 100x
None of the 100 to one fortune makes stocks of the last ten years were selling at high PE when opportunity beckoned. Their great price advance resulted from a compounding of earning gains by multiplier gains. Earning rose and so did the market price of each dollar of those earning. 
Assume that a company you selected has current PE and EPS information and you hold it for 20 years. Another assumption (just to prove a point) is that earning of the company increase by 18% over next 20 year.
|Yeas 1||Year 20|
|Earning Per share||10||273||Compounded annual growth of 18%|
There are various ways in which the company can provide 100x return.
Share prices = PE * Earning shares.
Change in share prices
= change in PE (number of times) * Change in EPS (number of times)
= 4 * 27
= 108 times.
As per above example, 100x can be achieved when earning multiple (PE) increased 4 times and EPS increased 27 times during the time. Again, this is not an impossible situation as consistent increase in earning improves the earning multiple for a stock.
100x can also be achieved by the stock, who’s earning multiple is constant but earning per shares increased by 100 times during the holding period.
However, selecting the stock with low multiple is not the only option.
This (selecting stock with low multiple) does not mean that it is impossible to make 100 to 1 in a stock bought at a high PE. It simply means that you must foresee much greater earning growth to warrants a hundredfold increase when you can count of little or no help from rising multiplier)
Hunting ground for 100x
Bet on a men and organization fired by zeal to meet human needs and wants., imbued with enthusiasm over solving mankind’s problem. Good intention are not enough, but when combined with emery and intellect the result make it unnecessary to seek profit. They some as serendipity divined on a well managed quest for a better world. 
Warren buffet call them intelligent fanatics.
- The investor should be influenced by only one factor- assurance that the company has the power to earn profit for a good many years. Financial statements give little indication of earning power. Piles of brick and stone mean nothing. Profits are rewards of human spirit and high endeavor- of great leadership.
- Perhaps the greatest advantage of all in buying top quality stocks without visible ceiling on their growth is that when we do so, we give ourselves the chance to profit by the unforeseeable and the incalculable.. Year after year mankind achieves the impossible but persist in underrating what it can and will do in the future.
- One of everyman primary investment objective should be to make as much money as possible while paying as little as possible while paying as little taxes as possible under whichever laws are in effect at the time. I can think of no more effective tax heaven than unrealized appreciation in a long-lived, soundly growing company.
The book has many pearls of wisdom. Warren Buffet was just starting his carrier when this book was published, but this guy had already figured out holy grail of investing before that and this book testimony to that.
This book is well worth a read and should be part of value investor’s library.
- Warren Buffet on Macroeconomics (http://www.investopedia.com/ask/answers/032615/should-investors-care-more-about-microeconomics-or-macroeconomics.asp#ixzz3zKyTPlxC)
- Wipro documents (http://www.wipro.com/documents/investors/pdf-files/Wipro-annual-report-2014-15.pdf and http://www.wipro.com/documents/investors/pdf-files/indian_gaap_press.pdf)
- Wipro historic prices (https://uk.finance.yahoo.com/q/hp?s=WIPRO.BO&a=00&b=3&c=1999&d=01&e=8&f=2016&g=d&z=66&y=3960)