Rule #1 Investing, by Phil B. Town

ISBN: 978-2-905-21131-9
Random House Business Books 2007

(Rule #1 is a Trademark of Phil B. Town)

Yes, this actually is one of those books along the line "how to earn a million dollars and become dirty rich", although the time frame of investing is more like 25 to lifetime, with the aim of having a pleasant and carefree retirement.

This is one of the good points about this book, because it gives the reader some relation of not expecting too much too soon. On the other hand the general spirit is that everyone can become a millionaire by applying some simple rules, because we as small private investors have some inherent advantage over large fonds investors. There are some very true and noteworthy points explained very straightforwardly in this book.

I assume that Phil Town has had some major success in his stock investing, becoming a millionaire, but selling a book and speaking to hundreds of thousands of people is a much safer way to a relaxed retirement after all; but this conjecture, I guess, is very common for this kind of literature and line of business, so no surprise here.

Town refers to Benjamin Graham (born Grossbaum) and Warren E. Buffet as being his main influences regarding value investing. He strongly agrees with their approaches to investing, but tries to simplify the whole process, because he doesn't want to claim being a market research genius like those idols, therefore resorting to basic formulas and research.

In the following paragraphs, I'd like to pick out some points that seem important to me.

Ethical investing

This important point, according to my opinion, boils down to meaning in Town's "Four Ms" criteria. In a nutshell, it says that you should only invest in something you understand and you believe in, which maps directly to having lower risks by knowing the business and competitors well, and building a better market by feeling personally responsible for the business you own, instead of just juggling with charts and impersonal numbers without caring what it entails ethically. This is meant in a way like "if everybody would act like that (investing only in what you believe in), there wouldn't be as much and large bubbles, and maybe less people investing in ethically questionable businesses like armament industry or environment-unfriendly production methods". Less fluctuations at the market would of course lower the profit margins and number of opportunities for investors, but on the other hand would stabilize the economy in a way yet unknown which might reduce global losses and speed up overall market development significantly.

General applicability

A critical point in Town's criteria is a company's 10-year average growth rate: Only companies that have a steady and reliable growth in several key numbers like Return On Invested Capital (ROIC), Equity / Book Value Per Share (BVPS), Sales and so on, are considered to have a wide moat (one of Town's "magic" Ms), that have proved to be competitive enough to be considered owning shares from. During my explorations of Town's ideas, I haven't found one single company, of which I can either find enough and reliable data or for which I could confirm such a steady historical growth; and of course just tomorrow everything can change to the worse, even if I found such a Kinder surprise.

So, if after long researching I would have found the perfect company for me, there are many more obstacles to overcome: It not only has to have a steady growth in every respect, at the same time it needs to be undervalued by the market, which seems fairly unlikely taking into account that Town demands at least 15% growth rates.

This being underrated is called Margin of Safety (MOS), a term coined by Graham, and is a tricky thing working like that: By using current Earnings per Share (EPS) and estimated future Equity growth rates, extrapolate future price and earnings. By demaning a minimal outcome of 15% per year, we can calculate back at what price we must buy the shares to have a 50% MOS now. This helps setting us a (non-automatic) buy-limit for the next years, until eventually (if not immediately) the price is so low that we are safe to buy, unless some obvious crisis is in the business. Whenever the stock price is or falls below that MOS-price, we are allowed to buy with a much reduced risk of losing something, because we assume the stocks are widely underrated and even if something goes wrong, we won't lose much or still make some marginal win, because in the long term prices in the market will return to their businesses inherent and true price, which is at least the double of what we paid for acquiring the shares, giving us some safety net.

Market timing

Even if you buy businesses as if you own them for lifetime, always check the signs to get out of a stock: Town lists three very simple indicators that can be applied on a daily or weekly basis. This is really simple and always works.

Summary of the book

You can find my short summary of all the book's contents for your convenience here.