One Up On Wall Street

Stocks vs. Bonds: The Long-Term Champion

Stocks are the long-term champion over bonds. Despite the ups and downs of the stock market, equities have consistently delivered superior growth for building wealth compared to bonds.

The book highlights how even in the worst-case scenario of a severe 20-year recession, an all-stock portfolio would still match the value of a $100,000 bond. This demonstrates the power of equity investing to outperform fixed-income assets over the long haul.

While stocks may experience periodic corrections and volatility, the key is to stay invested. Trying to time the market by moving in and out of stocks is a losing strategy. Investors who can weather the market's storms and maintain a disciplined, long-term approach to equities are the ones most likely to achieve their financial goals.

Here are the key examples from the context that support the insight that stocks have consistently outperformed bonds over the long-term:

• The context states that even in a "severe recession that lasts 20 years", with dividends and stock prices only increasing at half the normal 8% rate, an all-stock portfolio would still end up being worth $100,000 - equal to owning a $100,000 bond. This shows the long-term resilience of stocks compared to bonds.

• The context contrasts a scenario where a portfolio loses 25% of its value overnight due to a market correction. However, it notes that "20 years later, your portfolio will be worth $185,350, or nearly double the value of your erstwhile $100,000 bond." This illustrates the superior long-term growth potential of stocks over bonds.

• The context states that even if an investor had invested in the "best performing funds" over 3, 5, or 10 year periods, they would have still lagged the S&P 500 index. This suggests that passive, long-term investment in stocks outperforms active fund management strategies.

The key concepts reinforced are the long-term outperformance of stocks over bonds and the resilience of stocks to market volatility and corrections. The examples highlight how stocks can weather short-term downturns to deliver superior growth over the long run compared to bonds.

Empowering Amateur Investors

The key insight is that amateur investors can beat the market by following a disciplined investment approach focused on understanding companies, rather than chasing hot stocks or relying on market predictions.

The author argues that the rise of mutual funds and financial celebrities has led many individual investors to abandon stock-picking, believing they cannot compete with Wall Street "geniuses." However, the author shows that up to 75% of mutual funds fail to match market averages, proving that professional expertise is not a guarantee of success.

In contrast, the author outlines principles that empower amateur investors to outperform the market, such as: focusing on the fundamentals of companies rather than short-term stock movements, maintaining a concentrated portfolio of 5-12 well-understood stocks, and avoiding knee-jerk reactions to market volatility. The key is developing an investment strategy based on deep research and patience, not speculation.

The author's own experience managing the Magellan fund demonstrates that an amateur investor, armed with diligence and a long-term mindset, can identify overlooked growth opportunities and generate market-beating returns. This underscores the potential for disciplined individuals to succeed as stock pickers, even without Wall Street credentials.

Here are some examples from the context that support the key insight about empowering amateur investors:

• The author states that "the observant amateur can find great growth companies long before the professionals have discovered them." This suggests that with diligent research, non-professionals can identify promising investment opportunities before market experts.

• The author describes how he was able to identify the success of discount retail clubs like Costco and Wholesale Club before Wall Street analysts were covering them. He says "Employees and shoppers in these stores could have seen the evidence of prosperity with their own eyes, and learned the same details that [the author] did. The alert shopper has a chance to get the message about retailers earlier than Wall Street does, and to make back all the money he or she ever spends on merchandise—by buying undervalued stocks." This shows how amateur investors can leverage their firsthand knowledge to make profitable investments.

• The author emphasizes that "it only takes a handful of big winners to make a lifetime of investing worthwhile." This suggests that amateur investors don't need to match the performance of professional fund managers, but can still achieve significant returns by focusing on a few promising companies.

• The author states that "if you study 10 companies, you'll find 1 for which the story is better than expected. If you study 50, you'll find 5. There are always pleasant surprises to be found in the stock market—companies whose achievements are being overlooked on Wall Street." This highlights how amateur investors can uncover hidden gems through diligent research.

The Virtue of Investing Patience

Patience is the key to successful investing. Investors must be willing to hold onto stocks for the long-term, even through market downturns, in order to reap the rewards. Frequent buying and selling, driven by fear or impatience, is a recipe for failure.

The book emphasizes the importance of regular investing, where investors contribute to their portfolios on a consistent schedule, regardless of market conditions. This steady, disciplined approach allows investors to capitalize on market recoveries and avoid the pitfalls of trying to time the market.

Additionally, the book advises focusing on a manageable number of companies that you understand well, rather than constantly chasing the latest hot stock. Deeply understanding a few investments is more valuable than superficial knowledge of many. This patience and focus allows investors to weather market storms and benefit from long-term growth.

The message is clear - successful investing requires patience, discipline, and a long-term mindset. Investors who can resist the urge to panic or chase short-term gains will be positioned to truly prosper over time.

Here are examples from the context that support the key insight about the virtue of investing patience:

• The book states that "fund managers and athletes have this in common: they may do better in the long run if they're brought along slowly." This suggests that patience and gradual progress are important for success, rather than rushing into new investments.

• The author describes his early days managing the Magellan fund, when he was "preoccupied with getting rid of my predecessor's favorite selections and replacing them with my own picks." However, he notes that this constant buying and selling was not as successful as his later "buy-and-hold strategy" of maintaining positions over time.

• The author emphasizes the importance of "investing regularly" as one of his "Agnes chorus" principles, rather than trying to time the market. He states that "the person who never bothers to think about the economy, blithely ignores the condition of the market, and invests on a regular schedule is better off than the person who studies and tries to time his investments."

• When discussing the "January effect" of smaller stocks rebounding after tax-loss selling, the author advises "buying stocks from the low list in November and December during the tax-selling period and then holding them through January." This demonstrates the value of patience and riding out temporary market dips.

• The author cautions against the "common practice of buying, selling, and forgetting a long string of companies," instead advocating for "confining your buying and selling to these" core holdings that you have learned about over time. This reinforces the importance of patience and long-term investing.

Diversification Over Speculation

Diversify, Don't Speculate

Investing in a manageable number of companies is a better strategy than constantly buying and selling a long string of stocks. When you invest in just a few companies, you can really understand their business, industry, and performance. This allows you to make informed decisions about when to buy, hold, or sell.

In contrast, speculating by frequently trading many different stocks is unlikely to succeed. It often leads to losing money by selling too late or too soon. Investors who do this tend to avoid looking at the stocks they previously owned, unable to face the emotional pain of seeing a stock they sold go up in value.

Instead, diversify your portfolio across at least a few different stocks or stock funds. This helps mitigate the risks of any one investment performing poorly. Diversification gives your investments time to succeed, rather than constantly chasing the next hot stock. With a diversified portfolio, you can afford to be patient and let your superior investments pay off over the long run.

Here are examples from the context that support the key insight of diversification over speculation:

• "Don't pick a new and different company just to give yourself another quote to look up in the newspaper or another symbol to watch on CNBC! Otherwise, you'll end up with too many stocks and you won't remember why you bought any of them."
• "Getting involved with a manageable number of companies and confining your buying and selling to these is not a bad strategy."
• "The more common practice of buying, selling, and forgetting a long string of companies is not likely to succeed."
• "You should own a few different kinds of funds, with managers who pursue different styles of investing: growth, value, small companies, large companies, etc. Investing in six of the same kind of fund is not diversification."
• "The easiest approach is to divide up your money into six equal parts, buy six funds, and be done with the exercise. With new money to invest, repeat the process."

The context emphasizes the importance of diversification across a manageable number of companies or funds, rather than speculating with too many different stocks. It cautions against the common pitfall of constantly buying and selling a large number of stocks, which is unlikely to succeed. The examples highlight the benefits of a diversified portfolio to mitigate risks and enhance the potential for stable returns.

Leveraging Direct Company Research

The book highlights the power of direct company research as a key investing strategy. Rather than relying solely on secondary sources like analyst reports or financial news, the author emphasizes the importance of engaging directly with company executives and operations.

This approach allows the investor to uncover unique insights that may be overlooked by the broader market. By visiting company sites, speaking with management, and gathering firsthand information, the author was able to develop a deeper, more nuanced understanding of a business's strengths, weaknesses, and growth prospects.

For example, the author recounts how conversations with insurance industry leaders provided crucial context on market dynamics and competitive factors - knowledge that gave him an edge in identifying undervalued insurance stocks. Similarly, direct interactions with corporate representatives across various sectors helped the author stay ahead of emerging trends and identify promising investment opportunities.

The takeaway is that going beyond surface-level analysis and actively cultivating company-level intelligence can be a powerful differentiator for individual investors. By taking the time to conduct this hands-on research, the author was able to uncover hidden value and make more informed, successful investment decisions.

Here are specific examples from the context that support the key insight of leveraging direct company research:

• The author would have "at least one conversation with a representative of each major industry group, just in case business was starting to turn around or there were other new developments that Wall Street had overlooked." This direct engagement provided an "early-warning system" on industry trends.

• When meeting with company executives, the author found them to be "both objective and candid about the strengths and weaknesses in their own operations." This allowed the author to get a more honest assessment of the company's situation.

• The author met with executives at Aetna, Travelers, and Connecticut General in Hartford, which gave him a "crash course" on the insurance industry and allowed him to "identify the factors that make the earnings rise and fall."

• The author discovered the growth prospects of bank stocks by attending a regional investment conference in Atlanta organized by Robinson-Humphrey, where he started "thinking about banks" outside the conference.

• The author's assistant Will Danoff conducted direct research by "calling the big investment houses" and "contacting the companies directly" to confirm the strong business performance of discount retail companies like Costco, Wholesale Club, and Pace, which the author then invested in successfully.

The key is that the author and his team went directly to the source - the companies themselves - to uncover insights that were often overlooked by the broader market. This hands-on, investigative approach provided a significant informational edge.

Mastering the Art and Science of Stockpicking

Successful stock picking requires mastering both the art and science of investing. The art involves intuition, passion, and a keen eye for spotting promising opportunities. The science involves rigorous research, financial analysis, and a disciplined investment process.

Investors must strike the right balance between these two elements. Relying solely on intuition or "playing the market" is unreliable and often leads to losses. Conversely, an overly analytical approach can cause investors to miss out on valuable insights and underappreciated companies.

The most effective stock pickers blend these complementary skills. They leverage their analytical capabilities to deeply understand a company's fundamentals, financials, and industry dynamics. But they also tap into their intuitive senses to identify hidden gems and spot emerging trends before the broader market.

This blend of art and science allows investors to make informed, strategic decisions. They can identify undervalued companies poised for growth, while also maintaining the patience and discipline to weather market volatility. Mastering this balance is the key to consistent, long-term investment success.

Here are key examples from the context that support the insight that stock picking requires mastering both the art and science:

• The author states that stock picking "is both an art and a science, but too much of either is a dangerous thing." He contrasts those who are "infatuated with measurement" and have their "head stuck in the sand of the balance sheets" with those who view stock picking as pure "intuition and passion" without doing research.

• The author describes his own stock picking method as involving "elements of art and science plus legwork" - a balanced approach.

• He criticizes those who believe stock picking is just about having a "knack" and following "hunches", saying this viewpoint leads to neglecting research and results in losses. He argues that "to study the subject is futile" is an unfair perspective.

• The author keeps detailed notebooks to track the "continuing sagas" of companies he has invested in, blending quantitative and qualitative analysis to make informed decisions about when to buy or sell.

• When reviewing past stock recommendations, the author considers not just the price changes, but also whether the underlying "story" and fundamentals of the company have changed to warrant a new investment.

In summary, the context emphasizes that successful stock picking requires both analytical rigor (the "science") and intuitive judgment (the "art"), with the author advocating for a balanced approach that combines quantitative and qualitative factors.

Quotes

Let's take a look at some key quotes from "One Up On Wall Street" that resonated with readers.

The trick is not to learn to trust your gut feelings, but rather to discipline yourself to ignore them. Stand by your stocks as long as the fundamental story of the company hasn’t changed.

Effective investing requires discipline and objectivity, rather than relying on emotional instincts. It's essential to separate feelings from facts, focusing on a company's underlying fundamentals rather than personal biases. By doing so, investors can make informed decisions and avoid impulsive mistakes, ultimately leading to more successful investments.

Know what you own, and know why you own it

Having a clear understanding of your investments is crucial for making informed decisions. It's essential to be aware of the companies you've invested in, their business models, and the reasons behind your investment choices. This knowledge enables you to make rational decisions, avoiding impulsive actions driven by emotions or market fluctuations. By being informed, you can confidently hold onto your investments through market ups and downs.

People who succeed in the stock market also accept periodic losses, setbacks, and unexpected occurrences. Calamitous drops do not scare them out of the game.

Investors who thrive in the stock market understand that losses and setbacks are an inevitable part of the game. They don't let fear or panic dictate their decisions, even when faced with sudden and drastic changes in the market. Instead, they maintain a calm and level-headed approach, recognizing that such events are temporary and that the market will eventually recover.

Chapter Notes

Introduction: Escape from Bondage

• Stocks are more profitable than bonds, CDs, and money-market accounts: The author argues that putting money into stocks is far more profitable than putting it into bonds, certificates of deposit, or money-market accounts. This is evidenced by the fact that the stock market has outperformed these other investment options over the long term, even during bear markets and recessions.

• Declining investment in stocks: The author notes that the percentage of household assets invested in stocks has been declining steadily, from nearly 40% in the 1960s to only 17% in 1990, despite the fact that the stock market has been performing well. This is a "calamity for the future of individual and national wealth" that needs to be addressed.

• Importance of investing in stocks: The author emphasizes that if you want to have more money tomorrow than you have today, you need to put a significant portion of your assets into stocks. While there may be periods of bear markets and recessions, the long-term trend has been for stocks to outperform other investment options.

• Overcoming investor hesitation: The author acknowledges that some investors may be hesitant to invest in stocks due to the potential for short-term losses, but argues that this should not deter them from investing in the stock market, as the long-term benefits outweigh the short-term risks.

Chapter One: The Miracle of St. Agnes

Here are the key takeaways from the chapter:

• Investing in Stocks vs. Bonds: The author argues that over the long-term, investing in stocks has significantly outperformed investing in bonds. He cites data showing that a $100,000 investment in the S&P 500 would be worth $25.5 million after 64 years, compared to only $1.6 million for long-term government bonds. He concludes that "gentlemen who prefer bonds don't know what they're missing."

• Amateur Stockpicking Ability: The author provides evidence that amateur investors, including a group of 7th grade students at St. Agnes School and members of investment clubs sponsored by the National Association of Investors Corporation (NAIC), have been able to outperform professional mutual fund managers over extended periods of time. He attributes this to their simpler, more disciplined investment approaches focused on understanding the companies they invest in.

• Importance of Diversification: The author highlights the "Rule of Five" advocated by the NAIC, which recommends holding a portfolio of at least 5 stocks. This diversification helps mitigate the risk that one or two stocks in the portfolio will underperform, while allowing investors to benefit from the outperformance of their best investments.

• Disciplined, Long-Term Investing: The author emphasizes the importance of investing regularly over the long-term, rather than trying to time the market. He cites calculations showing the substantial benefits of consistently investing $1,000 per year in the S&P 500, as well as adding additional investments during market downturns.

• Avoiding Emotional Investing: The author warns against the "skittish investor" who gets "flushed out of the market by the brush beaters of doom." He argues that successful investing requires the ability to ignore short-term market worries and volatility in order to allow investments time to succeed.

• Importance of Understanding Investments: The author praises the approach of the St. Agnes students, who were only allowed to invest in companies they could explain and understand. He contrasts this with the tendency of many professional and amateur investors to be drawn to complex, opaque investments they don't fully comprehend.

Chapter Two: The Weekend Worrier

Here are the key takeaways from the chapter:

• Weekend Worrying: The chapter discusses the phenomenon of "weekend worrying" among a panel of investment experts, where they spend time discussing and debating the state of the economy and the potential for market crashes or recessions. This tendency to focus on negative news and potential disasters can lead investors to make poor decisions.

• Importance of Discipline and Faith in Investing: The author emphasizes the importance of maintaining discipline and faith in the stock market, even in the face of negative news and market declines. He argues that successful investors must be able to block out their own distress signals and focus on the long-term potential of the market.

• Historical Performance of Stocks: The author presents data showing that over the long-term, stocks have outperformed other investment options like bonds and CDs, despite the numerous "reasons the world might be coming to an end" that have occurred during this period. This historical performance should provide investors with confidence in the market.

• Overcoming Post-Crash Trauma: The author suggests that the cultural memory of the 1929 stock market crash continues to keep many investors away from the stock market, even though subsequent crashes have not led to economic collapses. He argues that this "post-crash trauma syndrome" has been costly for investors who have missed out on decades of stock market gains.

• Buying on Bad News vs. Good News: The author cautions against the common investment advice to "buy at the sound of cannons, sell at the sound of trumpets." He argues that buying on bad news can be a costly strategy, and that it is often healthier to wait for proof of good news before investing.

• Evaluating Potential Investments: The author provides examples of his process for evaluating potential investments, including analyzing a company's financial statements, speaking with management, and looking for reasons the company's performance may improve in the future.

• Importance of Free Cash Flow: When evaluating a company that makes frequent acquisitions, the author emphasizes the importance of analyzing the company's free cash flow, which can be obscured by accounting practices related to goodwill.

Chapter Three: A Tour of the Fund House

Here are the key takeaways from the chapter:

• Mutual Fund Proliferation: The number of mutual funds has grown exponentially, from 452 funds in 1976 to over 3,500 funds today, across a wide variety of categories (e.g. equity, bond, money market, sector, country, etc.). This has made it increasingly difficult for investors to choose the right funds.

• Asset Allocation: The author emphasizes the importance of the initial decision on the mix of stocks and bonds in a portfolio, as this has a major impact on long-term returns. He argues that most investors err on the side of income (bonds) and shortchange growth (stocks).

• Stocks vs. Bonds: Stocks have historically outperformed bonds over the long-term, with an average annual return of 10.3% compared to 4.8% for long-term government debt. This is because as companies grow, their stockholders benefit from increased profits and dividends.

• Retiree Dilemma: Retirees who rely primarily on bonds and CDs are finding it difficult to maintain their standard of living due to low interest rates and inflation. The author suggests they need to increase their allocation to stocks to generate sufficient growth.

• Diversification: The author advocates a diversified portfolio approach, investing in a mix of fund types (e.g. value, growth, sector, index) to ensure exposure to different market segments and mitigate the risk of any one fund or style underperforming.

• Passive vs. Active Management: The author notes that the majority of actively managed equity funds fail to outperform the market indexes, suggesting that passive index funds may be a better option for many investors.

• Sector Funds: Sector funds allow investors to target specific industries, but the author cautions that they can be risky if used speculatively, and are best suited for investors with deep knowledge of a particular sector.

• Closed-End and Country Funds: These specialized fund types offer exposure to specific markets or regions, but the author notes they often carry higher fees and can be subject to market sentiment swings that cause their prices to deviate from the underlying net asset value.

• International Investing: The author is skeptical of the perceived superiority of foreign markets and companies compared to their U.S. counterparts, citing issues with transparency, analyst coverage, and market manipulation in many non-U.S. markets.

Chapter Four: Managing Magellan: The Early Years

Here are the key takeaways from the chapter:

• Flexibility and Empirical Stockpicking: Peter Lynch did not have an overall investment strategy for the Magellan Fund. Instead, he adopted a flexible, empirical approach, going "sniffing from one case to another like a bloodhound" and buying stocks across a wide range of industries based on the specific details and stories of each company. This allowed him to find undervalued opportunities that other more constrained fund managers may have missed.

• Importance of On-Site Research: Lynch placed a strong emphasis on conducting his own on-site research, visiting companies' headquarters and facilities to get a firsthand understanding of their operations, products, and competitive positioning. This hands-on approach allowed him to identify promising investment opportunities, such as Taco Bell and Home Depot, that were overlooked by the broader market.

• Patience and Long-Term Holding: In retrospect, Lynch realized that he was too quick to sell some of his winning investments, such as Albertson's, Toys "R" Us, and Federal Express, instead of holding them for the long term. He refers to this as "pulling out the flowers and watering the weeds," a common mistake among investors.

• Underappreciated Regional Banks: Lynch was particularly impressed by the growth and profitability of regional banks, which he felt were consistently undervalued by the broader market. He invested heavily in regional banks like Wachovia, Norwest, and NBD Bancorp, which went on to become significant winners for the Magellan Fund.

• Importance of Corporate Access: Lynch took advantage of Fidelity's policy of hosting regular meetings and meals with corporate executives, which provided him with valuable insights and information about various industries and companies. This direct access to management teams gave him an informational edge over other investors.

• Patience in Building a Track Record: Lynch benefited from the fact that Magellan was closed to new investors for the first four years of his tenure, allowing him to build a track record and make mistakes without being in the public spotlight. He believes this "obscurity" was a blessing, as it enabled him to learn the trade and develop his investment approach without undue pressure.

Chapter Five: Magellan: The Middle Years

Here are the key takeaways from the chapter:

• Fidelity's Culture of Hard Work: Fidelity was a no-nonsense institution where employees, including fund managers, arrived early and worked long hours. Ned Johnson, the firm's leader, encouraged this culture of hard work.

• Importance of Keeping Track of Investment Decisions: Peter Lynch kept a notebook to record his interactions with companies and the rationale behind his investment decisions. He emphasized the importance of maintaining such a record to avoid forgetting the reasons behind past investment choices.

• Leveraging a Team of Researchers: Magellan was not a one-man show. Lynch had a team of talented assistants who conducted their own research, enabling him to be informed about a wider range of companies and investment opportunities.

• Fidelity's Approach to Research and Accountability: Fidelity required its fund managers to conduct independent research, rather than relying solely on the recommendations of analysts. This approach led to more thorough investigation and held fund managers accountable for their investment decisions.

• Sharing Ideas and Avoiding Criticism: Lynch encouraged a collaborative environment where fund managers and analysts shared investment ideas without fear of criticism. He believed that open criticism could undermine confidence and lead to missed opportunities.

• Patience and Long-Term Investing: As Magellan grew, Lynch became a more patient investor, holding positions for longer periods and reducing the fund's annual turnover rate. He recognized the potential for sustained growth in certain industries, such as retail and restaurants.

• Investing in Overlooked and Undervalued Stocks: Lynch was willing to invest in companies that were not widely followed by other portfolio managers, as he believed these "off-the-beaten-path" stocks offered greater potential for appreciation.

• Adapting to Market Conditions: Lynch adjusted Magellan's portfolio allocation based on his assessment of market conditions, rather than following a rigid investment strategy. For example, he increased his holdings in long-term government bonds when their yields exceeded the dividend yield of the S&P 500 by a significant margin.

• Contrarian Approach to Investing: Lynch was willing to invest in companies that were widely perceived as risky or facing challenges, such as Chrysler, when he believed the market was overly pessimistic about their prospects.

• Handling Fund Growth and Popularity: As Magellan's assets grew rapidly, Lynch adapted his investment approach to maintain a diversified portfolio and find new opportunities, even as the fund's size made it more challenging to build large positions in smaller companies.

Chapter Six: Magellan: The Later Years

• Diversification vs. Focus: The chapter discusses the debate around whether a large fund with a large number of stocks can outperform the market. The author argues that an "imaginative fund manager" can pick a diverse portfolio of 1,000 or more stocks and still outperform, as opposed to a more limited portfolio of 50 widely-held stocks.

• Small Positions and Opportunities: The author explains that many of the 900 stocks in Magellan's portfolio were small positions, either because the companies were quite small or because the author wasn't fully convinced about them. However, these small positions sometimes led to great opportunities, such as the author's investment in discount retail clubs after learning about their strong jewelry sales from a small position in Jan Bell Marketing.

• Importance of Research and Direct Contact: The author emphasizes the importance of doing thorough research, including directly contacting companies, to uncover investment opportunities that Wall Street has overlooked. This allowed him to identify the strong performance of discount retail clubs before Wall Street analysts were covering them.

• Industry Bets vs. Stock-Picking: The author discusses two approaches to making "industry bets" - deliberately allocating a certain percentage to a sector, or carefully selecting individual stocks within a sector. He prefers the latter, more research-intensive approach, over the former "dart-throwing" method.

• Avoiding Liquidity Concerns: The author argues that fund managers who avoid smaller, less liquid stocks miss out on potential opportunities. He believes that if a company is a good investment, the liquidity of the stock is not a major concern, as a patient investor can unwind the position profitably over time.

• Global Investing: The author was an early domestic fund manager to invest heavily in foreign stocks, particularly in Europe, where he found undervalued large companies that were not well-followed by Wall Street analysts.

• Hands-On Research Approach: The author describes his extensive research trips to Europe and Japan, where he met directly with company executives and immersed himself in understanding the businesses, rather than relying solely on financial reports.

• Flexibility and Adaptability: As Magellan's assets grew rapidly, the author had to continuously adjust his investment approach, such as building up positions gradually over time rather than making large, overnight purchases. He also had to adapt his vacation and travel plans to accommodate his fund management responsibilities.

Chapter Seven: Art, Science, and Legwork

Here are the key takeaways from the chapter:

• Stockpicking is a Combination of Art and Science: Stockpicking involves both intuition and analysis. Relying too heavily on either the "art" or "science" aspect can be detrimental. The ideal approach balances both elements.

• Importance of Doing Homework: Successful stockpicking requires thorough research and understanding of the companies being considered. Relying solely on financial data or "gut feelings" is not enough.

• Focusing on a Manageable Number of Stocks: It's better to deeply understand a smaller number of companies rather than trying to track a large portfolio. This allows an investor to monitor their holdings more effectively.

• Reviewing Past Investments: Revisiting previous stock recommendations, even ones that were sold, can provide valuable insights and identify potential opportunities to reinvest.

• Identifying Overpriced Stocks: Comparing a stock's price to its earnings line can quickly reveal if a stock is overvalued and likely to stagnate or decline, even in a rising market.

• Exploiting Tax-Selling Periods: The end-of-year tax-selling period can create opportunities to buy smaller stocks at depressed prices, which then tend to rebound in the following January.

• Avoiding Emotional Attachment to Stocks: Investors should overcome the tendency to avoid looking at stocks they previously owned, even if the stock has risen since they sold it. This emotional attachment can prevent recognizing new investment opportunities.

• Importance of Detailed Record-Keeping: Maintaining thorough records on past stock selections and the rationale behind them helps an investor stay informed and make more thoughtful decisions going forward.

Chapter Eight: Shopping for Stocks: The Retail Sector

Here are the key takeaways from the chapter:

• Retail Stocks as Investment Opportunities: The author highlights the Burlington Mall as a great place to identify potential investment opportunities in the retail sector. Retail companies that have experienced significant growth, such as Home Depot, The Limited, The Gap, and Walmart, have provided substantial returns to investors over time.

• Importance of Customer Insights: The author emphasizes the value of observing customer behavior and preferences at retail stores, as well as listening to the insights of family members and friends who are avid shoppers. This can provide valuable information about which companies and products are resonating with consumers.

• The Body Shop as a Case Study: The author discusses his experience visiting a Body Shop store at the Burlington Mall and the subsequent research he conducted on the company. Key points include the company's focus on natural ingredients, its franchise-based expansion model, and its strong financial performance despite the recession.

• Evaluating Growth Stocks: The author notes that while the Body Shop had an attractive growth profile, its high price-to-earnings (P/E) ratio of 42 was a concern. He suggests that a good rule of thumb is for a stock's P/E ratio to be at or below its growth rate, as very high P/E ratios can be unsustainable.

• The Importance of Patience in Retail Investing: The author highlights the example of Walmart, which continued to grow and provide substantial returns to investors even after its initial public offering and significant stock price appreciation. He emphasizes the importance of being patient and allowing retail companies to fully develop their growth potential before investing.

• Factors to Consider in Retail Investing: Key factors to consider when evaluating retail stocks include same-store sales growth, debt levels, adherence to expansion plans, and the company's ability to replicate its success in new markets. As long as these factors remain positive, the author suggests that it is often worthwhile to hold on to retail stocks.

Chapter Nine: Prospecting in Bad News: How the “Collapse” in Real Estate Led me to Pier 1, Sunbelt Nursery, and General Host

Here are the key takeaways from the chapter:

• Quiet Facts Can Reveal Opportunities: The author found that the quiet facts, such as the rising median house price and the favorable affordability index, told a different story than the prevailing negative narrative about the real estate market. This led him to identify undervalued companies like Toll Brothers that were poised to benefit from the eventual housing market recovery.

• Act Quickly on Bargains: The author notes that bargains in the stock market don't last long, as other investors quickly identify and buy up undervalued stocks. He missed out on recommending Toll Brothers because the stock price quadrupled before he could publish his recommendation.

• Pier 1 Benefiting from Housing Recovery: The author believed that Pier 1, a home furnishings retailer, would benefit from the eventual housing market recovery, as new homeowners would need to furnish their homes. Pier 1 was cutting costs, improving profit margins, and well-positioned for growth.

• Sunbelt Nursery's Potential as a National Chain: The author saw Sunbelt Nursery, a lawn and garden retailer, as having the potential to become a national chain, similar to how Dunkin' Donuts transformed the donut industry. Sunbelt was well-positioned in key markets and had a strong balance sheet.

• Evaluating General Host's Balance Sheet: The author conducted a detailed analysis of General Host's balance sheet, examining the reliability of its assets, the level of debt, and the company's cost-cutting efforts. He determined that the company's book value was likely accurate and that the stock was undervalued.

• Comparing Similar Companies to Estimate Value: The author used the valuation of Calloway's Nursery, a similar company, to estimate the potential value of General Host's Frank's Nursery chain, which he believed was undervalued by the market.

Chapter Ten: My Close Shave at Supercuts

• Supercuts is a franchise-based haircut chain: Supercuts is a nationwide franchise operation that provides quick and efficient haircuts, similar to the "McTrim of barbershops". The company has over 650 stores already established and is rapidly expanding.

• Supercuts targets the male market: The author notes that over 80% of Supercuts' clientele are male, while 95% of the stylists are female. This suggests Supercuts has positioned itself to cater to the male market for haircuts.

• Supercuts' business model is highly profitable: The company's franchise model allows for rapid expansion without excessive borrowing, as the capital to set up new stores comes from the franchisees. Additionally, each Supercuts store is highly profitable, generating a 50% pre-tax return on equity within two years of operation.

• Supercuts stylists are licensed professionals: Unlike fund managers, haircutters in the US are required to be licensed and undergo regular training, which the author sees as a positive for the quality and consistency of Supercuts' services.

• The author's personal experience at Supercuts was mixed: While the author was initially impressed by Supercuts' business model and prospects, his personal experience of getting an overly aggressive haircut left him dissatisfied with the in-store experience, despite still liking the stock.

• Supercuts faces competition from other chains: The author identifies Supercuts' main competitors as Regis Corporation (Mastercuts), Fantastic Sam's, and J.C. Penney's unisex salons. However, Supercuts is seen as having an advantage due to its focus on the male market, extended hours, and national advertising campaign.

• The author's investment thesis on Supercuts: Despite his personal experience, the author ultimately recommended Supercuts stock based on its strong financial performance, growth potential, and the favorable industry dynamics of a fragmented haircut market with a declining number of independent barbers.

Chapter Eleven: Blossoms in the Desert: Great Companies in Lousy Industries

Here are the key takeaways from the Chapter:

• Never hold on to a losing stock: The author emphasizes that it is shameful to hold on to a stock or buy more of it when the fundamentals are deteriorating. He avoided this mistake and sold his losing stocks rather than adding to them as they headed towards bankruptcy.

• Pay attention to bond prices: The author notes that when a company's bonds sell for a fraction of their par value (e.g., $20 for a $100 bond), it is a sign of deep trouble and the stock is likely to be worth even less.

• Cyclical stocks are risky: The author lost money on cyclical stocks like Chrysler and Eastman Kodak, noting that "Cyclicals are like blackjack: stay in the game too long and it's bound to take back all your profit."

• Technology stocks are challenging: The author acknowledges that he "never had much flair for technology" and lost significant amounts on technology stocks like Digital, Tandem, and IBM.

• Great companies in lousy industries: The author prefers to invest in great companies in lousy, slow-growing industries rather than popular, fast-growing industries. These companies are low-cost operators, avoid debt, and find overlooked niches.

• Southwest Airlines as a model: Southwest Airlines is highlighted as a great company in the lousy airline industry, with a focus on being the low-cost operator, avoiding excessive executive compensation, and maintaining a motivated workforce.

• Bandag, Cooper Tire, and other examples: The author provides several other examples of great companies in lousy industries, including Bandag (retreads), Cooper Tire (replacement tires), Green Tree Financial (mobile home loans), Dillard (department stores), and Crown Cork & Seal (cans).

• Nucor and the steel industry: Nucor is highlighted as a successful steel company that has thrived by being a low-cost producer, avoiding debt, and sharing profits with its non-unionized workforce.

• Shaw Industries and the carpet industry: Shaw Industries is presented as a dominant player in the carpet industry, growing rapidly by being the low-cost producer and acquiring competitors as the industry consolidates.

• Opportunities in the S&L industry: The author identifies several "Jimmy Stewart-type" S&Ls and "born-again" S&Ls as attractive investment opportunities, noting that their excess equity and lending capacity make them attractive acquisition targets for commercial banks.

Chapter Twelve: It’s a Wonderful Buy

Here are the key takeaways from the chapter:

• Types of S&Ls: The chapter identifies three main types of S&Ls:

  • The Bad Guys: S&Ls that perpetrated fraud, such as by taking in deposits at high interest rates and then lending the money to friends and associates for dubious construction projects.
  • The Greedy Guys: S&Ls that got caught up in the pursuit of profits, borrowing heavily from the Federal Home Loan Bank to invest in risky commercial real estate deals.
  • The Jimmy Stewarts: Conservatively-run S&Ls that stuck to traditional residential mortgage lending, avoided risky investments, and maintained strong financial positions.

• Characteristics of Successful S&Ls: The chapter highlights the key characteristics of the successful "Jimmy Stewart" S&Ls:

  • Maintain a high equity-to-assets (E/A) ratio, typically above 7.5%, indicating strong financial strength.
  • Concentrate their lending on traditional residential mortgages rather than commercial real estate or construction loans.
  • Keep overhead and expenses low by avoiding lavish spending on things like fancy offices and advertising.
  • Provide good customer service at the branch level to build a loyal deposit base.

• Investing in Undervalued S&Ls: The chapter outlines a framework for identifying potentially undervalued S&L stocks:

  • Look for S&Ls trading below their initial public offering price, as this may indicate the stock is undervalued.
  • Prioritize S&Ls with high E/A ratios, as this is the most important measure of financial strength.
  • Avoid S&Ls with high levels of high-risk real estate assets, such as commercial loans and construction loans, which have been problematic.
  • Look for S&Ls with low levels of nonperforming assets and real estate owned, indicating they have avoided major loan defaults.
  • Focus on S&Ls with low price-to-earnings (P/E) ratios, as this suggests the stock may be undervalued.

• Analyst Coverage: The chapter notes that S&Ls tend to have relatively little analyst coverage compared to larger companies, which can create opportunities for investors to identify undervalued stocks that the market has overlooked.

Chapter Thirteen: A Closer Look at the S&Ls

Here are the key takeaways from the chapter:

• Calling companies before investing: The author usually calls companies before investing in them to gather more information and improve his odds of making a good investment. This increases his phone bill but pays off in the long run.

• Understanding the S&L business model: An S&L needs loyal depositors, the ability to lend out deposits profitably, and low operating expenses to maximize profits. Bankers like to "live on threes and sixes" - borrow at 3%, lend at 6%, and play golf at 3%.

• Glacier Bancorp: This S&L had low non-performing loans, was growing through acquisitions, and had a conservative commercial lending portfolio focused on multi-family housing. The author was impressed by the company's performance.

• Germantown Savings: This prudent S&L had a "fortress balance sheet", low loan losses, and was being conservative in its lending. The author believed it would outlive many of its competitors.

• Sovereign Bancorp: This S&L was focused on residential mortgages, had a low level of non-performing loans, and was using the proceeds from a stock sale to acquire other troubled thrifts. The author liked its conservative approach.

• People's Savings Financial: This S&L had a high equity-to-assets ratio, was buying back its own shares, and was operating in a depressed economic environment, which the author saw as a positive.

• First Essex and Lawrence Savings: These "born-again" S&Ls had fallen on hard times due to commercial real estate losses, but the author saw them as potential turnaround opportunities if the commercial real estate market stabilized.

• The "cash-in-the-drawer" opportunity: When a mutual S&L or savings bank goes public for the first time, the proceeds from the stock sale go directly back into the institution, effectively doubling its book value. This creates an opportunity for investors to get a bargain.

• Remarkable performance of recent S&L IPOs: The author provides data showing that recent IPOs of mutual S&Ls and savings banks have produced remarkable returns, with many doubling or tripling in value within a short period of time.

• Opportunity to participate in future S&L IPOs: The author encourages readers to open accounts at mutual S&Ls and savings banks in their local areas, as this will entitle them to participate in the IPO when the institution eventually goes public.

Chapter Fourteen: Master Limited Partnerships: A Deal with a Yield

Here are the key takeaways from the chapter:

• Master Limited Partnerships (MLPs): MLPs are publicly traded companies organized as limited partnerships. They distribute all their earnings to shareholders, either as dividends or as a return of capital. The dividends are usually high, and a portion of the annual distribution is exempt from federal tax.

• Negative Perception of MLPs: Due to the bad publicity from failed tax-shelter partnerships in the past, MLPs continue to suffer from "guilt by association" and are often overlooked by investors, particularly fund managers, who are deterred by the extra paperwork required.

• Characteristics of Successful MLPs: Successful MLPs tend to be involved in down-to-earth, mundane activities like running amusement parks, selling auto parts, or owning shopping malls. They often have romantic-sounding names that seem out of sync with modern business.

• EQK Green Acres MLP: This MLP, which owns a large enclosed mall on Long Island, caught the author's attention due to its high dividend yield (13.5%) and the fact that its stock price had dropped during the "Saddam Sell-off" in 1990. The author visited the mall, checked the vacancy rates, and found the company's fundamentals attractive, despite some concerns about its highly leveraged balance sheet and vulnerability to a recession.

• Challenges Facing MLPs: MLPs that were created for tax-shelter purposes in the past must be closed out by 1997-98, at which point they will lose their tax benefits. This could lead to a significant drop in earnings for some MLPs, from $1.80 to $1.20 per share, which is something investors need to be aware of in the coming years.

Chapter Fifteen: The Cyclicals: What Goes Around Comes Around

Here are the key takeaways from the chapter:

• Cyclical Stocks: Cyclical stocks, such as those in the aluminum, steel, paper, auto, chemical, and airline industries, tend to rise and fall in a predictable pattern with the business cycle. Investing in cyclicals requires careful timing, as the market often anticipates the recovery of these industries before it actually occurs.

• Price-to-Earnings (P/E) Ratio: For cyclical stocks, a low P/E ratio is not necessarily a good sign, as it may indicate that the company is at the end of a prosperous period and its earnings are about to decline. Conversely, a high P/E ratio can signal that a cyclical company is emerging from a downturn and its earnings are poised to improve.

• Phelps Dodge: The author invested in Phelps Dodge, a copper mining company, because he believed the price of copper was likely to rebound. He analyzed the company's balance sheet, cash flow, and diversified business segments to determine that it was well-positioned to weather the downturn and benefit from an upturn in copper prices.

• Auto Industry Cycles: The author discusses the cyclical nature of the auto industry, noting that periods of pent-up demand (when actual sales lag behind the trend) are often followed by periods of strong sales growth. He used this "pent-up demand" indicator to time his investments in auto stocks.

• General Motors (GM): The author decided to invest in GM, despite its poor reputation in the 1980s, because he believed the market was overly pessimistic about the company's prospects. He noted that GM's non-automotive businesses, such as GMAC and Hughes Aircraft, were performing well and could help offset weakness in its core U.S. auto operations.

Chapter Sixteen: Nukes in Distress: CMS Energy

Here are the key takeaways from the chapter:

• Utility Stocks as Income Investments: Utility stocks have traditionally been attractive for investors seeking income, as they often provide steady dividends that tend to increase over time, as well as the potential for capital gains.

• Troubled Utilities as Opportunities: The author has had success investing in "troubled" utility companies that have faced issues such as nuclear plant problems or financing challenges. These companies often see their stock prices plummet, but can then recover and provide significant returns for investors who buy in at the right time.

• The "Troubled Utility Cycle": The chapter outlines a four-stage "troubled utility cycle" identified by analysts at NatWest Investment Banking Group, which describes the typical pattern of a utility company facing a major crisis, going through a period of cost-cutting and financial stabilization, and eventually recovering and returning to profitability.

• CMS Energy (Consumers Power) Case Study: The author provides a detailed analysis of CMS Energy (formerly Consumers Power), a utility company that faced significant challenges after building an expensive nuclear plant that it was not allowed to operate. The author ultimately recommends the stock, citing the company's strong cash flow, low-cost gas-fired generation, and potential for regulatory relief.

• Investing in Distressed Utilities: The author suggests that a successful strategy for investing in troubled utilities is to buy their stocks when the dividend is omitted, and hold until the dividend is restored, as this has historically proven to be a "strategy with a terrific success ratio."

• Importance of Regulation: The author notes that utilities are heavily regulated, and that the regulatory environment is a key factor in determining the success or failure of a troubled utility. Supportive regulators can help a utility overcome its challenges and return to profitability.

Chapter Seventeen: Uncle Sam’s Garage Sale: Allied Capital II

Here are the key takeaways from the chapter:

• Privatization of government-owned assets can be a good investment opportunity: When governments privatize state-owned assets like utilities, telecommunications companies, and other industries, the shares are often underpriced, leading to significant gains for investors. This has been the case in countries like the UK, where privatized companies like British Telecom and British Airways have performed well.

• Partial-paid shares can amplify investment returns: Some privatization deals, like the British water utilities, offered "partially paid shares" where investors only had to pay a portion (e.g., 40%) of the share price upfront. This allowed investors to earn a high dividend yield (e.g., 20%) on their initial investment in the first year, even if the share price remained flat.

• Privatization of state-owned enterprises in emerging markets can be lucrative: The author highlights the success of investing in privatized telephone companies in countries like Mexico and Spain, which were able to rapidly grow their networks and customer bases after being privatized.

• Allied Capital II is leveraging the Resolution Trust Corporation (RTC) to profit from the S&L crisis: Allied Capital II, a publicly traded venture capital firm, is using its pool of capital to purchase loans from the RTC that were made by failed savings and loan (S&L) institutions. This allows them to earn a spread between the interest they pay on their own borrowings and the interest they receive on the acquired loans.

• Investing in privatized assets requires due diligence: The author cautions that not all privatization deals are created equal, and that investors should carefully evaluate the fundamentals of the companies being privatized, such as their growth prospects, management, and financial condition.

Chapter Eighteen: My Fannie Mae Diary

• Fannie Mae's Transformation: Fannie Mae underwent a major transformation in the early 1980s, shifting from a company that was vulnerable to interest rate fluctuations to a more stable and profitable enterprise. This transformation was driven by two key changes:

  a. Mortgage-Backed Securities: Fannie Mae began packaging mortgages into mortgage-backed securities, which it could then sell to banks, insurance companies, and other investors. This allowed Fannie Mae to pass on the interest rate risk to these new buyers and earn fees for the packaging service.

  b. Matching Borrowing and Lending: Fannie Mae started offering longer-term bonds to match the duration of the mortgages it held, reducing its exposure to interest rate swings.

• Fannie Mae's Competitive Advantages: Fannie Mae had several key advantages over traditional banks and financial institutions:

  a. Lower Overhead: Fannie Mae had a much lower overhead compared to banks, with a payroll of only 1,300 people spread across four offices, compared to the thousands of branches maintained by large banks.

  b. Cheaper Borrowing: As a quasi-governmental agency, Fannie Mae could borrow money more cheaply than banks, corporations, or other financial institutions.

  c. Profitable Spread: Fannie Mae could earn a 1% spread on its mortgage portfolio by borrowing at 8% and lending at 9%, which was a highly profitable margin that most banks could not achieve.

• Peter Lynch's Investment Approach: Peter Lynch's investment approach with Fannie Mae illustrates several key principles:

  a. Continuous Research and Monitoring: Lynch closely followed Fannie Mae's progress over several years, regularly speaking with company executives and tracking key metrics like delinquency rates and mortgage-backed security volumes.

  b. Patience and Conviction: Despite periods of skepticism and volatility in Fannie Mae's stock price, Lynch maintained his conviction in the company's long-term potential and steadily increased his position over time.

  c. Identifying Transformative Changes: Lynch recognized Fannie Mae's shift from a cyclical, interest rate-dependent business to a more stable, fee-generating enterprise, and adjusted his investment thesis accordingly.

• Fannie Mae's Outsized Contribution to Magellan's Performance: Fannie Mae became one of the largest and most profitable positions in the Magellan Fund, generating over $500 million in profits for the fund over a five-year period. This underscores the potential impact a single, well-researched investment can have on a portfolio's overall performance.

• Lessons from Fannie Mae's Losses: While Fannie Mae was a hugely successful investment for Magellan, Lynch also discusses some of Fannie Mae's losses, particularly related to the Texas real estate market. This highlights the importance of understanding a company's risk exposure and the need to continuously monitor for potential problems, even in otherwise strong businesses.

Chapter Nineteen: Treasure in the Backyard: The Colonial Group of Mutual Funds

Here are the key takeaways from the chapter:

• Missed Opportunity in Mutual Fund Companies: The author missed investing in several top-performing mutual fund companies like Dreyfus, Franklin Resources, Colonial Group, T. Rowe Price, etc. during the late 1980s, which would have outperformed 99% of the funds they promoted.

• Investing in Mutual Fund Companies vs. Their Products: During periods when mutual funds are popular, investing in the companies that sell the funds is likely to be more rewarding than investing in their products. This is similar to the "Gold Rush" analogy where the people who sold picks and shovels did better than the prospectors.

• Profitability of Mutual Fund Companies: Mutual fund companies that specialize in bond and equity funds (e.g., Eaton Vance and Colonial) are exceptionally profitable when interest rates are declining, as more cash flows into these funds. Conversely, companies like Dreyfus that manage money-market assets do well when interest rates are rising, and people are moving out of stocks and long-term bonds.

• Missed Opportunity in 1991: The author failed to recommend any mutual fund companies to the 1991 Barron's panel, missing the rebound in stocks like Franklin, Dreyfus, T. Rowe Price, United Asset Management, Colonial Group, and State Street Bank, which nearly doubled in value that year.

• Investing in Colonial Group: Despite the 40% appreciation in Colonial Group's stock in 1991, the company was still selling for the same price as its 1985 IPO, with a stronger financial position and no debt. The author saw this as an undervalued opportunity within an attractive industry group.

• State Street Bank's Mutual Fund Venture: State Street Bank, a major provider of "back office" services to the mutual fund industry, decided to start its own mutual funds but hired Colonial Group to market them, as it did not want to compete directly with its clients.

Chapter Twenty: The Restaurant Stocks: Putting Your Money where your Mouth Is

• Restaurant Stocks as Profitable Investments: The chapter highlights how restaurant stocks, such as Kentucky Fried Chicken, Dunkin' Donuts, and McDonald's, have been highly profitable investments, with some stocks becoming "millionaire makers" for investors who recognized their potential early on.

• Factors Driving Restaurant Stock Success: The chapter identifies several factors that have contributed to the success of restaurant stocks, including the rise of fast food and people eating on the go, the ability of restaurant chains to expand across the country without facing significant competition from abroad, and the importance of capable management, adequate financing, and a methodical approach to expansion.

• Importance of Expansion Pace: The chapter contrasts the experiences of Chili's and Fuddrucker's, highlighting that while rapid expansion can lead to problems, a more measured pace of growth (30-35 new units per year for Chili's) can result in steady revenue, sales, and net income growth.

• Key Metrics for Evaluating Restaurant Stocks: The chapter outlines the key metrics to consider when evaluating restaurant stocks, including growth rate, debt levels, and same-store sales. It also notes that Montgomery Securities provides excellent analysis on the restaurant industry.

• Emerging Trends in the Restaurant Industry: The chapter suggests that the momentum in the restaurant industry is shifting away from fast food chains towards niche restaurants and medium-priced family restaurants that offer a varied menu, as the baby boomer generation moves away from fast food.

• Spotting Potential Winners: The chapter highlights Au Bon Pain as a potential winner, citing its combination of French sensibility and U.S. efficiency, its ability to grow during a recession, and its potential for overseas expansion. The chapter suggests that investors should look for companies with a 25% growth rate trading at 20 times earnings or less.

Chapter Twenty-One: The Six-Month Checkup

Here are the key takeaways from the chapter:

• Regular Portfolio Checkups: Even for blue-chip stocks, a "buy-and-forget" strategy can be unproductive and dangerous. Investors should conduct regular six-month checkups to assess whether a stock is still attractively priced and whether the company's story has improved, worsened, or remained unchanged.

• The Body Shop: The Body Shop's stock price had fallen 12.3% due to negative publicity, but the company's fundamentals remained strong, with increasing same-store sales and earnings. The author decided to increase his investment in the company.

• Pier 1 Imports: Pier 1 Imports had strengthened its balance sheet, reduced debt and inventory, and continued to expand, positioning it well for the eventual economic recovery. The author believed the stock was undervalued.

• General Host and Sunbelt Nursery: General Host had issued convertible preferred stock, which diluted earnings for existing shareholders. Sunbelt Nursery had lost money due to unfavorable weather, but the author believed Calloway's, the industry leader, was a better investment opportunity.

• Supercuts: The author was concerned about Supercuts' rapid expansion and the potential overhang of a large block of shares owned by Drexel Burnham Lambert's creditors.

• Savings and Loan (S&L) Stocks: The author's S&L picks had performed very well, with several stocks up over 40%. He highlighted First Federal of Michigan as a new opportunity, as it was lagging the other S&Ls due to unfavorable interest rate contracts.

• Colonial Group: The author believed Colonial Group, a specialist in bond funds, would benefit from the influx of money into bond funds if there was a stock market downturn.

• CMS Energy: The author was cautious about CMS Energy due to the uncertainty around the public service commission's rate decision, which could lead to a significant drop in the stock price.

• Master Limited Partnerships (MLPs): The author highlighted Sun Distributors and Tenera as MLP opportunities, with Tenera's consulting business showing signs of improvement.

• Fannie Mae: The author believed Fannie Mae's stock was undervalued, as the company continued to grow its mortgage-backed securities portfolio and maintain low delinquency rates despite the housing recession.

• Cyclical Stocks: The author was cautious about Phelps Dodge, as the easy money had already been made, but remained optimistic about General Motors and Chrysler, the latter of which he believed was undervalued.

25 Golden Rules

Here are the key takeaways from the chapter:

• Investing Requires Work: Investing is exciting but also dangerous if you don't do any research or work to understand the companies you're investing in.

• Leverage Your Existing Knowledge: Your "investor's edge" comes from your existing knowledge and understanding of certain companies or industries, not from Wall Street experts. You can outperform the experts by investing in what you already know.

• Ignore the Herd: The stock market is dominated by professional investors, but you can beat the market by ignoring the herd and investing in companies you understand, rather than following the crowd.

• Focus on the Company, Not the Stock: The long-term success of a stock is directly correlated with the success of the underlying company, even if there is no short-term correlation.

• Know What You Own: You need to thoroughly understand the companies you invest in and why you own them. Vague justifications like "this stock is sure to go up" are not enough.

• Concentrate, Don't Diversify: Owning a small number of companies (5-12) that you understand well is better than over-diversifying. Long shots and hot stocks are more likely to miss the mark.

• Prioritize Financial Health: Never invest in a company without understanding its financial situation and balance sheet. The biggest losses come from companies with poor financial health.

• Patience and Discipline: Investing requires patience and discipline. Avoid panic selling during market declines, which can be great opportunities to buy. Ignore short-term predictions and focus on the long-term fundamentals of the companies you own.

• Leverage Time: Time is on your side when you own shares of superior companies. Even if you miss the initial run-up, you can still benefit from long-term growth.

• Mutual Funds for Passive Investors: If you don't have the time or inclination to research individual companies, invest in a diversified portfolio of equity mutual funds with different investment styles.

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