Common strategies of the market greats

Whoever said “history repeats itself” must have found out the hard way that success comes to those who heed the lessons of the past.

We’ll end our studies on the investing styles of Benjamin Graham, Peter Lynch, John Neff, Philip Fisher, Gary Pilgrim, Warren Buffett and William O’Neil with a summary of the common elements in their respective strategies that contributed to their record of successful performances.

Automate

The first significant element is to automate one’s investment strategy.  This is not to be mistaken with the quantification of investment analysis for, as they have shown, “stock selection is more than quantification.”

This simply meant the need to lay down one’s investment criteria into clear logical terms as a protection against inherent emotional weakness.

The six market greats we studied knew this very well: Oftentimes, critical judgment weakens and false hopes govern in the absence of a system.  During this time, emotion may take control and it “usually lead investors to go into risky gambles.”

This was what Benjamin Graham talked about when he said “automation and measurable criteria give us something stable to fall back on when we get confused by bold headlines and great stories.”

Emotions, he explained, could make us feel that the market would go up just when we wanted it to go up or go down when we wanted it to go down.  But this is not going to happen.  The market will go up or down no matter what we feel. Our emotions make us mistake idle hope from intelligent action.

To avoid the influence of emotion, Gary Pilgrim uses a computer ranking system to find great stock picks.  If you will remember, it was Pilgrim who declared that “computer rankings and insistence on strong numbers keep emotions at bay.”

Peter Lynch, who seemed to be more conceptual than concrete in his investment system compared to the five other legendary masters, had his objectives clearly defined and measurable. He categorizes his company picks and assigns a number of characteristics that would make up his choices of what he fondly calls “perfect companies.”

William O’Neil, the last in our study, is probably the ultimate believer of automation. If you will remember, the only basis of his decision to buy a stock is the presence of all the seven attributes he specified in his investment system.  Not even the presence of a majority of the attributes is enough to convince him to buy a stock.

Certainly, his insistence on the use of a systematic basis of decision-making has led him to a long record of successes.

Strong financial numbers

Next, but not necessarily the second in importance, is to look for strong income statements and balance sheets. Strong financial positions are clear and unmistakable testimony as to how a company is managed.  They also reveal how the company makes money.

Investors are advised to avoid companies with low profit margins and lots of debts.  Excessive debts are killers, according to them.  “Like big debts that make life tragic to people trying to make ends meet, big debts kill companies trying to make a profit.”

What is clearly preferred are companies with high profit margins.  This is because “a high profit margin means the company keeps more of what it earns,” to quote one of them.

This is further illustrated in the following example: “If two companies sell $10 million worth of products each and one company spends $8 million to do it while the other spends only $4 million, you’d rather own the second company.”

In addition, they are unanimous on companies with good cash and cash flow.  As stated by one of them, “You would rather own a company that has a lot of cash on hand than a company that has a little.  Having a big bank account also means a company can easily expand its business or buy state-of-the-art equipment that could further enhance its comparative advantage over competitors, pay unexpected expenses and buy back its own stocks.  Buying back own shares usually lead to rise of share prices.”

In addition to these, they suggest to further subject the financial statements of the companies of their choice with additional measures of profitability, efficiency and growth that approximates the profile of market winners in the past.

These are the P/E ratio, price-to-book, dividends yield, price-to-sales ratio, relative price strength, sales and earnings acceleration rates.

Other considerations

Conduct thorough research.  Good decisions are better guided by good information and this can only come from hard work.

Invest, as well, in businesses you are familiar with.  In selecting a stock, it is better to approach it with the attitude that you are “buying business not picking stocks.”

This is not just a Buffett approach.  This is also reflected in the investment styles of the other market greats.   Peter Lynch said, in effect, that when you make your investment decisions with this as basis “you’d know the answer why you’re buying and you’d also know why you’re selling.”

Last but not the least, aside from making your own computations, you should also look at other analysts’ estimates.  Compare them with the stock’s current price.  Between the two prices, always buy below the market’s estimated value potential.

This is true for both value and growth stocks.  The primary objective of buying a value stock is to buy it below its current intrinsic value and when buying a growth stock, you must buy it below its expected value.

Bottom line spin

In my previous column, I said “last week’s trading results may just spell the market’s new trend.”

The statement gives the impression that the market will soon be on a new upward trend.  This also seemed to be corroborated  by the trading results for the weeks that ended Sept. 13 and 20.  The weekly gains were rising.  The market gained 158.62 points or 2.65 percent and 291 points or 4.75 percent, respectively.  However, the market fell last week, incurring a weekly loss of 86.04 points or 1.48 percent.

Along with other internal and external factors, it looks like the market is not yet about to have a new direction.  It is rather seen to stay on its sideways to downward trend for the time being.

(The writer is a licensed stockbroker of Eagle Equities Inc.  You may reach the Market Rider at [email protected], [email protected] or at www.kapitaltek.com)