The guru investor how to beat the market using historys best investment strategies

( c o n t i n u e d f r o m f r o n t f l ap ) $27.95 USA / $30.95 CAN REESE when you should sell, how many stocks you should own, and much more JACK M FOREHAND, CFA, is President of Validea.com and cofounder of Validea Capital Management, LLC Working in conjunction with John Reese, Forehand led the development of Validea’s investment models as well as the quantitative testing that led to the creation of Validea Capital Management’s consensus portfolios He graduated from the honors program of the University of Connecticut with a BA in economics and is a CFA charterholder z Visit www.guruinvestorbook.com Jacket Design: Paul McCarthy z What can we learn from those rare investors who have consistently generated outstanding returns over the long haul? In an easy-to-read and simple format, The Guru Investor dissects strategies from ten of Wall Street’s greatest investment “gurus” and shows exactly how to implement those strategies to improve your own long-term investment results This book offers a step-by-step guide to the investment methodologies of Warren Buffett, Peter Lynch, Joel Greenblatt, James O’Shaughnessy, David Dreman, John Neff, Benjamin Graham, Ken Fisher, Joseph Piotroski, and Martin Zweig Based on the model portfolio system that the author has developed, each strategy is turned into an actionable system that systematically addresses many of the common mistakes that hurt individual investors’ longterm investment results In addition, The Guru Investor shows how you can combine the proven strategies of these legendary gurus into a disciplined investing system for building and managing portfolios—including the author’s key rules for when to buy, when to hold, and when to sell O GURU INVESTOR JOHN P REESE, MBA, is the founder and CEO of Validea.com and Validea Capital Management He is also portfolio manager for the Omega American and International Consensus mutual funds offered in the Canadian market He is a regular columnist for Forbes com, RealMoney.com, and Israel’s Globes newspaper He holds two patents in the area of automated stock analysis and is a graduate of Harvard Business School and the Massachusetts Institute of Technology A detailed look at the successful strategies used by some of the world ’s best investors The z GURU INVESTOR HOW TO BEAT THE MARKET USING HISTORY’S BEST INVESTMENT STRATEGIES All investors can learn from the thinking, writing, and experience of Wall Street’s greatest investors The Guru Investor, and its free companion Web site—www guruinvestorbook.com—will teach you the lessons of these greats and give you all the tools needed to put those lessons to work in your investment strategy The Forehand ver the past six decades, the U.S stock market has averaged an annual return of about eleven percent per year Yet, except for a few renowned Wall Street gurus, the vast majority of investors, both amateur and professional, fail to come anywhere close to those eleven percent average annual gains Why most investors fail—and what those very successful investment gurus have in common? The Guru Investor identifies the stock picking methodologies developed by some of history’s best and most successful stock market gurus—including Peter Lynch, Warren Buffett, Benjamin Graham, Martin Zweig, John Neff, and others—and shows how you can combine these proven strategies into a disciplined investing system that has been proven to outperform the market John Reese breaks down the very different approaches of each of the gurus—encompassing value, growth, and quantitative investing—and lays out their philosophy and achievements, detailing step-by-step the secret formulas they used to beat the market, while explaining why these legendary investors consider certain factors to be so important when analyzing individual stocks Reese not only discusses the individual gurus, their strategies, and why they are important, but he also explains how to best use these strategies in the real world, showing how to sift through all of the choices to find a strategy that works for you The model portfolio system that the author has developed turns each strategy into an actionable system, addressing many of the common mistakes that doom investors to failure In addition to offering these individual guru-based models, Reese also explains how to combine and implement these approaches into a multi-guru system that will provide you with a comprehensive, practical stock investing strategy with a proven track record He reveals when you should buy, ( c o n t i n u e d o n b a ck f l ap ) ffirs.indd ii 12/15/08 2:23:05 PM The Guru Investor ffirs.indd i 12/15/08 2:23:05 PM ffirs.indd ii 12/15/08 2:23:05 PM The Guru Investor How to Beat the Market Using History’s Best Investment Strategies John P Reese with Jack M Forehand John Wiley & Sons, Inc ffirs.indd iii 12/15/08 2:23:05 PM Copyright © 2009 by John P Reese and Jack M Forehand All rights reserved Published by John Wiley & Sons, Inc., Hoboken, New Jersey Published simultaneously in Canada No part of this publication may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording, scanning, or otherwise, except as permitted under Section 107 or 108 of the 1976 United States Copyright Act, without either the prior written permission of the Publisher, or authorization through payment of the appropriate per-copy fee to the Copyright Clearance Center, Inc., 222 Rosewood Drive, Danvers, MA 01923, (978) 750-8400, fax (978) 646-8600, or on the Web at www.copyright.com Requests to the Publisher for permission should be addressed to the Permissions Department, John Wiley & Sons, Inc., 111 River Street, Hoboken, NJ 07030, (201) 748-6011, fax (201) 748-6008, or online at http://www.wiley.com/go/permissions Limit of Liability/Disclaimer of Warranty: While the publisher and author have used their best efforts in preparing this book, they make no representations or warranties with respect to the accuracy or completeness of the contents of this book and specifically disclaim any implied warranties of merchantability or fitness for a particular purpose No warranty may be created or extended by sales representatives or written sales materials The advice and strategies contained herein may not be suitable for your situation.You should consult with a professional where appropriate Neither the publisher nor author shall be liable for any loss of profit or any other commercial damages, including but not limited to special, incidental, consequential, or other damages For general information on our other products and services or for technical support, please contact our Customer Care Department within the United States at (800) 762-2974, outside the United States at (317) 572-3993 or fax (317) 572-4002 Wiley also publishes its books in a variety of electronic formats Some content that appears in print may not be available in electronic books For more information about Wiley products, visit our web site at www.wiley.com Library of Congress Cataloging-in-Publication Data: Reese, John, 1953The guru investor : how to beat the market using history’s best investment strategies / John P Reese, Jack M Forehand p cm Includes bibliographical references and index ISBN 978-0-470-37709-3 (cloth) Investments Investment analysis—Data processing Capitalists and financiers—United States—Biography Quantitative analysts—United States— Biography I Forehand, Jack M II Title III Title: Best investment strategies HG4521.R368 2009 332.6—dc22 2008040631 Printed in the United States of America 10 ffirs.indd iv 12/15/08 2:23:07 PM To Michael, Daniel, and Heather —John P Reese To Mom, Dad, and Aimee —Jack M Forehand ffirs.indd v 12/15/08 2:23:07 PM ffirs.indd vi 12/15/08 2:23:08 PM Contents Acknowledgements Introduction ix xi Part One Why You Need this Book Chapter Chapter Learn from the Worst The Cavalry Arrives Part Two The Value Legends Chapter Chapter Chapter Chapter Benjamin Graham: The Granddaddy of the Gurus John Neff: The Investor’s Investor David Dreman: The Great Contrarian Warren Buffett: The Greatest Guru Part Three The Growth Legends (With a Value Twist) Chapter Chapter Chapter Peter Lynch: The Star “GARP” Manager Kenneth L Fisher: The Price-Sales Pioneer Martin Zweig: The Conservative Growth Investor 19 31 33 55 73 95 127 129 155 175 vii ftoc.indd vii 12/15/08 2:23:48 PM viii contents Part Four The Pure Quants Chapter 10 Chapter 11 Chapter 12 James O’Shaughnessy: The Quintessential Quant 199 Joel Greenblatt: The Man with the Magic Formula 219 Joseph Piotroski: The Undiscovered Academic 233 Part Five Chapter 13 Chapter 14 From Theory to Practice Putting It Together: The Principles of Guru Investing The Missing Piece: Determining When to Sell Conclusion Time To Take The Wheel Appendix A Performance of Guru-Based 10- and 20-Stock Model Portfolios Appendix B Guru Yearly Track Record Comparison (Actual or Back-Tested Returns) References About the Authors Index ftoc.indd viii 197 247 249 269 279 283 287 295 303 305 12/15/08 2:23:48 PM Index A Accountant Looks at the Market, An (Briske/ Benedikt), 235 Actuarial models, quality, 256 ADR See American Depository Receipt Alger, William R., 73 Allocation, importance (O’Shaughnessy), 203–205 American Association of Individual Investors (AAII), Hulbert article, 259, 262–263 American Depository Receipt (ADR), 226 Amortization, 148 Anderson, Ed (success), 36 Annual earnings persistence, 190 Asset allocation breakdown, O’Shaughnessy examination, 204 Asset plays, Lynch opportunity, 136, 141 Asset turnover, change (Piotroski usage), 244 B Balance sheet, accounting-based measures (Piotroski), 234 Barus, ability, Basic industry, Fisher distinction, 161 Behavioral finance, Benedikt, Allison, 235 Berkshire Hathaway, 26 annual letter, 97, 100, 102 charities, donations, 101 Bernstein, Richard, 271 Bill & Melinda Gates Foundation, 101 Blended strategies, 21–22 Bogle, John (Senate Committee address), Bonaparte, Napoleon, 33 Book-market (B/M) ratios appeal, absence, 236 Piotroski usage, 241 Boroson, Warren, 98 Briske, Patricia, 235 Buffett, Mary, 102–107 Buffett, Warren, 26 appreciation, 100–101 biography, 98–99 Buffett-based model performance, 122–124 business categories, attention, 105–106 buy-and-hold strategy, 102–106 capital expenditures, 113–114 Coca-Cola appreciation, 103–104 company alignment, 110–111 assessment, 110–115 price, attractiveness, 115–122 consumer monopolies, search, 104–105 debt level, 112 305 bindex.indd 305 12/15/08 2:49:18 PM 306 Buffett, Warren, (Continued ) deep-value investors, 21 diversification, disinterest, 110 dividend payout ratio, 117 durable competitive advantage, 103–104 earnings predictability, 111–112 yield, 115–116 enduring moat, 103 EPS, 107 growth method, 120–122 negative level, examination, 111 equity per share, 116–117 equity prediction, 117 examination, 95 free cash flow, 107, 114 future EPS, 118 future equity, conversion, 118 future stock price, 118–120 dividends, inclusion, 119–121 high ROE, 106 initial rate of return, 115–116 Intelligent Investor (Graham), impact, 98–99 investing approach, 96 criteria, 124–125 investor strategy, 102–106 long-term debt, 112 long-term Treasury bond yield, 116 “Meet the Buffetts” (feature), 101 model portfolio risk/return statistics, 124t numbers, 106–109 Oracle of Omaha, 95, 99 percent average ROE after payout, 117–118 performance data, 289t–291t performance explanation, 292 personal style, 96 potential buys, qualities, 102–103 pre-Berkshire Hathaway success, 36 predictability criterion, 111 predicted future returns, averaging, 121–122 quantitative measures, 106–109 realm of confidence, 109–110 retained earnings, 106–107 usage, 114–115 risk, 109 ROE, 106–107 averages, 113 method, 116–117 ROTC, 113 simplicity/sensibility, 97–98 speculation, disinterest, 96–97 bindex.indd 306 index stock prediction, 108 purchase, discrepancy, 123 value, estimation, 108 strategy, 109–122 understanding, 28 success, 20 time horizon, 109 toll bridge companies, 110 track record, 109 trivia, 101–102 wisdom, 99–100 Zweig quote, 97 Buffettology (Buffett/Clark), 22, 102–106, 123 Bull’s Eye Investing (Mauldin), 265 Buy-and-hold investing, 266–267 Buy-and-hold strategy (O’Shaughnessy), 205 C Callahan, Craig, 266 Capital expenditures, Buffett usage, 113–114 Capital expenses, low level (Buffett attention), 106 Capital loss (recognition), inflation/taxes (impact), 81–82 Cash, net income (Piotroski comparison), 242 Cash flow from operations (CF), Piotroski usage, 242 Cash flow per share importance (O’Shaughnessy), 206 O’Shaughnessy usage, 214 Category-specific tests, 146–149 CF See Cash flow from operations Clark, David, 102 Coca-Cola, 96, 103, 105, and 110 durable competitive advantage, 24, 104 Coke, 223 Colvin, Geoffrey, Communications businesses, Buffett attention, 105 Company bargain prices, purchase, 223 business, characteristics (Buffett examination), 110 name, importance, 138 share buybacks, 139 spin-off status, 138–139 Compound interest, usage, 251 Compustat database, O’Shaughnessy usage, 200 Conservative growth strategy (Zweig), 179–181 Consumer monopolies, Buffett search, 104–105 12/15/08 2:49:19 PM Index Consumer services, repetition (Buffett attention), 105 Consumer spending reports, impact, Continuous dividend payments, Graham usage, 50 Contrarian indicators See Dreman Contrarian Investment Strategies:The Next Generation (Dreman), 74 Contrarian Investment Strategies (Dreman), 15–16, 26 postwar crises, identification, 79–80 strategies, existence, 75 Contrarian stocks, identification (Dreman), 83–84 Covenant violations, prevention, 238 Crisis investing, 79 Current quarterly earnings (Zweig), 189 Current ratio change, Piotroski usage, 243 Dreman usage, 88–89 Graham usage, 46–47 Cyclical companies (cyclicals) evaluation, P/CF ratio (usage), 87 Lynch opportunity, 135–136, 141 Cyclical stocks, PSR, 169 Cyclical super stocks, PSR, 171 D Daniel, Kent, 271 Da Vinci, Leonardo, 219 D/E See Total debt-equity Debt-equity ratio Dreman usage, 90–91 importance (Zweig), 183 Debt levels, Buffett usage, 112 Deep-value investors, 21 Defensive investor, 41–42 Depreciation, 148 Discipline, importance, 257–262 Discount brokerages, inexpensiveness (prevalence), 273–274 Discount rate, Zweig examination, 184 Diversification, usefulness, 262–264 Dividend-paying stocks, Windsor focus, 61 Dividend payout ratio, Buffett usage, 117 Dividends company profitability, 61–62 O’Shaughnessy usage, 214–215 yield importance (O’Shaughnessy), 207 O’Shaughnessy usage, 208 ranking (O’Shaughnessy), 214–215 bindex.indd 307 307 Dow Jones Industrial Average (DJIA), movement, 163 Downside volatility cost, 251 limitation, 251–252 Dreman, David, 3, 15, 26 advantage, 77–79 biography, 74–75 contrarian approach, application, 79 contrarian indications, identification, 83–84 contrarian indicators, 78 contrarian strategy, 75–77 current ratio, 88–89 debt-equity ratio, 90–91 Dreman-based model performance, 91–92 earnings surprise, impact, 76 trends, 86–87 EPS growth, 87–88 examination, 73 financial position, 88 fundamental factors, 78 fund/company management, 23 investing criteria, 93–94 investment surprises, impact, 76–77 market cap, 86 model portfolio risk/return statistics, 92t overoptimism, impact, 77 payout ratio, 89 P/B ratio, 85 P/CF ratio, 84–85 P/D ratio, 85–86 P/E ratio, 84 performance data, 289t–291t performance explanation, 292 Piotroski, comparison, 239–240 pretax profit margins, 90 psychology, investing (relationship), 75–77 reaction See Stock market risk, 83 defining, 80–82 ROE, 89–90 stocks, identification, 77–78 strategy, 82–91 time horizon, 83 track record, 82–83 yield, 90 Dreman Value Management, 74 Durable competitive advantage, 24l, 103–104 12/15/08 2:49:19 PM 308 index E E/A See Equity-to-assets Earnings acceleration, 191–192 cost/source, 187 fluctuation, 156 growth, Zweig usage, 190 importance (Zweig), 179–181 persistence, 189–190 See also Annual earnings persistence predictability, Buffett usage, 111–112 predictions, importance, 60–61 stability (Zweig), 189 trend Dreman usage, 86–87 Zweig usage, 189 volatility, 160 yield Buffett usage, 115–116 Greenblatt usage, 221, 230 O’Shaughnessy usage, 209 Earnings before interest and taxes (EBIT), Greenblatt usage, 224, 229 Earnings per share (EPS), 23–24 growth Buffett usage, 107 Dreman usage, 87–88 Lynch usage, 146 measurement, problem, 25 method, Buffett usage, 120–122 Zweig usage, 191 growth rate dividend yield, addition, 61 examination, 25 Neff usage, 66 See also Future EPS growth rate persistence Neff usage, 68–69 O’Shaughnessy usage, 212 projection, problems, 88 Earnings-price (E/P) ratio, Greenblatt usage, 224 Economic growth, impact, “Effect of Myopia and Loss Aversion, The” (Thaler), 259 Efficient market hypothesis, 19–20 Ellis, Charles D., 63 Emerson, Ralph Waldo, 95 Emotions impact, 11–15 reduction, 254–257 inconsistency, 256 short-circuiting, importance, 204 bindex.indd 308 “End of Behavioral Finance, The” (Thaler), 270–271 Enduring moat (Buffett), 103 Enterprise value, Greenblatt usage, 224–225, 230 Enterprising investor, 41–42 Equity funds, collective performance (overstatement), Equity per share, Buffett usage, 116–117 Equity prediction, Buffett usage, 117 Equity risk premium, 15 Equity-to-assets (E/A) ratio, Lynch usage, 145 Expectations, importance, 260–262 Expert Political Judgment: How Good Is It? How Can We Know? (Tetlock), 9, 255 Experts, 8–10 inability, 9–10 predictive ability, 8–9 F Farrell, Chris, 205 Fast-growers advice, 147 EPS growth, 146 examination, 142 Lynch category, 141 P/E/G ratio, 143 P/E ratio, 146 FCF See Free cash flow Feldman, Amy, 270 Financial leverage/liquidity (Piotroski), 237 Financial reporting issues, Piotroski focus, 234 Financial stocks, ratios (Lynch usage), 145 Fisher, Kenneth L., 26 biography, 156–159 causes, focus, 160 company evaluation, 159–160 cyclicals, PSR, 169 earnings volatility, 160 evolution, 164–167 examination, 155 Fisher-based model performance, 172–173 focus, 156 free cash flow per share, 171 glitches, 159–160 global economic indicators, examination, 166 inflation-adjusted EPS growth, 171 investing criteria, 174 investment approach, guidance, 167 low-PSR approach, cessation, 165–166 market timing, 163–164 rules, 163 model portfolio risk/return statistics, 173t 12/15/08 2:49:20 PM Index noncyclicals, PSR, 168 performance data, 289t–291t performance explanation, 292 presidential term cycle, 166 price-research ratio (PRR), 169–170 price-sales investing, 159–161 price-sales ratio (PSR), 156 level, 169 reliance, caution, 162 research, 161 rules, 161 usage, 168–169 risk, 167 strategy, 167–172 imperfection, 261 style focus, 165 selection, importance, 164–165 sub-asset allocation, 165 super companies, designation, 156 super stocks, PSR, 170–171 technology stocks, PSR, 168 three-year average net profit margin, 171 time horizon, 167 total debt-equity ratio, 169 track record, 167 trivia, 157–158 Fixed-income investments, inflation (threat), 15–16 Forecasting, futility, 6–8 Free cash flow (FCF) Buffett usage, 107, 114 Neff usage, 68 Free cash flow per share, Fisher usage, 171 Free cash flow per share-to-current price ratio, Lynch usage, 148–149 Fundamentals, impact, 272–273 Fundamentals-based approach, 257 Fundamentals-based system, usage, 263–264 Future EPS, Buffett usage, 118 Future EPS growth rate, Neff usage, 67 Future equity, conversion, 118 Future stock price Buffett usage, 118–120 dividends, inclusion (Buffett usage), 119–121 G Gabelli, Mario, 35 Gains appearance, 257–258 compounding, 251 bindex.indd 309 309 taxes, impact See Long-term gains; Short-term gains GARP See Growth At a Reasonable Price Gharib, Susie (Buffett interview), 97–98 Global economic indicators, Fisher examination, 166 Global Total Return strategy (Fisher), 26 Gotham Capital, 27 Graham, Benjamin, 3, 25–26 biography, 37–39 Buffett, Warren (similarities), 34 company sales, 46 concern, 41 continuous dividend payments, 50 current ratio, 46–47 deep-value investors, 21 examination, 33 Graham-based model performance, 51–52 investment criteria, 52–53 investment firm, initiation, 38 investor success, 19 legacy, 38–39 long-term EPS growth, 48 losses, minimization, 42 margin of safety, 43–44 model portfolio risk/return statistics, 52t net current assets, long-term debt (relationship), 47 PE ratio, 48–49 performance data, 289t–291t performance explanation, 292 price-to-book (P/B) ratio, 49 pupils, success, 35–36 rationale, 40–41 risk, 44–45 safety, 41–44 sector, 45–46 status, 34 strategy, 44–51 time horizon, 45 total debt-equity (D/E) ratio, 50 track record, 34–35, 44 Great Depression, impact, 13, 34, 56 Greenblatt, Joel, 27 approach, 220–221 back-tested average returns, 220 biography, 221–222 down years, necessity, 227 earnings before interest and taxes (EBIT), usage, 224, 229 earnings-price (E/P) ratio, usage, 224 earnings yield, 221, 230 12/15/08 2:49:20 PM 310 index Greenblatt, Joel, (Continued ) educational impact, 222–223 enterprise value, 224–225, 230 examination, 219 Greenblatt-based model performance, 231 investing criteria, 232 Magic Formula, 220 belief, 226–227 investing, 223–226 performance, 260–261 reduction, 225 market capitalization, 229 model portfolio risk/return statistics, 232t performance data, 289t–291t performance explanation, 293 portfolio management, 227–228 rankings, combination, 230 return on asset (ROA) calculation, 224 return on capital (ROC), 229–230 return on total capital (ROTC), 221 risk, 228 strategy, 228–230 tangible capital employed, 224 time horizon, 228 track record, 228 Gross margin, change (Piotroski usage), 243–244 Growth importance (Neff), 59–61 stock model (O’Shaughnessy), 208–209 strategies, 21–22 See also Conservative growth strategy Growth At a Reasonable Price (GARP) approach, 143 Growth-focused strategy, usage, 250–251 Gudder, Stanley, 199 Guerin, Rick (success), 36 Guru-based 10-stock model portfolios, performance, 283–284 data, 285t Guru-based 20-stock model portfolios, performance, 283–284 data, 286t Gurus perfection, impossibility, 276–277 yearly track record comparison, actual-tested/ back-tested returns, 287–288 H High book-market strategy (Piotroski), 236–239 Hindsight bias, 12 Historical growth, comparison, 191 Howard, C Thomas, 266 bindex.indd 310 How to Retire Rich (O’Shaughnessy), 202 Hsu, H Christine, 263 Hulbert Financial Digest, 27, 176, 179, 186 Hulbert, Mark, 5, 258–259, 261-262 I Ibbotson, Roger, 13 Indicators, Zweig usage, 183–186 Inflation impact, 81 readings, impact, Inflation-adjusted EPS growth, Fisher usage, 171 Initial rate of return Buffett usage, 115–116 long-term Treasury bond yield, comparison, 116 Insiders buyers, equivalence, 139 transactions, Zweig usage, 192 Installment debt, Zweig usage, 184 Intelligent Investor,The (Graham), 19, 34 analysis, 39–40 impact, 100 introduction, 41 revision, Zweig involvement, 45 update, 35 Internet bubble, 271 Inventory-to-sales ratio, change (Lynch usage), 144 Invest Like the Best (O’Shaughnessy), 202 Investment decisions, problems, 13 Graham perspective, 39–40 intuition, outperformance, probability, 82 possibilities, limitation, 264–266 principles, 250 strategies combination, advantages, 250–254 discipline, 258 success, paths, 3–4 time horizon, capital preservation, 81 Investors See Defensive investor; Enterprising investor criteria, quantification, 23–25 decisions, difficulty, 64 Graham perspective, 39–40 humility, perfection, impossibility, 276–277 return, 11 similarities, 27–29 strategy See Buffett 12/15/08 2:49:21 PM Index disclosure, 22 success, 40 track record, 22–23 underperformance, J Jefferson, Thomas, 175 J.K Lasser’s Pick Stocks Like Warren Buffett (Boroson), 98 John Neff on Investing (Neff), 56, 63 K Kemper-Dreman High Retrn Fund, 26 performance, 74 Knapp, Tom (success), 36 “Know When To Fold ‘Em” (Feldman), 270 L Large-cap value, 264–265 Little Book That Beats the Market,The (Greenblatt), 27, 220 Longfellow, Henry Wadsworth, 129, 233 Long-term debt-assets (LTD/A)ratio, change (Piotroski), 242–243 Long-term debt (LTD) Buffett examination, 112 relationship See Net current assets Long-term EPS growth Graham usage, 48 Zweig usage, 190 Long-term gains, taxes (impact), 275 Long-term investing, 266–268 Long-term Treasury bond yield, comparison See Initial rate of return Losses, pain (reasons), 271 Low P/E investing, 58–59 Low P/E investor, Neff identification, 58, 65 LTD See Long-term debt LTD/A See Long-term debt-assets Lynch, Peter, 3, 26 asset plays, appreciation, 136 biography, 131–133 bonus criteria, 148–149 categories, 141–142 classification, determination, 142–143 category-specific testes, 146–148 company qualities, examination, 138–139 cyclicals, appreciation, 135–136 declines, appearance, 260 discipline, 140 disclaimer, 134 equity-to-assets ratio, 145 bindex.indd 311 311 examination, 129 financial stocks, ratios, 145 fortitude, 29 free cash flow per share-to-current price ratio, 148–149 fundamentals, 135 fund/company management, 23 GARP approach, 143 inventory-to-sales ratio, change, 144 investing criteria, 151–152 knowledge, 133–135 Lynch-based model performance, 150–151 model portfolio risk/return statistics, 151t net cash per share-to-current price ratio, 149 opportunities, 135–136 P/E/G investing, 133–135 P/E/G ratio, 137–138 usage, 143–144 performance data, 289t–291t performance explanation, 292 risk, 141 ROA, 145 slow-growers, 147–148 sales, 147–148 yield, 148 stalwarts, 147 EPS, 147 sales, 147 stocks, examination, 143–145 strategy, 141–149 success, 20 test marketing, 134 time horizon, 141 total debt-equity ratio, 144–145 track record, 130, 141 turnarounds, appreciation, 136 wisdom, 130–131, 140 M Magellan Fund (Fidelity Investment), 26 investors, losses (proportion), 261 returns, 129–130 Magic Formula (Greenblatt), 220 belief, 226–227 investing, 223–226 reduction, 225 Margin of safety, 41–42 Graham determination, 43–44 Market See Stock market “Market Efficiency in an Irrational World” (Daniel/Titman), 271 Mauldin, John, 265 12/15/08 2:49:21 PM 312 index Midcap growth, 264–265 Miller, Bill, 22 Model portfolio risk/return statistics Buffett results, 124t Dreman results, 92t Fisher results, 173t Graham results, 52t Greenblatt results, 323t Lynch results, 151t Neff results, 70t O’Shaughnessy results, 217t Piotroski results, 246t Zweig results, 194 Monetary Model (Zweig), 185 Money Masters of Our Time (Train), 62 Morningstar Investor Return, 11 Mr Market See Stock market Multiguru blending approach, impact, 253 Munger, Charles (success), 36 Mutual funds, fees (problems), 11 Myopic loss aversion, 13 strategy, 65–69 time horizon, 65 total return to P/E ratio examination, 24, 67–68 track record, 65 weigtings, 62 Net cash per share-to-current price ratio, Lynch usage, 149 Net current assets, long-term debt (relationship), 47 Net profit margin See Three-year net profit margin Neuroeconomics, Newman, Jerome, 38 Newsletter strategies, NBER study, 5–6 Niches, Lynch interest, 139 No-growth industries, 139 Noncyclical stocks, PSR, 168–169, 170 Numbers discipline, 254–257 examination, 20–22 N Name recognition, 24 Navigate the Noise: Investing in the New Age of Media and Hype (Bernstein), 271 Neff, John, 26, 35 biography, 56–58 decisions, difficulty, 64 discipline/dedication, 62–63 dividends, importance, 61–62 earnings predictions, importance, 60–61 EPS growth rate, 66 EPS persistence, 68–69 examination, 55 expectations, importance, 59 free cash flow, 68 fund/company management, 23 future EPS growth rate, 67 growth importance, 59–61 rates, calculation (time frame), 61 investment criteria, 70–71 low P/E investing, 58–59 model portfolio risk/return statistics, 70 Neff-based model performance, 69–70 performance data, 289t–291t performance explanation, 292 price-earnings (P/E) ratio, focus, 59–60, 66, 236 risk, 65 sales growth, 67 O Occam’s razor, validity, 206 100 Minds That Made the Market (Fisher), 158 Only Three Questions That Count,The (Fisher), 158, 165 Operating earnings, 148 Operating efficiency (Piotroski), 237 Operations, cash flows (Piotroski usage), 242 Opportunity cost See Stocks O’Shaughnessy, James, 4–5, 27 allocation, importance, 203–205 asset allocation breakdown, examination, 204 back-tested results, 208 biography, 201–202 buy-and-hold strategy, 205 cash flow per share, 214 importance, 206 Cornerstone Growth strategy, 211–213 Cornerstone Value strategy, 213–215 criteria, 206–208 discipline, 202–203 dividends, 214–215 dividend yield importance, 207 usage, 208 earnings yield, 209 emotions, short-circuiting (importance), 204 EPS persistence, 212 examination, 199 growth model tests, 208–209 bindex.indd 312 12/15/08 2:49:21 PM Index investing criteria, 218–219 investment strategy, patent, 202 low-relative strength strategy, 209 market cap, examination, 206, 211–212, 213 model portfolio risk/return statistics, 217t O’Shaughnessy-based model performance, 216–217 performance data, 289t–291t performance explanation, 292 price-book (P/B) ratio, 209 price-sales ratio (PSR), 212 levels, 207, 209 quantitative stock market study, 200 relative strengths, 212–213 P/S ratios, combination, 208 risk, 211 shareholder yield variable, 210 shares outstanding, 214 Sharpe ratio, usage, 208–209 simplicity, 206–208 six-month relative strength criteria, addition, 210 strategies, 21, 210–215 improvement, 208–210 three-month relative strength criteria, addition, 210 time horizon, 211 track record, 210 ability, 200 trailing 12-month sales, 214 United Cornerstone investing, 202–203 United Cornerstone strategy, 200–201 improvement, 208–210 risk-adjusted returns, quality, 252 value-based criterion, 207 value stock, attractiveness, 206–207 O’Shaughnessy Asset Management (OSAM), 201 P Payout ratio, Dreman ratio, 89 P/E/G investing, 133–135 P/E/G ratio, 137–138 usage, 143–144 Percent average ROE after payout, Buffett usage, 117–118 Piotroski, Joseph, 27 asset turnover, change, 244 balance sheet, accounting-based measures, usage, 234 balance sheet tests, 237 biography, 234–236 book-market (B/M) ratios, 241 bindex.indd 313 313 appeal, absence, 236 cash, net income (comparison), 242 cash flow from operations (CF), 242 change area, examination, 238 comparison See Dreman current ratio, change, 243 examination, 233 financial leverage/liquidity, 237 financial reporting issues, focus, 234 gross margin, change, 243–244 high book-market strategy, 236–239 improvement, search, 238 investing criteria, 246 long-term debt-assets (LTD/A) ratio, 242–243 model portfolio risk/return statistics, 246t operating efficiency, 237 performance data, 289t–291t performance explanation, 293 Piotroski-based model performance, 244–245 profitability, measurement, 237 return on assets (ROA), 241 change, 241–242 improvement, 238 returns, improvement, 236–237 risk, 240 shares outstanding, change, 243 small stocks, attention, 239 strategy, 240–244 time horizon, 240 track record, 240 Portfolio building, stock selection, 272 diversification, 44 examination frequency, reduction, 259 management, Greenblatt usage, 227–228 reweighting, 274–275 Positive earnings growth, Zweig usage, 189 Predicted future returns, average (Buffett usage), 121–122 Predicting the Markets of Tomorrow (O’Shaughnessy), 202 allocation scenario, 203–204 Presidential term cycle, 166 Pretax profit margins, Dreman usage, 90 Price-cash flow (P/CF) ratio, Dreman usage, 78, 84–85 Price-dividend (P/D) ratio, Dreman usage, 78, 85–86 Price-earnings (P/E) ratio, 23–24 Dreman usage, 78, 84 excess, determination, 43 Graham usage, 48–49 12/15/08 2:49:23 PM 314 index Price-earnings (P/E) ratio, (Continued ) importance (Zweig), 180 investing See Low P/E investing Lynch usage, 146 Neff usage, 66 Zweig usage, 187 Price-research ratio (PRR), 169–170 Price-sales investing, 159–161 Price-sales ratio (PSR), 156 consideration, 160 focus, 267–268 level, O’Shaughnessy examination, 207 O’Shaughnessy usage, 212 reliance, caution, 162 research, 161 rules, 161 usage, 168–169 Price-to-book (P/B) ratio Dreman usage, 78, 85 excess, determination, 43 Graham usage, 49 O’Shaughnessy usage, 209 Prime rate, impact (Zweig), 184 Products complexity, Buffett (disinterest), 110–111 repurchase, Lynch interest, 139 stability, Buffett attention, 105–106 usage, Buffett attention, 105 Profitability, Piotroski measurement, 237 PRR See Price-research ratio Prudent Speculator,The, 262 PSR See Price-sales ratio Psychology, investing (relationship), 75–77 Psychology and the Stock Market (Dreman), 75 Q Quantitative strategy, modifications (problems), 256–257 Quarterly earnings, Zweig usage, 189 R RBC O’Shaughnessy U.S.Value fund, return, 201 Realm of confidence See Buffett Rebalance period, usage, 274–275 timing, 273–275 Regret, fear, 270 Relative strengths O’Shaughnessy usage, 212–213 P/S ratios, combination, 208 Retained earnings Buffett attention, 106–107 bindex.indd 314 Buffett usage, 114–115 Return on assets (ROA) change, Piotroski usage, 241–242 determination, 224 Greenblatt calculation, 224 improvement, Piotroski usage, 238 Lynch usage, 145 Piotroski usage, 241 Return on capital (ROC), 223 Greenblatt usage, 229–230 Return on equity (ROE) after payout, Buffett usage See Percent average ROE after payout averages, Buffett usage, 113 Buffett usage, 106 Dreman usage, 89–90 method, Buffett usage, 116–117 Return on total capital (ROTC) Buffett usage, 113 Greenblatt usage, 221 Returns improvement (Piotroski), 236–237 initial rate See Initial rate of return maximization, 250–254 Revenue growth, EPS growth relation (Zweig), 188 Risk minimization, 250–254 redefining (Dreman), 80–82 Risk-adjusted returns O’Shaughnessy measurement, 208–209, 252 Zweig rating, 27 Risk reduction, concept, 44 ROA See Return on assets ROC See Return on capital ROE See Return on equity ROTC See Return on total capital Ruane, Bill (success), 36 Rumors, impact, 139 Runbeck, Margaret Lee, 155 Russell 1000 Growth index, proxy usage, 203–204 S Safety See Margin of safety Sahadi, Jeanne, 16 Sales growth Neff usage, 67 Zweig usage, 188 Sawyer, Jack, 256 Schloss, Walter J., 35 success, 36 12/15/08 2:49:23 PM Index Security Analysis (Graham), 34 Self-esteem, lowering, 271 Sell decision assessment, 273 difficulty, 270 intelligence, 272–275 tax considerations, 267 timing, 269–270 Selling frenzy, initiation, 10–11 Shareholder yield variable, 210 Shares outstanding change, Piotroski usage, 243 O’Shaughnessy usage, 214 Sharpe, William, 17, 252 Sharpe ratio, O’Shaughnessy usage, 208–209, 252 Short-term gains, taxes (impact), 275 Short-term trading, encouragement (problem), 11 Siegel, Jeremy, 14 “Silent Storm, The” (O’Shaughnessy), 204 Sinquefield, Rex, 13 Six-month relative strength criteria, O’Shaughnessy usage, 209 Size-focused systems, investment limitation, 264–266 Slow-growth industries (slow-growers), 147–148 examination, 142 Lynch category, 139, 141 yield, comparison, 148 Small-cap growth, 264–265 Small stocks, Piotroski attention, 239 Smokestack industries, slow growth, 161 Smokestack stocks, Fisher distinction, 161 Soros, George, 22 quote, 55 Stalwarts, 147 EPS, 147 examination, 142 Lynch category, 141 P/E/G ratio, 144 sales, 147 Standard deviation, 252 Standard & Poor’s 500 (S&P500) index fund, purchase, 263 investment, performance, 16 mutual fund managers, performance (spread), outperformance, performance explanation, 293 usage, yield, comparison, 148 Statistical models, quality, 255–256 bindex.indd 315 315 “Stock Diversification in the U.S Equity Market” (Hsu/Wei), 263 Stock market annual standard deviation, 14 capitalization (cap) Dreman usage, 86 Greenblatt usage, 229 O’Shaughnessy usage, 211–212, 213 crisis, Dreman reaction, 79–80 future, 7–8 idiosyncrasies, survival, 29 improvement, 13 investors performance, failure, 4–6 reaction, 76 leaders O’Shaughnessy examination, 206 performance, 207 long-term investment, 15–17 Mr Market (Graham term), 250 performance predictability, 13–14 short-term discomfort, impact, 15 short-term fluctuations impact, 16 understanding, 28 short-term move, predictive ability, 10–11 short-term unpredictability, 12 timers, impact, 20 timing Fisher approach, 163–164 occurrence, 10 problems, 10–11 rules, 163 strategy, Zweig usage, 185–186 underperformers, year-to-year fluctuations, 14–15 Stocks anonymity, 139 bargain prices, 19 combined interest, 253 fluctuation, 12, 82 Lynch explanation, 13 fundamentals, impact, 272–273 future worth, Buffett estimation, 108 holding, opportunity cost, 267 investment safety (Dreman), 82 long-term holding, 266–268 movement, multiguru approval, 253 per-share price, 21 prediction (Buffett), 108 prices 12/15/08 2:49:23 PM 316 index Stocks (Continued ) attack, 87 earnings impact, 59 targets, setting, 271–272 reevaluation, continuation, 273 risk, perception, 15 selection process (Zweig), 181–182 T-bills, performance (comparison), 15–16 “Total Blend” portfolio, strategy usage, 252–253 Stocks for the Long Run (Siegel), 14 Strategy-based investing, 265–266 Style-box investing, 264 problems, 265 Style-focused systems, investment limitation, 264–266 Sub-asset allocation, 165 “Superinvestors of Graham-and-Doddsville” (Buffett), 35 Super stocks, PSR, 170–171 Super Stocks (Fisher), 26, 156 approach, differences, 162 company evaluation process, 162 criteria, 170 strategy, 159 Symbiotic triangle, 10 Syrus, Publilius, T Tangible capital employed, Greenblatt usage, 224 Taxes, impact, 275–276 See also Long-term gains; Short-term gains Technology Buffett, disinterest, 109 stocks, PSR, 168–169, 170 Templeton, John, 35 Tetlock, Philip, Thaler, Richard H., 259, 270 Three-month relative strength criteria, O’Shaughnessy usage, 209 Three-year net profit margin, Fisher usage, 171 Titman, Sheridan, 271 Toll bridge companies See Buffett “Total Blend” approach, 252–254 Total debt-equity (D/E) ratio Fisher usage, 169 Graham usage, 50 Lynch usage, 144–145 Zweig usage, 192 Total return percentage, measurement, 11 Total return/price-earnings ratio, 24 Neff usage, 67–68 bindex.indd 316 Trailing 12-month sales, O’Shaughnessy usage, 214 Train, John, 62 Trust, involvement, 260 Turnarounds Lynch opportunity, 136, 141 types, 136 U United Cornerstone (O’Shaughnessy) investment, 202–203 strategy, 200–201 improvement, 208–210 U.S gross domestic product (GDP), comparison, 165 U.S small-cap value industrials, 165 V Validea founding, 205 portfolios, rebalancing, 205 Validea Hot List portfolio, 253 Value Buffett definition, 31 investing, 20 explanation, 39–41 stocks, targeting, 206 strategies, 21–22 Value-focused strategy, usage, 250–251 “Value Investing: The Use of Historical Financial Statement Information to Separate Winners from Losers” (Piotroski), 235 Value Investing Made Easy (Lowe), 38 Value Investor portfolio, examination, 51–52 Vanguard Total Market Index Fund, purchase, 263 Volatility See Earnings impact, 80 reduction, blended approach (usage), 254 W Wall Street analysts, performance (problems), 76 Wall Street Waltz,The (Fisher), 158 Wei, H Jeffrey, 263 “What Determines Corporate Transparency?” (Piotroski), 235 What Works on Wall Street (O’Shaughnessy), 4–5, 27, 200–202, 256 discipline, importance, 202 Occam’s razor, validity, 206 revision, 211 strategy, improvement, 208–210 12/15/08 2:49:24 PM Index Windsor Fund, 56 dividend-paying stocks, focus, 61 stocks sale, 64 targeting, 59 Winning on Wall Street (Zweig), 176 stock market profits, 185 stock selection process, 181–182 strategy, 179–180 Woulda-coulda-shoulda thinking, 270 Y Yield, Dreman usage, 90 You Can Be a Stock Market Genius (Greenblatt), 222 Your Money and Your Brain (Zweig), 6–7 Z Zacchini, Mario, 269 Zuill, Lilla, 203 Zweig, Jason, 6–7, 27 Zweig, Martin annual earnings persistence, 190 biography, 176–179 conservative growth strategy, 179–181 current quarterly earnings, 189 debt-equity ratio, importance, 183 discount rate, usage, 184 earnings acceleration, 182–183, 191–192 cost/source, 187 growth, 190 importance, 179–181 persistence, 189–190 stability, 189 trend, 189 EPS growth, 191 examination, 175 expectations, 186 Fed battle, avoidance, 185 focus, 180–181 bindex.indd 317 317 growth investor, 180 indicators, 183–186 models, usage, 185 insider transactions, 192 installment debt, examination, 184 investing criteria, 194–195 lifestyle, 177 long-term EPS growth, 190 market timing strategy, 185–186 model portfolio risk/return statistics, 194 Monetary Model, 185 P/E criterion, importance, 180 P/E ratio, 187 performance data, 289t–291t performance explanation, 292 positive earnings growth, 189 prime rate, impact, 184 quarterly earnings, 189 revenue growth, EPS growth (relationship), 188 rifle approach, 181–182 risk, 186 risk-adjusted returns, Hulbert Financial Digest ranking, 176 sales examination, 182–183 growth, 188 shotgun approach, 181–182 stocks examination, 183 hunting, 181–182 knowledge, 176 strategy, 186–193 time horizon, 186 total debt-equity ratio, 192 track record, 186 Zweig-based model performance, 193–194 Zweig Dimenna Partners, 179 Zweig Forecast, initiation, 179 Zweig Fund, introduction, 179 Zweig Total Return Fund, 179 12/15/08 2:49:24 PM bindex.indd 318 12/15/08 2:49:25 PM ( c o n t i n u e d f r o m f r o n t f l ap ) $27.95 USA / $30.95 CAN REESE when you should sell, how many stocks you should own, and much more JACK M FOREHAND, CFA, is President of Validea.com and cofounder of Validea Capital Management, LLC Working in conjunction with John Reese, Forehand led the development of Validea’s investment models as well as the quantitative testing that led to the creation of Validea Capital Management’s consensus portfolios He graduated from the honors program of the University of Connecticut with a BA in economics and is a CFA charterholder z Visit www.guruinvestorbook.com Jacket Design: Paul McCarthy z What can we learn from those rare investors who have consistently generated outstanding returns over the long haul? In an easy-to-read and simple format, The Guru Investor dissects strategies from ten of Wall Street’s greatest investment “gurus” and shows exactly how to implement those strategies to improve your own long-term investment results This book offers a step-by-step guide to the investment methodologies of Warren Buffett, Peter Lynch, Joel Greenblatt, James O’Shaughnessy, David Dreman, John Neff, Benjamin Graham, Ken Fisher, Joseph Piotroski, and Martin Zweig Based on the model portfolio system that the author has developed, each strategy is turned into an actionable system that systematically addresses many of the common mistakes that hurt individual investors’ longterm investment results In addition, The Guru Investor shows how you can combine the proven strategies of these legendary gurus into a disciplined investing system for building and managing portfolios—including the author’s key rules for when to buy, when to hold, and when to sell O GURU INVESTOR JOHN P REESE, MBA, is the founder and CEO of Validea.com and Validea Capital Management He is also portfolio manager for the Omega American and International Consensus mutual funds offered in the Canadian market He is a regular columnist for Forbes com, RealMoney.com, and Israel’s Globes newspaper He holds two patents in the area of automated stock analysis and is a graduate of Harvard Business School and the Massachusetts Institute of Technology A detailed look at the successful strategies used by some of the world ’s best investors The z GURU INVESTOR HOW TO BEAT THE MARKET USING HISTORY’S BEST INVESTMENT STRATEGIES All investors can learn from the thinking, writing, and experience of Wall Street’s greatest investors The Guru Investor, and its free companion Web site—www guruinvestorbook.com—will teach you the lessons of these greats and give you all the tools needed to put those lessons to work in your investment strategy The Forehand ver the past six decades, the U.S stock market has averaged an annual return of about eleven percent per year Yet, except for a few renowned Wall Street gurus, the vast majority of investors, both amateur and professional, fail to come anywhere close to those eleven percent average annual gains Why most investors fail—and what those very successful investment gurus have in common? The Guru Investor identifies the stock picking methodologies developed by some of history’s best and most successful stock market gurus—including Peter Lynch, Warren Buffett, Benjamin Graham, Martin Zweig, John Neff, and others—and shows how you can combine these proven strategies into a disciplined investing system that has been proven to outperform the market John Reese breaks down the very different approaches of each of the gurus—encompassing value, growth, and quantitative investing—and lays out their philosophy and achievements, detailing step-by-step the secret formulas they used to beat the market, while explaining why these legendary investors consider certain factors to be so important when analyzing individual stocks Reese not only discusses the individual gurus, their strategies, and why they are important, but he also explains how to best use these strategies in the real world, showing how to sift through all of the choices to find a strategy that works for you The model portfolio system that the author has developed turns each strategy into an actionable system, addressing many of the common mistakes that doom investors to failure In addition to offering these individual guru-based models, Reese also explains how to combine and implement these approaches into a multi-guru system that will provide you with a comprehensive, practical stock investing strategy with a proven track record He reveals when you should buy, ( c o n t i n u e d o n b a ck f l ap ) ... 12/15/08 2:23:05 PM The Guru Investor ffirs.indd i 12/15/08 2:23:05 PM ffirs.indd ii 12/15/08 2:23:05 PM The Guru Investor How to Beat the Market Using History’s Best Investment Strategies John P... suggested that the majority of active managers underperform the market had a flipside to it—there had to be a group of investors that did beat the market I wanted to know how they did it, and how I could... answer as to how to beat the market Still, I was convinced that there must be a way, that there had to be some strategy that I could use to succeed in the market over the long term After all, the fact