The Five Rules for Successful Stock Investing E-Book

Pat Dorsey

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Sprache: Englisch

Seitenzahl: 569

Veröffentlichungsjahr: 2011

Beschreibung

The Five Rules for Successful Stock Investing "By resisting both the popular tendency to use gimmicks that oversimplify securities analysis and the academic tendency to use jargon that obfuscates common sense, Pat Dorsey has written a substantial and useful book. His methodology is sound, his examples clear, and his approach timeless." --Christopher C. Davis Portfolio Manager and Chairman, Davis Advisors Over the years, people from around the world have turned to Morningstar for strong, independent, and reliable advice. The Five Rules for Successful Stock Investing provides the kind of savvy financial guidance only a company like Morningstar could offer. Based on the philosophy that "investing should be fun, but not a game," this comprehensive guide will put even the most cautious investors back on the right track by helping them pick the right stocks, find great companies, and understand the driving forces behind different industries--without paying too much for their investments. Written by Morningstar's Director of Stock Analysis, Pat Dorsey, The Five Rules for Successful Stock Investing includes unparalleled stock research and investment strategies covering a wide range of stock-related topics. Investors will profit from such tips as: * How to dig into a financial statement and find hidden gold . . . and deception * How to find great companies that will create shareholder wealth * How to analyze every corner of the market, from banks to health care Informative and highly accessible, The Five Rules for Successful Stock Investing should be required reading for anyone looking for the right investment opportunities in today's ever-changing market.

Leseprobe

Table of Contents

Title Page

Copyright Page

Foreword

Acknowledgments

Introduction

It’s the Business that Matters

The Long-Term Approach

Having the Courage of Your Convictions

Let’s Get Started

Chapter 1 - The Five Rules for Successful Stock Investing

Do Your Homework

Find Economic Moats

Have a Margin of Safety

Hold for the Long Haul

Know When to Sell

Investor’s Checklist: The Five Rules for Successful Stock Investing

Chapter 2 - Seven Mistakes to Avoid

Swinging for the Fences

Believing that It’s Different This Time

Falling in Love with Products

Panicking When the Market Is Down

Trying to Time the Market

Ignoring Valuation

Relying on Earnings for the Whole Story

Investor’s Checklist: Seven Mistakes to Avoid

Chapter 3 - Economic Moats

Evaluating Profitability

Building an Economic Moat

How Long Will It Last?

Industry Analysis

Investor’s Checklist: Economic Moats

Chapter 4 - The Language of Investing

The Basics

Where the Money Goes

Practical Financials—The Statements in Use

Investor’s Checklist: The Language of Investing

Chapter 5 - Financial Statements Explained

The Balance Sheet

The Income Statement

The Statement of Cash Flows

Conclusion

Investor’s Checklist: Financial Statements Explained

Chapter 6 - Analyzing a Company—The Basics

Growth

Profitability

Financial Health

The Bear Case

Conclusion

Investor’s Checklist: Analyzing a Company—The Basics

Chapter 7 - Analyzing a Company—Management

Compensation

Character

Running the Business

Investor’s Checklist: Analyzing a Company—Management

Chapter 8 - Avoiding Financial Fakery

Six Red Flags

Seven Other Pitfalls to Watch Out For

Investor’s Checklist: Avoiding Financial Fakery

Chapter 9 - Valuation—The Basics

Paying Up Rarely Pays Off

Using Price Multiples Wisely

Say Yes to Yield

Investor’s Checklist: Valuation—The Basics

Chapter 10 - Valuation:—Intrinsic Value

Cash Flow, Present Value, and Discount Rates

Calculating Present Value

Fun with Discount Rates

Calculating Perpetuity Values

Margin of Safety

Conclusion

Investor’s Checklist: Valuation—Intrinsic Value

Chapter 11 - Putting It All Together

Advanced Micro Devices

Biomet

Conclusion

Chapter 12 - The 10-Minute Test

Does the Firm Pass a Minimum Quality Hurdle?

Has the Company Ever Made an Operating Profit?

Does the Company Generate Consistent Cash Flow from Operations?

Are Returns on Equity Consistently above 10 Percent, with Reasonable Leverage?

Is Earnings Growth Consistent or Erratic?

How Clean Is the Balance Sheet?

Does the Firm Generate Free Cash Flow?

How Much “Other” Is There?

Has the Number of Shares Outstanding Increased Markedly over the Past Several Years?

Beyond the 10 Minutes

Chapter 13 - A Guided Tour of the Market

Where to Look

Conclusion

Chapter 14 - Health Care

Economic Moats in Health Care

Pharmaceuticals

Generic Drug Companies

Biotechnology

Medical Device Companies

Health Insurance/Managed Care

Investor’s Checklist: Health Care

Chapter 15 - Consumer Services

Companies We See Every Day

Restaurants

Retail

Conclusion

Investor’s Checklist: Consumer Services

Chapter 16 - Business Services

Outsourcing Trend

Economic Moats in Business Services

Technology-Based Businesses

People-Based Businesses

Hard-Asset-Based Businesses

Investor’s Checklist: Business Services

Chapter 17 - Banks

It’s All about Risk

Managing Credit Risk

Selling Liquidity

Managing Interest Rate Risk

Economic Moats in Banks

Hallmarks of Success for Banks

Investor’s Checklist: Banks

Chapter 18 - Asset Management and Insurance

Asset Management

Life Insurance

Property/Casualty Insurance

Investor’s Checklist: Asset Management and Insurance

Chapter 19 - Software

Segments of the Software Industry

Economic Moats in the Software Industry

Software Accounting 101

Red Flags

Hallmarks of Success for Software Companies

What’s Not to Like about Software?

Conclusion

Investor’s Checklist: Software

Chapter 20 - Hardware

What Drives the Hardware Industry

Hardware Industry Dynamics

Economic Moats in Hardware

Hallmarks of Success for Hardware Companies

Investor’s Checklist: Hardware

Chapter 21 - Media

How Media Companies Make Money

Economic Moats in Media

Publishing Profits

Broadcasting and Cable

Investing in the Entertainment Industry

Hallmarks of Success in the Media Sector

Risks in the Media Sector

Investor’s Checklist: Media

Chapter 22 - Telecom

Telecom Economics

Economic Moats in Telecom

Hallmarks of Success in Telecom

Conclusion

Investor’s Checklist: Telecom

Chapter 23 - Consumer Goods

How Companies Make Money in Consumer Goods

Key Strategies for Growth

What’s Not to Like in Consumer Products

Economic Moats in Consumer Goods

Hallmarks of Success in Consumer Goods

Conclusion

Investor’s Checklist: Consumer Goods

Chapter 24 - Industrial Materials

The Problem with Cyclicality

Economic Moats in Basic Materials

Economic Moats in Industrial Materials

Hallmarks of Success in Industrial Materials

Red Flags

Finding Opportunities in Industrial Materials

Investor’s Checklist: Industrial Materials

Chapter 25 - Energy

From the Ground

To the Pipelines

To the Refineries

To the Consumers

Providing the Services

The Impact of Commodity Prices

Economic Moats in Energy

Hallmarks of Success for Energy Companies

Risks in the Energy Sector

Conclusion

Investor’s Checklist: Energy

Chapter 26 - Utilities

Electricity Primer

Regulation, Regulation, Regulation

Financial Characteristics of Utilities

Hallmarks of Success for Utility Companies

Risks in the Utilities Sector

The Big Picture

Investor’s Checklist: Utilities

Appendix

Recommended Readings

Morningstar Resources

Index

Copyright © 2004 by Morningstar, Inc. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication Data:

Dorsey, Pat.

The five rules for successful stock investing : Morningstar’s guide to building wealth and winning in the market / Pat Dorsey.

p. cm.

Includes bibliographical references and index.

ISBN 0-471-26965-4 (CLOTH)

1. Investments. 2. Stocks. I. Morningstar, Inc. II. Title.

HG4521.D646 2004

332.63’22—dc22

2003018287

Foreword

BECAUSE I’M THE founder of Morningstar, you might think I invest most of my personal assets in mutual funds. The truth is I own few mutual funds. Nearly all of my assets are in stocks. Although I love funds, I have an even greater passion for stocks. Funds are great for those who don’t want to spend a lot of time doing research. But if you enjoy analyzing companies—and I think it’s a tremendous amount of fun—you can do perfectly well investing in equities yourself.

My interest in equity analysis began in business school at the University of Chicago. There I learned about efficient markets and how collectively security analysts add little or no value. That did little to excite me about stock investing. Why, after all, spend time studying companies if a market basket of stocks will do just as well? After graduation, though, I stumbled across The Money Masters by John Train and read about Warren Buffett.

Now that was exciting. Buffett used an approach I could readily grasp and inspired me by showing how much fun and intellectually challenging investing could be. Moreover, Buffett’s track record—and the record of others who shared his philosophy—was stellar. I went back and read all the Berkshire Hathaway annual reports. My life changed course as a result.

I went to work as a stock analyst at Harris Associates in Chicago. I chose Harris because I admired its value-oriented, Buffett-like approach, and I liked the people. It was a great job, and I worked with some terrific financial minds—Clyde MacGregor, Chuck McQuaid, Bill Nygren, Ralph Wanger, Sherwin Zuckerman, to name a few. They all practiced a rigorous, bottomsup investment style that involved looking for companies selling at a discount to their true worth. I spent my days reading annual reports, talking to company managers, and learning from my peers. And I got paid to do it.

The idea for Morningstar came from trying to teach myself equity analysis. I called regularly to get the mutual fund reports from managers I admired—people such as Kurt Lindner (Lindner Funds), George Michaelis (Source Capital), Michael Price (Mutual Shares), Bill Ruane (Sequoia Fund), John Templeton (Templeton Funds), and Ralph Wanger (Acorn). I examined their holdings to see what stocks they were buying and tried to figure out why they were buying them.

One day, when I had all these shareholder reports scattered across my dining room table, I thought it would be useful if someone compiled all that valuable information into a book. The proverbial light bulb clicked. I started to research the mutual fund industry. I could see that it was growing nicely and that there were few sources to help investors make intelligent decisions about funds. Thus, Morningstar was born.

I left my stock analyst job at Harris, cleared out the living room of my apartment, bought several PCs, and got started. I wrote to all the funds to get their materials, entered everything into a database, and six months later a 400-page Mutual Fund Sourcebook was sitting on my desk. In 1984, this in-depth fund information was very hard to get—and certainly not available for $32.50. The Sourcebook, for example, provided complete portfolio holdings. It took five pages just to list the 800 stocks in Peter Lynch’s Magellan Fund. I sold 700 copies of that first publication, and Morningstar was on its way.

By bringing a stock perspective to the mutual fund world, we began to define the Morningstar approach to fund investing. It’s hard to believe now, but back then investors purchased mutual funds based on recent returns and not much else. Morningstar brought rigorous, fundamental analysis to the industry. We realized that by looking carefully at the stocks a fund owned, we could understand the manager’s strategy more clearly. So we developed our equity expertise as a way of doing better fund analysis.

While Morningstar began by serving fund investors, over time, we broadened our mission to help all investors. And that meant stock investors, too. This wasn’t soulless corporate expansion, but logical growth based on a passion for equity analysis. And the more we looked at information available for stock investors, the more we realized that we had something innovative, useful, and unique to offer. There was little new in equity research, and many existing products seemed dated and not particularly helpful. We thought we could do better.

Our approach to equity analysis builds on the Ben Graham and Warren Buffett school of investing. It would be hard to find two better mentors—and we’re grateful and indebted to them for all that they have done for investors. You’ll find some of their key lessons embedded in our advice—concepts such as margin of safety and economic moats. We add value by systemizing, broadening, and explaining their approach so you can do it yourself. The result is a robust framework that should serve you well in making your own investment decisions.

But we haven’t cornered the market on advice. We’ve included a reading list, and I urge you to use it as a guide. There aren’t many great books on investing, so you should be able to master most of them. If you aren’t doing so now, I suggest you begin reading the major business magazines regularly—Barron’s, BusinessWeek, Forbes, Fortune,—as well as The Wall Street Journal daily. You’d be surprised how many investors neglect to do these basic things. Among our own publications, you’ll find Morningstar.com and Morningstar StockInvestor, our monthly newsletter, helpful. I also recommend all the Berkshire Hathaway annual reports and Outstanding Investor Digest for its lengthy interviews with leading money managers.

You need to read widely to build a “latticework of mental models,” as Berkshire Hathaway’s Charlie Munger says. By looking closely at many companies, you’ll see common themes that drive their success or failure. And you’ll begin to form models that you can apply to situations you want to analyze. Then you must ask some questions. How is the world changing? How will those changes affect this company’s prospects? You can begin to see the challenge and the fun of investing.

The Five Rules for Successful Stock Investing: Morningstar’s Guide to Building Wealth and Winning in the Market is the effort of Pat Dorsey, the head of equity research at Morningstar. Among his many talents, Pat can communicate in a clear and engaging way, and he has the rare ability to distill complex questions to a form so that the answer appears obvious. Pat works closely with Haywood Kelly, Morningstar’s chief of securities analysis and editor-in-chief of Morningstar.com, and Catherine Gillis Odelbo, president of securities analysis and head of our retail business, to guide our equity effort. We’re indebted to all three for what they’ve created at Morningstar and for defining the investment philosophy that is the framework for this book.

A common quality of successful investors is the steadfast ability to think independently. Don’t be swayed by what the “experts” say—even us. Graham and Buffett often point out that if your reasoning is right, that’s all you need to worry about. I hope you read this book with a questioning mind. I hope you challenge our thinking. Above all, I hope you learn guiding principles that will shape your personal investment philosophy. Although no one can guarantee success, if you apply the precepts in this book and think for yourself, you’ll be well on your way.

JOE MANSUETO

Acknowledgments

ALTHOUGH ONLY ONE name appears on the cover, this book was very much a team effort. Erica Moor kept the project on track and ably orchestrated text, graphics, deadlines, and schedules to produce a finished manuscript, while Amy Arnott worked tirelessly to tighten the initial muddled prose into something worthy of publication. Both deserve a great deal of credit. Dave Pugh at John Wiley & Sons also contributed valuable edits and a fresh perspective on the material. Morningstar designer Jason Ackley transformed complicated concepts into lucid graphics, while analyst Sanjay Ayer collected the data that underpin the tables and charts.

I have the great fortune to work with a group of very talented and dedicated analysts, and a round of applause is due to the entire Equity Analyst team at Morningstar. They contributed the lion’s share of this book’s second half. This book could not have been written without their accumulated industry expertise. I’m also indebted to Mark Sellers for helping develop Morningstar’s investment philosophy; and to Mike Porter, Jason Stipp, and Rich McCaffery for valuable editorial feedback. Mike also deserves credit for shouldering many of my duties while I completed the book. Special thanks go to Haywood Kelly for being not only the world’s most patient boss, but a great editor, mentor, and friend. Thanks also to Catherine Odelbo, president of securities analysis and our retail business, for her ongoing support of this project and our equity research efforts at Morningstar, and to founder Joe Mansueto for having the vision to take a risk and build Morningstar. Joe’s unwavering commitment to independence and objectivity sets the example for the whole firm.

On a more personal note, my late grandfather, E. V. Patrick, deserves credit for introducing me to investing at a relatively young age, while my parents, Herb and Carol, have given me enormous support throughout my career. None, however, are more deserving of gratitude than my wife Katherine, whose good humor and unflagging patience are my most valuable assets. This book could not have been written without her support.

P. D.

Introduction: Picking Great Stocks Is Tough

SUCCESSFUL INVESTING IS simple, but it’s not easy.

One of the big myths of the bull market of the 1990s was that the stock market was essentially a savings account that returned 15 percent per year. You picked up a copy of Fortune, you watched a little CNBC, you opened an online account, and you were on the road to riches. Unfortunately, as many investors discovered when the bubble popped, things that look too good to be true usually are.

Picking individual stocks requires hard work, discipline, and an investment of time (as well as money). Expecting to make a large amount of money with only a little effort is like expecting to shoot a great round of golf the first time you pick up a set of clubs. There’s no magic formula, and there’s no guarantee of success.

That’s the bad news. The good news is that the basic principles of successful stock-picking aren’t difficult to understand, and the tools for finding great stocks are available to everyone at a very low cost—you don’t need expensive software or high-priced advice to do well in the stock market. All you need are patience, an understanding of accounting and competitive strategy, and a healthy dose of skepticism. None of these is out of the average person’s grasp.

The basic investment process is simple: Analyze the company and value the stock. If you avoid the mistake of confusing a great company with a great investment—and the two can be very different—you’ll already be ahead of many of your investing peers. (Think of Cisco at 100 times earnings in 2000. It was a great company, but it was a terrible stock.)

Remember that buying a stock means becoming part owner in a business. By treating your stocks as businesses, you’ll find yourself focusing more on the things that matter—such as free cash flow—and less on the things that don’t—such as whether the stock went up or down on a given day.

Your goal as an investor should be to find wonderful businesses and purchase them at reasonable prices. Great companies create wealth, and as the value of the business grows, so should the stock price in time. In the short term, the market can be a capricious thing—wonderful businesses can sell at fire-sale prices, while money-losing ventures can be valued as if they had the rosiest of futures—but over the long haul, stock prices tend to track the value of the business.

It’s the Business that Matters

In this book, I want to show you how to focus on a company’s fundamental financial performance. Analyst upgrades and chart patterns may be fine tools for traders who treat Wall Street like a casino, but they’re of little use to investors who truly want to build wealth in the stock market. You have to get your hands dirty and understand the businesses of the stocks you own if you hope to be a successful long-term investor.

When firms do well, so do their shares, and when business suffers, the stock will as well.

Wal-Mart, for example, hit a speed bump in the mid-1990s when its growth rate slowed down a bit—and its share price was essentially flat during the same period. On the other hand, Colgate-Palmolive posted great results during the late 1990s as it cut fat from its supply chain and launched an innovative toothpaste that stole market share—and the company’s stock saw dramatic gains at the same time. The message is clear: Company fundamentals have a direct effect on share prices.

This principle applies only over a long time period—in the short term, stock prices can (and do) move around for a whole host of reasons that have nothing whatsoever to do with the underlying value of the company. We firmly advocate focusing on the long-term performance of businesses because the short-term price movement of a stock is completely unpredictable.

Think back to the Internet mania of the late 1990s. Wonderful (but boring) businesses such as insurance companies, banks, and real estate stocks traded at incredibly low valuations, even though the intrinsic worth of these businesses hadn’t really changed. At the same time, companies that had not a prayer of turning a profit were being accorded billion-dollar valuations.

The Long-Term Approach

Given the proclivity of Mr. Market to plead temporary insanity at the drop of a hat, we strongly believe that it’s not worth devoting any time to predicting its actions. We’re not alone in this. After talking to literally thousands of money managers over the past 15 years or so, we’ve discovered that none of the truly exceptional managers spend any time at all thinking about what the market will do in the short term. Instead, they all focus on finding undervalued stocks that can be held for an extended time.

There are good reasons for this. Betting on short-term price movements means doing a large amount of trading, which drives up taxes and transaction costs. The tax on short-term capital gains can be almost double the rate of long-term capital gains, and constant trading means paying commissions more frequently. As we’ll discuss in Chapter 1, costs such as these can be a huge drag on your portfolio, and minimizing them is the single most important thing you can do to enhance your long-term investment returns.

We’ve seen this borne out in long-term studies of mutual fund returns: Funds with higher turnover—ones that trade more—generally post lower results than their more deliberate peers, to the tune of about 1.5 percentage points per year over 10 years. This may not sound like much, but the difference between a 10 percent annual return and an 11.5 percent annual return on a $10,000 investment is almost $3,800 after 10 years. That’s the price of impatience.1

Having the Courage of Your Convictions

Finally, successful stock-picking means having the courage to take a stance that’s different from the crowd. There will always be conflicting opinions about the merits of any company, and it’s often the companies with the most conflict surrounding them that make the best investments. Thus, as an investor, you have to be able to develop your own opinion about the value of a stock, and you should change that value only if the facts warrant doing so—not because you read a negative news article or because some pundit mouths off on TV. Investment success depends on personal discipline, not on whether the crowd agrees or disagrees with you.

Let’s Get Started

My goal in this book is to show you how to think for yourself, ignore the dayto-day noise, and make profitable long-term investment decisions. Here’s our road map.

First, you need to develop an investment philosophy, which I’ll discuss in Chapter 1. Successful investing is built on five core principles:

1. Doing your homework

2. Finding companies with strong competitive advantages (or economic moats)

3. Having a margin of safety

4. Holding for the long term

5. Knowing when to sell

Building a solid stock portfolio should be centered on these five ideas; once you know them, you’ll be ready to start learning how to look at companies.

Second, I’ll take a step back and review what not to do—because avoiding mistakes is the most profitable strategy of all. In Chapter 2, I’ll go over the most common mistakes that investors make. If you steer clear of these, you’ll start out ahead of the pack.

In Chapter 3, I’ll show you how to separate great companies from mediocre ones by analyzing competitive advantages, which we call economic moats. I’ll explain how economic moats are what help great companies keep their top-tier status and why they’re a big part of what separates long-run winners from flashes in the pan. Understanding the sources of a firm’s economic moat is critical to thoroughly analyzing a company.

Chapters 4 through 7 show you how to analyze companies by reading their financial statements. First, I’ll describe how financial statements work—what the line items mean and how the different statements fit together. Once you know how to read balance sheets and income statements, I’ll show you a five-step process for putting all the numbers in context and finding out just how solid a company really is. I’ll also show you how to evaluate management.

In Chapter 8, we’ll look at how you can detect aggressive accounting, and I’ll tell you what red flags to watch out for so you can minimize the odds of a big blowup in your portfolio.

In Chapters 9 and 10, I’ll show you how to value stocks. You’ll learn the underlying theory of investment value, when ratios such as price-to-earnings are (and aren’t) useful, and how to figure out whether a stock is trading for more or less than its intrinsic value. The cheapest stock isn’t always the best investment, and what looks expensive may actually be cheap when viewed from another angle.

Chapter 11 provides two case studies. I’ll apply the tools presented in the previous chapters to two real-world companies, so you can see for yourself how the process of fundamental analysis works in practice.

In Chapter 12, I’ll explain the 10-Minute Test, a quick-and-dirty checklist that can help you separate firms that are unlikely to be worth your time from the ones that deserve a thorough, in-depth examination.

In Chapters 13 through 26, I’ll lean on Morningstar’s team of equity analysts to give you tips for analyzing different sectors of the stock market. From semiconductors to drugs to banks, we’ll tell you exactly what you need to know to analyze companies from every corner of the market. You’ll learn what industry-specific characteristics separate the great firms from the also-rans, what industry jargon means, and which industries are more (and less) likely to offer fertile hunting ground for great investment ideas.

Finally, we’ll wrap up with some recommended readings for those who want to learn more.

The structure of the book is the same as the basic investment process that we advocate: Develop a set of investing principles, understand the company’s competitive environment, analyze the company, and value the stock. If you can follow this process while avoiding most big mistakes, you’ll do just fine as an investor.

1

The Five Rules for Successful Stock Investing

IT ALWAYS AMAZES me how few investors—and sometimes, fund managers—can articulate their investment philosophy. Without an investing framework, a way of thinking about the world, you’re going to have a very tough time doing well in the market.

I realized this some years ago while attending the annual meeting of Berkshire Hathaway, the firm run by billionaire superinvestor Warren Buffett. I overheard another attendee complain that he wouldn’t be attending another Berkshire meeting because “Buffett says the same thing every year.” To me, that’s the whole point of having an investment philosophy and sticking to it. If you do your homework, stay patient, and insulate yourself from popular opinion, you’re likely to do well. It’s when you get frustrated, move outside your circle of competence, and start deviating from your personal investment philosophy that you’re likely to get into trouble.

Here are the five rules that we recommend:

1. Do your homework.

2. Find economic moats.

3. Have a margin of safety.

4. Hold for the long haul.

5. Know when to sell.