 the  most  spectacularly  performingmarket average, you would have had a compound gain of 352 percent. Mypoint is that nine of the 25 top-performing funds barely exceeded a buy-and-hold strategy in the Dow. Keep in mind that we’re looking at the bestfunds here—the ones that did the very best job of selecting growth stocks.Of the thousands and thousands of funds, only a handful were able to justkeep up with the U.S. stock market itself! Only a select few were able to
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make much of a difference beyond a buy-and-hold strategy in the Dow. Ithink there are about 3,000 active mutual funds, so the table shown heretells us that only a minuscule number of the funds, of those guys lookingfor  the  highﬂiers,  were  able  to  beat  the  averages.  The  brightest  of  thebrightest barely outshone the averages!
If the professionals can’t catch the highﬂiers, I don’t think you and Ican, either. But what we can do is seek quality, seek value, and we willbe rewarded.
Being successful in this business of investing, then, is all about havingclear intentions with a single purpose in mind. That purpose is focused onthe correct time frame for your investments as well as the correct vehiclefor  those  investments.  There’ll  be  many  sideshow  attractions  to  lure  youaway from your purpose. In the heat of the moment you’ll see stocks youwished  you  owned,  and  you’ll  be  upset  that  somebody  is  making  moneywhen  you  are  not  doing  as  well.  Someone  will  always  be  outperformingyou, but let’s see where that person is six months or a year or two fromnow, because today’s darlings usually turn into next year’s dogs.
Dreams of investment success are shadows in a game that’s all aboutreality.  Maintain  your  intentions,  focus  your  purpose  and  you  will  ﬁndstock market success.
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HOW TO SUPERCHARGEYOUR INVESTMENT RETURN
The opposite of any generally accepted idea is worth afortune to somebody.
—Francis Scott Fitzgerald Key
Most investors get it all wrong: They think investing is about ﬁnding oneor two hot stocks or a great piece of real estate, buy it, then cash out for ahuge  gain.  That’s  not  how  money  is  really  made  in  the  world  of  invest-ments. Far from it, this is a business of getting a return on your money. Itis a business of making an amount of money worth more later than it isnow. It is not about ﬁnding one-hit wonders or stocks that may zoom upin the future.
That,  as  we  have  seen  earlier,  is  very  much  a  game  of  Russianroulette. It’s a bit like baseball—home run hitters strike out a lot. Isn’t itinteresting  that  despite  the  huge  success  of  Mark  McGwire,  SammySosa, and Barry Bonds when it comes to hitting home runs, their teamsdon’t  get  to  or  win  the  World  Series?  They  don’t  even  win  their  divi-sions. So much for home runs! While they are spectacular and awesomethings to see, almost as awesome as a stock that triples or quadruples ina six-month period, investing in this fashion becomes very much a hit-or-miss  approach.  You  will  strike  out.  Lots.  And  that’s  an  expensivething  to  do  in  this  business.  In  baseball  you  get  to  bat  again,  but  thatmay not be so easy for an investor.
In their search for investment proﬁts people focus on the spectacular,
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forgetting that the way to long-term objectives is reached by having a cam-paign  of  action  that  includes  goals,  a  theoretical  understanding  of  whatyou hope to achieve, and a precise way of accomplishing those goals.
In this chapter I would like to help you construct a battle plan for in-
vestment survival.
FIRST RULE
Hopefully,  by  now  you  have  realized  the  folly  of  trying  to  catch  high-ﬂiers, or holding on forever to “growth stocks.” If the funds can’t do it,and  few  of  them  do,  it  will  be  nearly  impossible  for  us  to  consistentlyﬁnd  these  runaway  stocks.  The  entire  approach  to  investing  in  thesestocks, or so-called opportunities, basically revolves around stories andrumors, or noticing stocks that have gone up a great deal in anticipationthey will go higher.
Trying to ﬁnd such stocks is hardly an approach to investing; it is morelike gambling. You are not purchasing stocks, you are purchasing hopes,high ones at that, and these hopes are usually based more on hype and in-vestors’  froth  than  anything  substantial.  In  short,  there  simply  is  nomethodology to this type of investment. I say this because in all my studiesI have found there is absolutely nothing that consistently selects the high-ﬂiers that keep ﬂying.
Most often, just about the time we buy the highﬂier, an engine conks
out, a wing falls off, and our hard-earned cash goes up in ﬂames.
This is very much a short-term approach to investing. It has nothingto do with a consistent application of proven investment techniques orstrategies  that  we  know  make  money.  The  major  error  I  made  when  Iﬁrst began trading and investing in stocks was to be attracted by thesehighﬂiers. I believed it was possible to ﬁnd them, buy them, and hold ona  short  time  to  make  seemingly  instant  wealth.  The  reality  was  that  Iwas not able to do that and have not found anyone else who has consis-tently done it, either. Hot stocks are very random. I have learned to getrid of randomness in my life. Random success is accompanied by just asmuch random failure. Keep in mind that if the great minds and comput-ers  of  Wall  Street  could  do  this  they  would  have  much  better  perfor-mance than they do.
Successful investing is all about having an advantage. My favorite par-allel of this would be the casinos in Las Vegas. I assume you have been there
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or have seen pictures of this amazing town, which now possesses miniaturemock-up  replicas  of  all  of  the  world’s  wonders  with  the  exception  of  theGreat Wall of China. I suppose the next thing they will build there will be areconstruction of the tower of Babel. Then again, that may be there now.
How do you suppose those buildings, those fantastic hotels and densof iniquity, were ﬁnanced? “Oh, I know,” you reply. “It was done fromthe  losings  of  would-be  gamblers,  people  who  think  they  can  beat  thehouse.” That is absolutely true. Gamblers are very much hit-or-miss in-vestors.  They’re  trying  to  catch  a  winner  in  a  game  were  the  odds  areagainst  them.  Yes,  sometimes  they  succeed,  but  since  the  casinos  keepbuilding  more  monstrosities,  it  suggests  to  us  the  casinos  are  the  oneswho bank on consistency.
So  how  do  they  do  it?  It’s  really  quite  simple;  they  have  a  gamewherein they have a slight advantage ranging from 1.5 percent all way upto a 5 percent advantage. The average advantage is somewhere around 2.5percent for most of their games of chance. “Games of chance,” I like that;that’s what catching highﬂiers is, a game of chance.
A 2.5 percent advantage doesn’t turn on most investors. That’s becausethey operate on an emotional basis where they think the way to bulk up in-vestment return is by getting spectacular gains.
Instead, these people should listen to what Albert Einstein said: that hethought the most amazing thing in the world was compounding numbers.Let me give you an example of this.
We  have  two  investors.  One  has  a  very  good  long-term  investmentprogram that yields 7.1 percent per year, while the other investor has aprogram  that  does  a  little  bit  better  at  10.0  percent  per  year.  At  ﬁrstblush you might think there won’t be much difference in the net resultsthese  two  investors  will  have—after  all,  the  difference  in  yield  is  lessthan 3 percent per year. However, because of the magic of compoundingover 60 years (a little longer than most of us will be or want to be in-vesting, but it proves the point), the investor getting 7.1 percent a yearwill have turned $10,000 into $6 million. He’ll be a happy guy until heﬁnds that his neighbor with a slightly higher rate of return on the sameamount of money, $10,000 in both cases, has ended up with a staggering$34 million.
That  tiny  little  2.9  percent  difference,  because  of  the  mathematics  ofcompounding,  made  $28  million  more  than  the  7.1  percent  return.  Whydoes this happen? Simply because the compounding effect is gargantuan.Notice that neither investor had a particularly phenomenal rate of return,
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so  it  was  not  the  investment  strategy  that  made  either  of  them  wealthy,nearly as much as it was the consistency of an approach that was followedon a long-term basis and boosted up thanks to the compounding effect.
What this tells us, then, is that if we wish to maximize the return onour money we don’t need a huge advantage in the game. We don’t have tohave  100  percent  returns,  year  after  year,  to  beat  the  pants  off  the  stockmarket. We don’t need excessive risk to succeed.
Most investors have unrealistic goals that can never be reached. Thus,they lose interest as well as their money. The approach I suggest is one thatrecognizes the reality of how difﬁcult it is to catch hot stocks or to makemoney off of hot tips and rumors. The reality of investing is that we don’tneed  to  expose  ourselves  to  these  risks  or  capture  the  gains  to  be  wildlysuccessful in this business.
THE BEST INVESTMENT GOAL
Our goal, then, is not about making a killing on any one individual deci-sion. Our goal is to develop an approach that consistently makes moneyand then consistently use that approach. If we beat the averages, we beat80 percent of the brightest minds on Wall Street, and can make a fortuneover time. I’m happy with that!
So how is all this accomplished?There are really only two aspects to this type of investing.The ﬁrst is to ﬁnd stocks that have a distinct tendency to outperform
the market, to rally, to reward investors.
The second is to identify the most appropriate times when these stocks
will rally.
While it is very popular to read in investment books that timing your
entry into the markets is likely a waste of time, I totally disagree.
In the three years of 1999, 2000, and 2001, more than 60 percent ofthe stocks on the Nasdaq declined in value. In other words, you had only a40 percent chance of getting a stock that went up. Over at the New YorkStock  Exchange  we  found  better  odds,  but  not  much  better.  In  the  year2000 about 58 percent of those stocks posted gains, and 42 percent wentlower.  In  2001,  only  55  percent  of  the  New  York  Stock  Exchange  issuesadvanced, cutting your odds of ﬁnding a winner even more.
It really gets down to this: Stocks are much better buys when the majormarket indexes are inclined to rally. It’s just like the old adage says: Don’t
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confuse brains with a bull market. A bull market bails out almost every in-vestment error we can make.
When you consider the above percentages, keep in mind they are justpercentage  tabulations  of  how  many  stocks  were  up  or  down  and  havenothing to do with the magnitude of the move, which is even more impor-tant. Consider this: You buy 55 stocks that go up and 45 that go down.That looks like a winning scenario, but you’d lose money if the downerslost more than the uppers gained.
So,  then,  we  have  a  two-pronged  investment  goal:  Besides  ﬁndingstocks that are likely to outperform, we must seek out the most opportunetimes when on an overall basis we expect stocks to rally, which I believeI’ve done to a large extent for you with our cyclical analysis.
Most likely we will not call the exact lows of many market moves, butit is just as likely that we will be on the sidelines during bear markets, dur-ing times when other investors are exposed to risk.
There are other tools you can use that will most likely have you in-vesting at what is a market low point. The seasonal tendency of the stockmarket is extremely powerful, and I believe that can and should be one ofyour  ﬁrst  considerations.  I  see  little  reason  for  investors  to  be  fully  in-vested during the months stocks have been most likely to decline and haveposted  major  market  crashes.  By  and  large,  that’s  from  March  throughOctober.  That  is  a  high-risk  time  period  for  investors.  By  sitting  on  thesidelines  during  this  time  you  will  miss  major  market  moves.  Big  deal!Consider the consequences of a crash that takes away 50 percent of thevalue of your holdings. That means the market must now stage a 100 per-cent rally to get you back to being even. That’s a tough scenario—why ex-pose yourself to it?
October is such a fascinating month. While it is a very bad month tocome in on the long side, it has been a very good month to go out of on thelong  side.  The  one  thing  that  will  most  inﬂuence  your  ability  to  makemoney in the market will be your success in sidestepping market declines.They are the bugaboo we need to protect ourselves from, the monster hid-ing in the dark shadows cast by all those Wall Street skyscrapers. If we cansimply avoid one or two, if not the majority of market slides, we will sub-stantially outperform all other investors.
I have shown you when most of these market slides occur, so why putourselves in a place where trouble is most likely to ﬁnd us? It boggles mymind why investors stay fully invested at times trouble is most likely to oc-cur. These people would certainly not stand in front of a speeding freight
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train, yet have no reluctance to have all their money invested at the worstpossible times.
I am always amused to see investors who are so meticulous about theissues they select to buy yet have no knowledge of market timing. But tim-ing can make a huge difference. The ﬁrst part of my investment strategy isto align with the major cyclical up moves in stock prices. We need to focuson this; we need to pay attention to it. It needs to be as much, part and par-cel, of our investment strategy as what issues we select to invest in.
Your  ﬁrst  lesson,  then,  is  to  focus  your  investment  decisions  at  thesetimes and only at these times, as opposed to being fully invested 100 per-cent of the time. I believe one reason funds have not been able to beat themarket averages is that due to their size they can’t get out at times, even ifthey wanted to.
We  have  a  distinct  advantage  over  the  funds  in  that  regard.  We  canpull our punches, wait until we think we are at opportune buying times orzones. We certainly don’t expect to call all the swings of the marketplace,but we do expect—and it is a reasonable expectation—to generally makeour purchases at times the stock market is most likely to rally in the ensu-ing  12  months.  Timing  does  make  a  difference;  long-term  studies  showperfect timing can almost triple your rate of return. But again, the empha-sis there is on perfect timing, a difﬁcult thing to accomplish.
The  ﬁnal  lesson  is  that  the  business  of  investing  is  a  long-range  ap-proach. Once you determine your basic battle plan, stick with it. Just as tostay in good physical condition one needs to exercise on a consistent basis,so it is with capital appreciation of your money. You need to set time asideon a weekly or monthly basis so that you can follow your plan of action. Ifyou don’t follow a plan of action, why make a plan of action? This is seri-ous  business  here;  this  is  about  money,  your  money.  Your  ability  to  en-hance  the  return  on  your  money  will  be  directly  proportional  to  theconsistent application of your strategy.
Trust me on this. The markets are not always easy; they will test whatyou are made of; they continually put your emotions up against a wall. Attimes like these most investors fold, or switch horses midstream. When un-der pressure it is amazing what the human mind can dredge and dream up.You  will  rationalize  that  the  strategy  doesn’t  work  anymore,  though  thestrategies have worked for almost 100 years. Yet at any given point in timethey may falter. That is to be expected.
Let’s talk about that.
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To me our objective is to beat the stock market averages. If we can dothat on a consistent basis we come out way ahead. Thus if the stock mar-ket is down we may, if we’re fortunate, be slightly up or marginally down.At  times  we  may  underperform  the  stock  market  itself.  Continuing  withmy Las Vegas analogy, please keep this point foremost in your thinking: Atany given time in every casino of the world, the house will have a losingstreak. Some lucky punter will be winning.
How  do  the  casinos  handle  that?  Do  they  shut  down  the  tables?  Dothey  come  in  and  decide  to  make  new  rules?  Of  course  not!  Why  wouldthey do that? They know they have a game where they will come out aheadin  the  long  run,  which  is  why  they  consistently  spin  the  wheel,  deal  thecards, and roll the dice. While they do not like anyone taking their money,any more than you like a stock declining against you, it is not a reason tochange  the  game,  to  invent  a  strategy  radically  different  from  what  hasbeen proven to be so successful in the past.
There are really two parts to correct action in this part of our invest-ment  strategy.  The  impeccable  warrior,  and  that  is  such  a  great  way  tothink of yourself in this game of investments, will go to war only when it isthe correct time to wage war and will consistently use proven strategies. Itreally gets down to the hard work and drudgery of repetitive action. Peopledon’t like repetitive action, especially investors. They want exciting action,big up moves, thrills—all those things that are destined to lead to . . . spills.Our  secret  of  success  is  the  consistent  application  of  doing  the  rightthing. Do it for a long enough time period and you’re bound to ﬁnd suc-cess. You can’t avoid it; it will happen.
OUR SECOND GOAL
It’s time to get down to work now, to show you how an investor can ac-complish  an  advantage  in  selecting  individual  issues.  Our  strategy,  then,would be to combine general, overall, market timing with a superior selec-tion strategy. Our goal is to ﬁnd stocks where we have a distinct advantagethat  they  will  rally.  Our  selection  process  deliberately,  and  consciously,does not attempt to catch the uncatchable or delve into the dream stocksthat have become the downfall of so many investors.
In  the  next  chapter  I’m  going  to  present  to  you  numerous  strategiesthat  have  been  proven  by  a  tremendous  amount  of  research,  as  well  as
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real-time investing, to give us an advantage in the game . . . to put us onestep ahead other investors. You don’t have to be particularly intelligent tobe successful in this business. Hard work and native intelligence will carrythe day for an investor.
Success  in  the  business  world,  probably  in  the  entire  world,  comesfrom being smart. Being smart, or smarter than the next guy, is the productof studying and learning. Being successful, or more successful than the nextguy, is the product of the application of what you’ve learned.
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THE OLD ECONOMYIS THE NEW ECONOMY
Historians ponder the past; investors ponder the future.. . . One is more proﬁtable than the other.
“The  new  economy”—it  was  supposed  to  solve  all  the  problems  ofmankind. Sales and marketing, along with virtually all levels of corporateexistence, were to be radically changed—changed forever. The rules of thepast were to have been tossed out, as we were promised sweeping new in-novations that would make life easier and investors much richer.
It  was  same  song,  same  dance  to  me.  I  had  heard  this  “new  world”concept  in  the  1960s,  and  then  again  in  the  1970s.  Each  time,  shortlythereafter, the stock market crashed. As the French say, “The more thingschange the more they stay the same.” In the new economy the lessons andrules from the past supposedly didn’t matter. Stocks were to be valued notby what the companies did, but rather by what they might do in the future.Suddenly stocks were selling at 100 times earnings—some all the way up to200 times. Sad to say, many investors lost a substantial part of their money,in many instances actual fortunes, all because they did not pay attention toone simple little number—the price-earnings ratio. It was telling investorsit would take 200 years for the company to earn enough money to justifythe current price of one share of stock!
Talk about being long-term investors; the short-term speculators were
betting on a 200-year hold.
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“Momentum,” that’s what it was all about they said. The new breedof  investors,  who  I  think  should  be  called  punters,  had  run  stock  datathrough their computers to discover that stocks that went higher contin-ued going higher. That was true because the overall market of the 1980swas  in  a  gargantuan  uptrend.  Noticing  this,  the  hotshot  wizards  fromHarvard, Stanford, and the like used the same strategy of buying strongstocks. That lasted for awhile, just long enough for them to look reallygood. Hence, they acquired more money under management, so when theultimate day of reckoning did come they did not lose just a little—theylost a lot.
As I have frequently said, “The reward of value may be delayed, butultimately  it  cannot  be  denied.”  The  opposite  of  that  is  equally  true:Stocks may become overvalued and then become even more overvalued,but ultimately chickens come home to roost. There’s never been a stockin  history  that  has  been  able  to  consistently  maintain  a  P/E  ratio  over100  without  a  signiﬁcant  market  collapse  and  decline  in  price.  Never,ever, ball fans.
The price-earnings ratio has been with us for many years. As a youngman I was told that whenever the Dow Jones Industrial Average sported aP/E ratio greater than 30 there was trouble ahead. Nowadays stocks canexceed  that  30  reading,  but  in  most  cases  not  for  long.  What  this  ratiolooks  at  is  the  price  of  the  stock  divided  by  the  earnings  the  company  isproducing. The cool thing about this indicator is it deals with reality—itlooks  at  the  current  price  versus  the  current  amount  of  money  the  com-pany is earning. There’s no conjecture here, no room for myth or hype, itsimply  is  what  it  is.  One  simply  divides  the  current  price  by  the  currentearnings to arrive at this ratio.
It all starts with earnings, then, doesn’t it? When companies are earn-ing  money  they  are  appreciated  by  long-term  investors  much  more  thanwhen earnings are negligible or nonexistent. It sounds ridiculously simpleto ask this question: “Is the company you are investing in making moneyor not?” Had millions of investors had the gumption to ask just that onequestion about the highﬂiers of the high-tech new economy, I suspect theywould never have put down a single nickel for all those stocks that lost allthat money. Why didn’t they ask that question? is my question.
The answer is simple: They got so carried away with the up move inindividual prices that they simply threw all caution to the winds. Realitydidn’t matter; after all, we were in a new economy, with new rules. The lawof  gravity  had  been  repealed.  The  economic  laws  had  also,  apparently,
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been  revoked.  There  was  a  short  circuit  of  the  logical  process  as  priceswent to astronomical levels for no reason at all. Investors kept dancing tothe sound of the piper’s music, buying and buying, chasing strength.
All that has changed now. The piper came to be paid. A July 2001 WallStreet Journal article was headlined, “Merrill’s Recent Picks Are Strong onStability.”  Value  stocks  have  substantially  outperformed  growth  stockswas the point of the article. I think we are going to see a whole lot more ofthis investment strategy in the future as brokerage ﬁrms and investment ad-visers return to the fundamentals of value.
Bob Doll, from Merrill Lynch, expressed it this way: “We’re shootingfor earnings visibility.” Considering the size of Merrill’s operation—some$57  billion  in  assets  in  48  funds—one  gets  a  sense  of  the  impact  thischange in the investment community may make on individual issues.
HOW TO KNOW WHAT THE FUNDS ARE DOING
You can follow what these large institutional ﬁrms are buying each Friday.That’s the day Investor’s Business Daily reveals the 25 largest stock posi-tions for the largest mutual funds. This is an excellent way of seeing whatstocks these funds are holding and may be a good place for you to look forlong-term stocks to run through our various value models. Notice that thenewspaper  places  the  capital  letter  N  next  to  a  new  position  a  fund  hastaken since the last reporting period. Additionally, you’ll ﬁnd a plus or mi-nus to indicate whether the fund is adding to the position or selling off partof  it.  This  can  be  an  extremely  important  reference,  not  only  for  seeinghow your stocks are doing, but also as a quick and easy way to spot poten-tial investment candidates.
As an example, a recent listing shows the largest accumulation of in-dividual stocks by Merrill Lynch had been Bristol-Myers Squibb, HomeDepot,  and  PepsiCo.  The  largest  sells  were  Citigroup,  Verizon,  andPﬁzer. There is additional information that we can also quickly discover,thanks  to  the  newspaper.  An  investor  is  clearly  shown  the  industrieswhere these funds are making their largest bets. This may focus our at-tention  on  a  particular  industry.  In  this  tabulation,  the  largest  invest-in  thement  by  the  funds  under  Merrill  Lynch’s  control  was medical-ethical  drugs  industry  with  some  $153  million  of  new  moneypouring  in.  The  retail/wholesale  industry  was  a  distant  second  with  aninﬂux of $97 million of new money.
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