Excerpts From One Up On Wall Street

Usually business books are too much fluff, repetition, and little content. This one is different. It’s full of interesting insights about stock-picking and investing.

“Judging by the Maserati sales in Silicon Valley, dot.coms are highly rewarding to entrepreneurs who take them public and early buyers who make timely exits. But I’d like to pass along a word of caution to people who buy shares after they’ve levitated. Does it make sense to invest in a dot.com at prices that already reflect years of rapid earnings growth that may or may not occur? By the way I pose this, you’ve already figured out my answer is “no.””
“To my mind, the stock price is the least useful information you can track, and it’s the most widely tracked.”
“If you can follow only one bit of data, follow the earnings—assuming the company in question has earnings. As you’ll see in this text, I subscribe to the crusty notion that sooner or later earnings make or break an investment in equities. What the stock price does today, tomorrow, or next week is only a distraction.”
“The Internet is far from the first innovation that changed the world. The railroad, telephone, the car, the airplane, and the TV can all lay claim to revolutionary effects on the average life, or at least on the prosperous top quarter of the global population. These new industries spawned new companies, only a few of which survived to dominate the field. The same thing likely will happen with the Internet. A big name or two will capture the territory, the way McDonald’s did with burgers or Schlumberger did with oil services. Shareholders in those triumphant companies will prosper, while shareholders in the laggards, the has-beens, and the should-have-beens will lose money. Perhaps you’ll be clever enough to pick the big winners that join the exclusive club of companies that earn $1 billion a year.”
“I mention Microsoft and Cisco to add contemporary examples to illustrate a major theme of this book. An amateur investor can pick tomorrow’s big winners by paying attention to new developments at the workplace, the mall, the auto showrooms, the restaurants, or anywhere a promising new enterprise makes its debut. While I’m on the subject, a clarification is in order.”
“My clunkers remind me of an important point: You don’t need to make money on every stock you pick. In my experience, six out of ten winners in a portfolio can produce a satisfying result. Why is this? Your losses are limited to the amount you invest in each stock (it can’t go lower than zero), while your gains have no absolute limit.”
“For instance, in 1998 the S&P 500 index was up 28 percent overall, but when you take a closer look, you find out the 50 biggest companies in the index advanced 40 percent, while the other 450 companies hardly budged. In the NASDAQ market, home to the Internet and its supporting cast, the dozen or so biggest companies were huge winners, while the rest of the NASDAQ stocks, lumped together, were losers. The same story was repeated in 1999, where the elite group of winners skewed the averages and propped up the multitude of losers.”
“Twenty years in this business convinces me that any normal person using the customary three percent of the brain can pick stocks just as well, if not better, than the average Wall Street expert.”
“The more right you are about any one stock, the more wrong you can be on all the others and still triumph as an investor.”
“During a lifetime of buying cars or cameras, you develop a sense of what’s good and what’s bad, what sells and what doesn’t. If it’s not cars you know something about, you know something about something else, and the most important part is, you know it before Wall Street knows it. Why wait for the Merrill Lynch restaurant expert to recommend Dunkin’ Donuts when you’ve already seen eight new franchises opening up in your area?”
“Under the current system, a stock isn’t truly attractive until a number of large institutions have recognized its suitability and an equal number of respected Wall Street analysts (the researchers who track the various industries and companies) have put it on the recommended list.”
“Dunkin’ Donuts was a 25-bagger between 1977 and 1986, yet only two major firms follow it even today. Neither was interested five years ago. Only a few regional brokerages, such as Adams, Harkness, and Hill in Boston, got on to this profitable story, but you could have initiated coverage on your own, after you’d eaten the donuts.”
“Whoever imagines that the average Wall Street professional is looking for reasons to buy exciting stocks hasn’t spent much time on Wall Street. The fund manager most likely is looking for reasons not to buy exciting stocks, so that he can offer the proper excuses if those exciting stocks happen to go up. “It was too small for me to buy” heads a long list, followed by “there was no track record,” “it was in a nongrowth industry,” “unproven management,” “the employees belong to a union,” and “the competition will kill them,” as in“Stop & Shop will never work, the 7-Elevens will kill them,” or “Pic ’N’ Save will never work, Sears will kill them,” or “Agency Rent-A-Car hasn’t got a chance against Hertz and Avis.””
“If IBM goes bad and you bought it, the clients and the bosses will ask: “What’s wrong with that damn IBM lately?” But if La Quinta Motor Inns goes bad, they’ll ask: “What’s wrong with you?””
“Seven Oaks makes a lot of money doing this boring job, and the shareholders are well-rewarded. It’s exactly the kind of obscure, boring, and highly profitable company with an inscrutable name that I like to own.”
“The stocks I try to buy are the very stocks that traditional fund managers try to overlook. In other words, I continue to think like an amateur as frequently as possible.”
“To me, an investment is simply a gamble in which you’ve managed to tilt the odds in your favor. It doesn’t matter whether it’s Atlantic City or the S&P 500 or the bond market. In fact, the stock market most reminds me of a stud poker game.”
“There’s a very interesting correlation here: the “riskier” the fund, the better the payoff. If you’d put $10,000 into the average bond fund in 1963, fifteen years later you’d come out with $31,338. The same $10,000 in a balanced fund (stocks and bonds) would have produced $44,343; in a growth and income fund (all stocks), $53,157; and in an aggressive growth fund (also all stocks), $76,556.”
“Only invest what you could afford to lose without that loss having any effect on your daily life in the foreseeable future.”
“The problem isn’t that investors and their advisors are chronically stupid or unperceptive. It’s that by the time the signal is received, the message may already have changed. When enough positive general financial news filters down so that the majority of investors feel truly confident in the short-term prospects, the economy is soon to get hammered.

What else explains the fact that large numbers of investors (including CEOs and sophisticated business people) have been most afraid of stocks during the precise periods when stocks have done their best (i.e., from the mid-1930s to the late 1960s) while being least afraid precisely when stocks have done their worst (i.e., early 1970s and recently in the fall of 1987).”

“The trick is not to learn to trust your gut feelings, but rather to discipline yourself to ignore them. Stand by your stocks as long as the fundamental story of the company hasn’t changed.”
“If you knew there was going to be a Florida real estate boom and you picked Radice out of a hat, you would have lost 95 percent of your investment. If you knew there was a computer boom and you picked Fortune Systems without doing any homework, you’d have seen it fall from $22 in 1983 to $17/8 in 1984. If you knew the early 1980s was bullish for airlines, what good would it have done if you’d invested in People Express (which promptly bought the farm) or Pan Am (which declined from $9 in 1983 to $4 in 1984 thanks to inept management)?”
“If you work in the chemical industry, then you’ll be among the first to realize that demand for polyvinyl chloride is going up, prices are going up, and excess inventories are going down. You’ll be in a position to know that no new competitors have entered the market and no new plants are under construction, and that it takes two to three years to build one. All this means higher profits for existing companies that make the product.”
“If you’re considering a stock on the strength of some specific product that a company makes, the first thing to find out is: What effect will the success of the product have on the company’s bottom line?”
“GE has 900 million shares outstanding, and a total market value of $39 billion. The annual profit, more than $3 billion, is enough to qualify as a Fortune 500 company on its own. There is simply no way that GE could accelerate its growth very much without taking over the world. And since fast growth propels stock prices, it’s no surprise that GE moves slowly as La Quinta soars. Everything else being equal, you’ll do better with the smaller companies.”
“[Types of stocks] THE SLOW GROWERS: Usually these large and aging companies are expected to grow slightly faster than the gross national product. Slow growers didn’t start out that way. They started out as fast growers and eventually pooped out, either because they had gone as far as they could, or else they got too tired to make the most of their chances.”
“Another sure sign of a slow grower is that it pays a generous and regular dividend. As I’ll discuss more fully in Chapter 13, companies pay generous dividends when they can’t dream up new ways to use the money to expand the business.”
“So while the smaller fast growers risk extinction, the larger fast growers risk a rapid devaluation when they begin to falter. Once a fast grower gets too big, it faces the same dilemma as Gulliver in Lilliput. There’s simply no place for it to stretch out. But for as long as they can keep it up, fast growers are the big winners in the stock market. I look for the ones that have good balance sheets and are making substantial profits. The trick is figuring out when they’ll stop growing, and how much to pay for the growth.”
“If you discover an opportunity early enough, you probably get a few dollars off the price just for the dull or odd name, which is why I’m always on the lookout for the Pep Boys or the Bob Evanses, or the occasional Consolidated Rock.

I get even more excited when a company with a boring name also does something boring. Crown, Cork, and Seal makes cans and bottle caps. What could be duller than that? You won’t see an interview with the CEO of Crown, Cork, and Seal in Time magazine alongside an interview with Lee Iacocca, but that’s a plus. There’s nothing boring about what’s happened to the shares of Crown, Cork, and Seal.”

“Large parent companies do not want to spin off divisions and then see those spinoffs get into trouble, because that would bring embarrassing publicity that would reflect back on the parents. Therefore, the spinoffs normally have strong balance sheets and are well-prepared to succeed as independent entities.”
“If you find a stock with little or no institutional ownership, you’ve found a potential winner. Find a company that no analyst has ever visited, or that no analyst would admit to knowing about, and you’ve got a double winner. When I talk to a company that tells me the last analyst showed up three years ago, I can hardly contain my enthusiasm.”
“Many people prefer to invest in a high-growth industry, where there’s a lot of sound and fury. Not me. I prefer to invest in a low-growth industry like plastic knives and forks, but only if I can’t find a no-growth industry like funerals. That’s where the biggest winners are developed.”
“There’s nothing thrilling about a thrilling high-growth industry, except watching the stocks go down. Carpets in the 1950s, electronics in the 1960s, computers in the 1980s, were all exciting high-growth industries, in which numerous major and minor companies unerringly failed to prosper for long. That’s because for every single product in a hot industry, there are a thousand MIT graduates trying to figure out how to make it cheaper in Taiwan. As soon as a computer company designs the best word-processor in the world, ten other competitors are spending $100 million to design a better one, and it will be on the market in eight months. This doesn’t happen with bottle caps, coupon-clipping services, oil-drum retrieval, or motel chains.”
“Instead of investing in computer companies that struggle to survive in an endless price war, why not invest in a company that benefits from the price war—such as Automatic Data Processing? As computers get cheaper, Automatic Data can do its job cheaper and thus increase its own profits. Or instead of investing in a company that makes automatic scanners, why not invest in the supermarkets that install the scanners?”
“In general, corporate insiders are net sellers, and they normally sell 2.3 shares to every one share that they buy.”
“Although it’s a nice gesture for the CEO or the corporate president with the million-dollar salary to buy a few thousand shares of the company stock, it’s more significant when employees at the lower echelons add to their positions.”
“There are many reasons that officers might sell. They may need the money to pay their children’s tuition or to buy a new house or to satisfy a debt. They may have decided to diversify into other stocks. But there’s only one reason that insiders buy: They think the stock price is undervalued and will eventually go up.)”
“You aren’t clever at selling hot stocks (and the fact that you’ve bought them is a clue that you won’t be), you’ll soon see your profits turn into losses, because when the price falls, it’s not going to fall slowly, nor is it likely to stop at the level where you jumped on.”
“Copying has been a respectable industry for two decades and there’s never been a slowdown in demand, yet the copy machine companies can’t make a decent living.”
“Instead of buying back shares or raising dividends, profitable companies often prefer to blow the money on foolish acquisitions. The dedicated diworseifier seeks out merchandise that is (1) overpriced, and (2) completely beyond his or her realm of understanding. This ensures that losses will be maximized.”
“As often as a dull name in a good company keeps early buyers away, a flashy name in a mediocre company attracts investors and gives them a false sense of security.”
“An average p/e for a utility (7 to 9 these days) will be lower than the average p/e for a stalwart (10 to 14 these days), and that in turn will be lower than the average p/e of a fast grower (14–20). Some bargain hunters believe in buying any and all stocks with low p/e’s, but that strategy makes no sense to me. We shouldn’t compare apples to oranges. What’s a bargain p/e for a Dow Chemical isn’t necessarily the same as a bargain p/e for a Wal-Mart.”
“There are five basic ways a company can increase earnings*: reduce costs; raise prices; expand into new markets; sell more of its product in the old markets; or revitalize, close, or otherwise dispose of a losing operation.”
“The more homogeneous the country gets, the more likely that what’s popular in one shopping center will also be popular in all the other shopping centers. Think of all the brand names and products whose success or failure you’ve correctly predicted.”
“The p/e ratio of any company that’s fairly priced will equal its growth rate.”
“The p/e of Coca-Cola is 15, you’d expect the company to be growing at about 15 percent a year, etc. But if the p/e ratio is less than the growth rate, you may have found yourself a bargain.”
“Among turnarounds and troubled companies, I pay special attention to the debt factor. More than anything else, it’s debt that determines which companies will survive and which will go bankrupt in a crisis. Young companies with heavy debts are always at risk.”
“The more cash that builds up in the treasury, the greater the pressure to piss it away.”
“What you want, then, is a relatively high profit-margin in a long-term stock that you plan to hold through good times and bad, and a relatively low profit-margin in a successful turnaround”
“The more stocks you own, the more flexibility you have to rotate funds between them. This is an important part of my strategy.”
“A price drop in a good stock is only a tragedy if you sell at that price and never buy more. To me, a price drop is an opportunity to load up on bargains from among your worst performers and your laggards that show promise.”
“One obvious sell signal is that inventories are building up and the company can’t get rid of them, which means lower prices and lower profits down the road. I always pay attention to rising inventories. When the parking lot is full of ingots, it’s certainly time to sell the cyclical.”
“In my experience no downtrodden stock ever returns to the level at which you’ve decided you’d sell. In fact, the minute you say, “If it gets back to $10, I’ll sell,” you’ve probably doomed the stock to several years of teetering around just below $9.75 before it keels over to $4, on its way to falling flat on its face at $1. This whole painful process may take a decade, and all the while you’re tolerating an investment you don’t even like, and only because some inner voice tells you to get $10 for it. Whenever I’m tempted to fall for this one, I remind myself that unless I’m confident enough in the company to buy more shares, I ought to be selling immediately. ”
“If you give up on a stock because you’re tired of waiting for something wonderful to happen, then something wonderful will begin to happen the day after you get rid of it. I call this the postdivestiture flourish.”
“It takes remarkable patience to hold on to a stock in a company that excites you, but which everybody else seems to ignore. You begin to think everybody else is right and you are wrong. But where the fundamentals are promising, patience is often rewarded—Lukens stock went up sixfold in the fifteenth year, American Greetings was a sixbagger in six years, Angelica a sevenbagger in four, Brunswick a sixbagger in five, and SmithKline a threebagger in two”
“There’s a generous broker’s commission attached to every purchase to boot. Options are the broker’s gravy train. A broker with only a handful of active options clients can make a wonderful living.”
“Today, the average household has two wage earners instead of one, and that provides an economic cushion that didn’t exist sixty years ago. If we have a depression, it won’t be like the last one!”