Beating the Street (22 page)

Those who hold this viewpoint tend to prove its validity by neglecting to do research and “playing” the market, which results in
more losses, which reinforce the idea that they're lacking in knack. One of their favorite excuses is that “a stock is like a woman—you can never figure one out.” This is unfair to women (who wants to be compared to a share of Union Carbide?) and to stocks.

My stockpicking method, which involves elements of art and science plus legwork, hasn't changed in 20 years. I have a Quotron, but not the newfangled work station that many fund managers are using, which reports on what every analyst in the universe is saying about every company, draws elaborate technical charts, and for all I know plays war games with the Pentagon and chess with Bobby Fischer.

Professional investors are missing the point. They're scrambling to buy services like Bridge, Shark, Bloomberg, First Call, Market Watch, and Reuters to find out what all the other professional investors are doing when they ought to be spending more time at the mall. A pile of software isn't worth a damn if you haven't done your basic homework on the companies. Trust me, Warren Buffett doesn't use this stuff.

At earlier
Barron's
panels, my enthusiasm for stocks caused me to go a bit overboard on the recommendations, beginning in 1986, when I recommended more than 100 stocks, a record that stood until the next year, when I recommended 226, causing Alan Abelson to comment: “Maybe we should have asked you what you don't like.” At the 1988 panel, the gloomiest on record, I showed some restraint and touted 122, or 129 if you count the seven Baby Bells separately. “You are an equal-opportunity buyer,” quipped Abelson. “You're being nondiscriminatory.”

In 1989, I showed additional restraint and mentioned only 91 of my favorites, which still was enough to get another rise out of the
Barron's
emcee, who said, “We're once again in the positon of perhaps having to ask you what you don't like—it's a shorter list.” In 1990 I reduced the number further, to 73.

I've always believed that searching for companies is like looking for grubs under rocks: if you turn over 10 rocks you'll likely find one grub; if you turn over 20 rocks you'll find two. During the four-year stretch mentioned above, I had to turn over thousands of rocks a year to find enough new grubs to add to Magellan's outsized collection.

The change in my status from full-time to part-time stockpicker caused me to cut back on my recommendations, to 21 companies in
1991 and 21 again in 1992. Since I'd gotten more involved with my family and my charity work, I had time to turn over only a few rocks.

This was OK with me, since the part-time stockpicker doesn't need to find 50 or 100 winning stocks. It only takes a couple of big winners in a decade to make the effort worthwhile. The smallest investor can follow the Rule of Five and limit the portfolio to five issues. If just one of those is a 10-bagger and the other four combined go nowhere, you've still tripled your money.

By the time the Roundtable convened in January 1992, stocks in the Dow had enjoyed a great rise to a year-end high of 3200, and optimism abounded. In the festive atmosphere that surrounded a recent 300-point gain in the Dow in three weeks, I was the most depressed person on the panel. I'm always more depressed by an overpriced market in which many stocks are hitting new highs every day than by a beaten-down market in a recession.

Recessions, I figure, will always end sooner or later, and in a beaten-down market there are bargains everywhere you look, but in an overpriced market it's hard to find anything worth buying. Ergo, the devoted stockpicker is happier when the market drops 300 points than when it rises the same amount.

Many of the larger stocks, especially high-profile growth companies such as Philip Morris, Abbott, Wal-Mart, and Bristol-Myers, had risen in price to the point that they'd strayed far above their earnings lines, as shown in
Figures 7-1
,
7-2
,
7-3
, and
7-4
. This was a bad sign.

Stocks that are priced higher than their earnings lines have a regular habit of moving sideways (a.k.a. “taking a breather”) or falling in price until they are brought back to more reasonable valuations. A glance at these charts led me to suspect that the much-ballyhooed growth stocks that were the champions of 1991 would do nothing or go sideways in 1992, even in a good market. In a bad market, they could suffer 30 percent declines. I told the
Barron's
panel that on my list of prayers, Mother Teresa had to be moved down. I was more worried about the growth stocks.

There's no quicker way to tell if a large growth stock is overvalued, undervalued, or fairly priced than by looking at a chart book (available in libraries or a broker's office). Buy shares when the stock price is at or below the earnings line, and not when the price line diverges into the danger zone, way above the earnings line.

The Dow and the S&P 500 had also reached very pricey levels relative to book value, earnings, and other common measures, but many of the smaller stocks had not. In the late fall, which is always when I begin to do my
Barron's
homework, annual tax selling by disheartened investors drives the prices of smaller issues to pathetic lows.

You could make a nice living buying stocks from the low list in November and December during the tax-selling period and then holding them through January, when the prices always seem to rebound. This January effect, as it's called, is especially powerful with smaller companies, which over the last 60 years have risen 6.86 percent in price in that one month, while stocks in general have risen only 1.6 percent.

Small stocks are where I expected to find the bargains in 1992. But before beginning to explore the small-stock universe, I turned my attention to the companies I had recommended to
Barron's
readers in 1991.

Don't pick a new and different company just to give yourself another quote to look up in the newspaper or another symbol to watch on CNBC! Otherwise, you'll end up with too many stocks and you won't remember why you bought any of them.

Getting involved with a manageable number of companies and confining your buying and selling to these is not a bad strategy. Once you've bought a stock, presumably you've learned something about the industry and the company's place within it, how it behaves in recessions, what factors affect the earnings, etc. Inevitably, some gloomy scenario will cause a general retreat in the stock market, your old favorites will once again become bargains, and you can add to your investment.

The more common practice of buying, selling, and forgetting a long string of companies is not likely to succeed. Yet many investors continue to do this. They want to put their old stocks out of their minds, because an old stock evokes a painful memory. If they didn't lose money on it by selling too late, then they lost money on it by selling too soon. Either way, it's something to forget.

With a stock you once owned, especially one that's gone up since you sold it, it's human nature to avoid looking at the quote on the business page, the way you might sneak around the aisle to avoid meeting an old flame in a supermarket. I know people who read the stock tables with their fingers over their eyes, to protect themselves from the emotional shock of seeing that Wal-Mart has doubled since they sold it.

People have to train themselves to overcome this phobia. After running Magellan, I'm forced to get involved with stocks I've owned before, because otherwise there'd be nothing left to buy. Along the way, I've also learned to think of investments not as disconnected events, but as continuing sagas, which need to be rechecked from time to time for new twists and turns in the plots. Unless a company goes bankrupt, the story is never over. A stock you might have owned 10 years ago, or 2 years ago, may be worth buying again.

To keep up with my old favorites I carry a large wire-bound, campus-style notebook, a sort of
Boswell's Life of Johnson & Johnson
, in which I record important details from the quarterly and annual reports, plus the reasons that I bought or sold each stock the last time around. On the way to the office or at home late at night, I thumb through these notebooks, as other people thumb through love letters found in the attic.

This time around, I reviewed the 21 selections I'd made in 1991. It was a mixed bag that did extremely well in a year when the market at large enjoyed a broad-based rally. The S&P rose 30 percent; I think my recommendations rose 50 percent or more. The list included Kemper (insurance and financial services), Household International (financial services), Cedar Fair (amusement parks), EQK Green Acres (shopping center), Reebok (sneakers), Caesars World (casinos), Phelps Dodge (copper), Coca-Cola Enterprises (bottling), Genentech (biotechnology), American Family, now AFLAC (Japanese cancer insurance), K mart (a retailer), Unimar (Indonesian oil), Freddie Mac and Capstead Mortgage (mortgages), SunTrust (a bank), five savings and loans, and Fannie Mae (mortgages), a stock that I touted for six straight years.

I perused my diaries and noted several important changes. Mostly, the prices had gone up. This wasn't necessarily enough of a reason not to repeat a recommendation, but in most cases it meant that the stock had ceased to be a bargain.

One such stock was Cedar Fair, which owns amusement parks in
Ohio and Minnesota. What had brought Cedar Fair to my attention in 1991 was that the stock had a high yield (11 percent). It was selling for less than $12 then. A year later, it was selling for $18, and at that price the yield was reduced to 8.5 percent. It was still a nice yield, but not nice enough to cause me to want to put more money into Cedar Fair. I needed some indication that earnings would improve, and from what I could gather in a chat with the company, there was nothing in the works that would provide such a boost. So I figured there were better opportunities elsewhere.

I went through the same drill with the other 20 companies. EQK Green Acres I rejected because of a passing reference in its latest quarterly report. I've always found it useful to pay attention to the text in these little brochures. What caught my eye was that this company, which owns a Long Island shopping center, was debating whether or not to pay the regular quarterly increase (of one cent) in the dividend as was customary. Green Acres had raised its dividend every quarter since it went public six years earlier, so to break this string to save $100,000 I took as evidence of short-term desperation. When a company that has a tradition of raising the dividend mentions in public that it might discontinue the practice for the sake of a paltry savings, it's a warning that ought to be heeded. (In July 1992, EQK Green Acres not only didn't raise the dividend, it cut it drastically.)