TableofContents

APLUMEBOOKTitlePageCopyrightPageAcknowledgementsForewordChapter1-Speakthe

LanguageofStocksChapter2-HowtheMastersTellUstoInvestChapter3-HowHistoryTellsUstoInvestChapter4-PermanentPortfoliosChapter5-GetReadytoInvestChapter6-ResearchtoRichesChapter7-ThisBook’sStrategyChapter8-BonVoyage

Appendix1:-WhatYouShouldRetainfromThisBookAppendix2:-ASamplingofExchange-TradedFundsAppendix3:-ValueAveragingtheS&PSmallCap600Index

APLUMEBOOK

THENEATESTLITTLEGUIDETOSTOCKMARKET

INVESTING

JASONKELLYgraduatedin

1993 from the University ofColorado at Boulder with abachelor of arts in English.He worked for several yearsat IBM’s Silicon ValleyLaboratory, where he wrotearticles and books that wonhimtheSocietyforTechnicalCommunications MeritAward. He moved fromwriting about computers towriting about finance, andfound his niche in the stockmarket. Having realized his

dream of being able to liveand work anywhere in theworld, Jasonmoved to Japanin 2002 and works from hisoffice in the countrysideabouttwohoursfromTokyo.He keeps busy writing newbooks, editing The KellyLetter, maintaining onlinebusinesses, and exploringlittle-known parts of Japan.Visit his website atwww.jasonkelly.com.

“TheNeatestLittleGuide standsalone.Thereisnootherbookonthemarketlikethisone.”—MichaelH.Sherman,

chairman,SierraGlobalManagement

LLC,onTheNeatestLittleGuideto

MutualFundInvesting

PLUME

PublishedbythePenguinGroupPenguinGroup(USA)Inc.,375HudsonStreet,NewYork,NewYork10014,U.S.A.•PenguinGroup(Canada),90EglintonAvenueEast,Suite700,

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Themeanestlittleguidetostockmarketinvesting/JasonKelly,—Rev.ed.p.

cmeISBN:978-1-101-22281-2

1.Stocks.2.Investmentanalysis.3.

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TenStepstoInvestinginStocks

1. Learn WhyStocks Are GoodInvestments12. Learn How toEvaluateStocks193. Learn How theMasters Tell Us to

Invest424.SeeHowHistoryTells Us to Invest975.SeeHowtoBeatthe Dow withLeverage1156. See HowLeveragingMedium-SizedCompanies WorksEvenBetter1267.ChooseaBroker144

8. Research YourStocks1539.BuyYourStocks23910. Sell YourStocks248

Acknowledgments

I’m fortunate toworkwith awonderfulteamofpeople.DorisMichaelsremainsthe

onlyagentI’veeverhad,andit’s a joy to still work withherafteralltheseyears.I’m not the only one who

tookalikingtoDoris.CharlieMichaels met her first and

married her. He is presidentof Sierra GlobalManagement, LLC, a hedgefund company in New YorkCity. Charlie’s thoroughunderstanding of the stockmarket helped with the firstedition of this book, and hiscomments have provided thelastword in each subsequentedition.Thisbookispackedfullof

content from many finepeople and organizations.

Thanks toBillMiller, oneofthe best mutual fundmanagersinthebusinesswhotook time to review thematerial I wrote about himandtoanswerquestionsfromsubscribers to The KellyLetter. Thanks toMorningstar, Standard &Poor’s, Value Line, andYahoo!Financeforsupplyingme with all the data Irequested, and toOnlineTradingConcepts.com

and StockCharts.com forsupplying the charts Irequested.Finally, a nod of gratitude

to the swell folks at Plume.My editor, Nadia Kashper,has been with this book foryears, first as its editor’sassistant and now as itseditor. She’s always apleasure.

Foreword:ThisBookAlwaysWorks

The advice in this bookworks. It keeps you out ofdangerous stocks and showsyou how to find good stocksthatmakemoneyovertime.I wrote the first edition in

1996 and 1997, just before

the market began its steepascent into the bubble of thecentury. Back then, Enronand WorldCom were talkedaboutasmust-owncompaniesandtheInternetwasexpectedtoput so-calledoldeconomycompanies likeWal-Martoutofbusiness.Whowouldwalktheaislesofastorewhentheycould shop online in theirpajamas?Plenty of us, evidently. In

the years following this

book’s first publication toearly 2009, Wal-Mart stocknearly doubled while mostInternet start-upsdisappearedand Enron and WorldComdeclaredbankruptcy. In early2008, Wal-Mart’s annualsales were $405 billion. Thetwo leading Internetmerchants at that time,Amazon.com and eBay, hadannual sales of only $19billion and $9 billion,respectively.

The subprime crash of2008 destroyed famouscompanies like AIG (-97percent), Bear Stearns (-100percent), Lehman Brothers(-100 percent), and GeneralMotors (-100 percent). Wal-Mart stock, however, gained20 percent in 2008. Itincreasedsalesandcashflowper share in everyoneof theprevioustenyears,anddidsoagain in 2008. Had youinvested$10,000inWal-Mart

in 1974, it would have beenworth $29.5 million at theend of 2008, thanks to thecompany’ssteadygrowthandnine2-for-1stocksplits.Thisbookwouldhavekept

yououtofEnron,WorldCom,thedot.comdisasters,andthelikes of Lehman Brothers. Itwould not have kept you outofthemarket’svolatility,andno approach to stocks will.Themarket is volatile in theshort term and rises over the

longterm.On that path, you want

companies like Wal-Martworkingforyourmoney.Thisbook shows you how to findthem. Itsmethodswin in flatmarkets, rising markets, andfalling markets becausesuperior companies alwayscomeoutontop.Invest in them and you’ll

comeoutontop,too.I also present a value

averaging technique that

produces steady 3 percentquarterly growth, and boldindex strategies for beatingthe market over time. TheDow dividend strategies andmydoublingstrategiesfortheDow and S&P MidCap 400offer excellent profitpotential. When combinedwithmethods to limitmarketweakness,theyworkwondersonyourwealth.This book is packed with

advice that youcanuse right

away. Read it, follow it, andwatchyournetworthgrow.

1

SpeaktheLanguageofStocks

Anybodycanmakemoneyinthe stockmarket.By pickingup the phone or turning on

thecomputer,youcanownapiece of a company—and allof its fortune or folly—without ever attending aboard meeting, developing aproduct, or devising amarketing strategy. When Iwas eleven years old, mygrandfather explained to mein less than ten secondswhyhe invested in stocks.Wesatby his pool in Arcadia,California, and he read thestock tables. I asked why he

lookedatallthatfineprintonsuchabeautifulday.Hesaid,“Because it takes only$10,000 and two tenbaggersto become a millionaire.”Thatdidn’tmeanmuchtomeatthetime,butitdoesnow.Atenbagger is a stock thatgrowstenfold.Invest$10,000in your first tenbagger andyou have $100,000. Investthat$100,000 inyour secondtenbagger and you have $1million.That,inlessthanten

seconds, is why everybodyshouldinvestinstocks.This chapter further

explains why investing instocks is a good idea, thencovers some basicinformation you’ll use in therest of the book when youbegininvesting.

WhyStocksAre

GoodInvestments

You should know whystocks are good investmentsbefore you start investing inthem. There are two reasonsto own stocks. First, becausethey allow you to ownsuccessful companies and,second,becausethey’vebeenthe best investments overtime.

StocksAllowYoutoOwnSuccessfulCompanies

Stocks are goodinvestments because theyallow you to own successfulcompanies. Just like you canhave equity in your home,you can have equity in acompanybyowningitsstock.That’s why stocks aresometimescalledequities.Thinkofalltherichpeople

you’ve read about. How did

they get rich? Was it bylending money to relativeswhoneverrepay?No.Wasitby winning the lottery? Notvery often. Was it byinheriting money? In somecases, but it’s irrelevantbecause nobody has controlover this factor. In mostcases,richpeoplegotrichbyowningsomething.Thatsomethingmighthave

been real estate.You learnedthe first time you watched

GonewiththeWind that landhas value and that owningsome isagood idea. Inmostcases,though,peoplegetrichby owning a business.Schoolchildren learn aboutJohnD.Rockefeller,AndrewCarnegie, and J.P. Morgan.They all owned businesses.Henry Ford sold cars, RayKroc sold hamburgers fromMcDonald’s,ThomasWatsonsold business machines fromIBM, Scott Cook and Tom

Proulxsoldfinancialsoftwarefrom Intuit, Howard Schultzsold coffee from IlGiornale.What’s that, younever heardof Il Giornale? Oh, but youhave, just not by that name.Schultz rebranded itStarbucks after buying thecompany from its originalowners in 1987. All thesepeople owned theircompanies. I sold magazinesubscriptions door-to-door inschool toraisemoneyfor the

student council. I didn’t getrichbecauseIdidn’townthesubscription company. Seethedifference?Icouldhavetakensomeof

thatmoneyIearnedpawningoff another copy ofReader’sDigest on Mrs. Klein andbought shares of thesubscription company.Suddenly, Iwouldhavebeenabusinessownerencouragingmy classmates to “sell, sell,sell!” even if it meant they

wouldwin the portable radioinsteadofmewinningit.Thebusiness they generatedwould have improved thesubscription company’sbottom line and, as ashareholder, I would haveprofited. If all went asplanned, I couldhaveboughtadozenportableradios.That’s why owning stocks

is a good idea. They makeyou an owner of a company.Notanemployeeora lender,

an owner. When a companyprospers,sodoitsowners.

StocksHaveBeentheBestInvestmentsoverTime

That’s cute, you’rethinking, but does it reallywork that way? Let’s take alookathistoryandafewhardnumbers.The stock market has

returnedabout10.5percenta

year for the past 75 years orso. Corporate bonds returned4.5 percent, U.S. Treasuriesreturned 3.3 percent, andinflation grew at 3.3 percent.Notice that Treasuries andinflation ran neck and neck?That means your investmentinTreasuriesreturnednothingto you after inflation. Whenyou include the drain oftaxes, you lost money byinvesting in Treasuries. Youneed stocks. Everybody who

intends to be around longerthantenyearsneedstoinvestin stocks. That’s where themoneyis.Investing in stocks helps

both the investor and thecompany. Take McDonald’s,forinstance.Itwentpublicin1965 at $22.50 per share. Ifyou bought 100 shares, thecompanywould have had anextra $2,250 to put towardnew restaurants and betterhamburgers. Maybe your

money would have fundedtheresearchanddevelopmentof the Big Mac, one ofAmerica’s great inventions.Forty-two years and elevenstock splits later, your 100shares ofMcDonald’s wouldhave become 37,180 sharesworthmorethan$1.6million.Both you and McDonald’sprospered,thankstothestockmarket.

HowStocksTrade

When stocks are boughtand sold, it’s called trading.So a personmight say “IBMis trading at $140.” Thatmeans if you wanted to buyIBM stock, you’d pay $140foroneshare.Every company has a

ticker symbol, which is theunique code used to identify

its stock. In articles andreports, the ticker symbol isusually shown in parenthesesafter the first instance of thecompanyname.Forexample,Google (GOOG), Harley-Davidson (HOG), IBM(IBM),andToyota(TM).A$1moveinstockpriceis

called a point. If IBM goesfrom$140to$143,you’dsaythatitrosethreepoints.Inthereal world, IBM doesn’tusually trade in such clean

incrementsas$140and$143.Instead it would trade for,say,$143.38.Some investors purchase

shares of stock in blocks of100.Ablockof100sharesiscalledaroundlot.Roundlotsprovide a convenient way totrack your stock investmentsbecause for every round lotyou own, a one point moveupordownaddsor subtracts$100 from the value of yourinvestment. If you own 100

shares of IBM at $143, it’sworth$14,300.If it rises twopoints to $145, yourinvestment is worth $200more for a total of $14,500.Simple,eh?

PreferredStockvs.CommonStock

There are two types of

stock,preferredandcommon.Bothrepresentownershipinacompany.Preferredstockhasa set dividend that does notfluctuate based on how wellthe company is performing.Preferred stockholdersreceivetheirdividendsbeforecommon stockholders.Finally, preferredstockholders are paid first ifthe company fails and isliquidated.Common stock is what

most of us own. That’swhatyou get when you place astandard order for somenumber of shares. Commonstock entitles you to votingrights and any dividends thatthe company decides to pay.The dividends will fluctuatewith the company’s successorfailure.

HowYouMake

MoneyOwningStocks

This is really the bottomline to investors. The onlyreasonyouownabusiness istoprofitfromit.Thewayyouprofit by owning stocks isthrough capital appreciationanddividends.

ThroughCapitalAppreciation

Sometimes called capitalgains,capital appreciation isthe profit you keep after youbuy a stock and sell it at ahigher price. Buy low, sellhighisacommoninvestmentaphorism but it is just aslegitimate to buy high, sellhigher.Expressedas apercentage,

the difference between your

purchase price and your sellprice is your return. Forexample,ifyoubuyastockat$30 and sell it later for $60,your return is 100 percent.Sell it later for $90 andyourreturn is 200 percent. If youbought Cisco in 1990 at 10cents and sold it in 2000 at$70, your return was 69,900percent. If you boughtHansen Natural in February2003at40centsandsolditinJuly2006at$50,yourreturn

was12,400percent.The goal is appreciation,

but sometimes investors endup with depreciation bymistake. If you boughtCitigroup in November 2007at $35 and sold it inNovember 2008 at $6, yourreturnwas-83percent.

ThroughDividends

Asanownerofacompany,

you might share in thecompany’sprofitsintheformof a stock dividend takenfrom company earnings.Companies report earningsevery quarter and determinewhether topayadividend. Ifearnings are low or thecompany loses money,dividendsareusuallythefirstthing to get cut. On adeclaration date in eachquarter, thecompanydecideswhatthedividendpayoutwill

be.Toreceiveadividend,you

mustownthestockbytheex-dividend date, which is fourbusiness days before thecompany looks at the list ofshareholders to see who getsthe dividend. The day thecompanyactuallylooksatthelist of shareholders is calledtherecorddate.Ifyouownthestockbythe

ex-dividend date, and aretherefore on the list of

shareholders by the recorddate, you get a dividendcheck. The company decideshow much the dividend willbe per share, multiplies thenumberofsharesyouownbythedividend,anddepositsthetotal amount into yourbrokerage account. If youown 10,000 shares and thedividendis$.35,thecompanywill deposit $3,500 on thepayment date. It’s thatsimple.

Most publications report acompany’s annual dividend,not the quarterly. Thecompany that justpaidyoua$.35 per share quarterlydividend would be listed inmostpublicationsashavingadividendof$1.40.That’sjustthe $.35 quarterly dividendmultiplied by the fourquartersintheyear.

TotalReturn

Themoneyyoumakefroma stock’s capital appreciationcombined with the moneyyou make from the stock’sdividend is your total return.Just add the rise in the stockprice to the dividends youreceived, then divide by thestock’spurchaseprice.For instance, let’s say you

boughtIBMat$45andsoldittwoyears later at $110. IBMpaid an annual dividend of$1.00thefirstyearand$1.40

the second year. The rise inthestock’spricewas$65,andthe total dividend paid persharewas$2.40.Addthosetoget$67.40.Dividethatbythestock’spurchasepriceof$45and you get 1.5, or 150percenttotalreturn.

AllAboutStockSplits

Astocksplitoccurswhenacompany increases the

number of its stock sharesoutstanding withoutincreasing shareholders’equity.Toyouasaninvestor,that means you’ll own adifferent number of sharesbutthey’lladduptothesameamountofmoney.Acommonstocksplitis2-for-1.Sayyouown 100 shares of a stocktradingat$180.Youraccountisworth$18,000.Ifthestocksplits 2-for-1 you will own200 shares that trade at $90.

Your account is still worth$18,000. What’s the point?The point is that you nowhave something to do withyour spare time: adjust yourfinancial statements toaccountforthesplit.Notreally.Companiessplit

their stock to make itaffordable to more investors.Manypeoplewouldshyawayfroma$180stock,butwouldconsider a $90 one. Perhapsthat’sstilltooexpensive.The

company could approve a 4-for-1 split and take the $180stockdownto$45.Your100shares would become 400shares, but would still beworth $18,000. Peopleconsidering the stock mightbemore likely to buy at $45than at $180, even thoughthey’re getting the sameamount of ownership in thecompanyforeachdollar theyinvest. It’s a psychologicalthing, and who are we to

questionit?Mathematically, stock

splits are completelyirrelevant to investors buttheyareoftena signofgoodthings to come. A companyusually won’t split its stockunless it’s optimistic aboutthe future. Think about it.Would you cut your stockprice in half or more if themarket was about to do thesame? Of course not.Headlines would declare the

end of your fortunes andlawsuitsmightpileup.Stocksplits tend to happenwhen acompany has done well,driven up the price of itsstock, expects to continuedoingwell,dropsthepriceofits stock through a split, andexpectstokeepdrivingupthestockpriceafterthesplit.Stock splitswereeveryday

occurrencesinthe1990sbullmarket. IBM split twice,Oracle split five times,

Microsoft split seven times,andCiscospliteighttimes.A$10,000 investment inMicrosoft in January 1990wasworthabout$900,000 inJanuary 2000. The stockdidn’tjustrunstraightup90-fold,however.Itmadefive2-for-1 splits and two 3-for-2splits along the way. It roseand split, rose and split, roseand split, rose and split, roseand split, rose and split, androseandsplituntilvoilà!$10

grandturnedinto$900grand.You can be sure thatMicrosoftwouldn’thavebeensplitting its stock if itwasn’texcitedaboutitsfuture.Remember that a stock

split drops the price of thestock. Lower prices tend tomove quicker than higherprices. Also, the fluctuationsofalowerpricedstockhaveagreater percentage impact onreturn than they do againsthigher priced stocks. A $2

increase is a 4 percent gainfor a$50 stock, but only a2percentgainfora$100stock.More important than all

this, however, is that splitsare downright fun. You’lllove itwhenyour100sharesbecome 200 and every $1gain in price puts $200 inyour pocket instead of theprevious $100. You’ll feellikearealprowhenrevealingyour performance to friendsandneedtotossinthephrase

“split adjusted” at the end. Irecommend raising oneeyebrow and lowering yourvoiceforeffect.

WhyandHowaCompanySellsStock

Companies want you tobuy their stock so they canuse your money to get new

equipment, develop betterproducts, and expand theiroperations. Your investmentmoney strengthens thecompany. But first thecompany needs to make itsstock available. This sectiondescribeshow.Themagazine subscription

selling job I held in schoolmade me think a lot aboutbecomingabusinessowner.Iimagined teaching all theother kids how to sell

subscriptions, collecting theirmoneyat the endof theday,using some of it to buy aprize for the top seller,sendingasmallamounttothemagazines,anddepositingtherest in my bank account.Prettysimplebusinessmodel,right? Pretend for a minutethat I did it. I called mybusinessMisterMagazine.I realized early on that

Mister Magazine neededoffice space. A treehouse

woulddo.Ineededlumbertobuild it, and I needed to getelectricity and phonesinstalled. That takes moneythat I didn’t have. After all,that’s why I went intobusiness:tomakemoney.IfIalready had it, I wouldn’thave needed to go intobusiness!TherearetwowaysIcouldhaveraisedmoneyforMisterMagazine.First, I could have drawn

up a business plan and

pleaded with my local bank.When I showed the officerthe sketches of corporateheadquarters in a tree, myguess is that our interviewwould have been quite short.A lot of fledgling businessesface just that problem. Theyaren’t established enough toget a loan, or if they do getoneitcomeswithsuchahighinterest rate tooffset the riskthat it ends up strangling thebusiness anyway. Nope, a

loanwouldn’tdoitforMisterMagazine.

SellingStockIsaGreatWaytoRaiseMoney

My second option was tosell shares of MisterMagazine to investors whowanted a piece of theupcoming profits. By sellingsharesIwouldraisemoney,Iwouldn’t owe anybody

anything,andIwouldacquireabunchofpeoplewhoreallywanted Mister Magazine tosucceed. They would ownpartofitafterall!Ichosethissecondoptiontoraisemoney,and I decided that 10 sharescomprisedMisterMagazine’sentireoperation.Icouldhavechosen100sharesor100,000shares. The amount doesn’tmatter. The only thinginvestors care about is whatpercentage of Mister

Magazine they’ll own. Idecided to keep 6 shares formyself to retain majorityownershipandsell4sharestoparents inmycommunityfor$100 each. The parentsweremyventurecapitalists in thiscase.After the sale, I owned60 percent of MisterMagazineandfourparentsinthe community owned 40percent.Itwasaprivatedeal,though. You couldn’t findMisterMagazinelistedinthe

paperyet.The first year of operation

at Mister Magazine wentgreat. I hired 20 kids to sellmagazines door-to-door, Inegotiated a cheap deal withthemagazines, and I foundawholesale prize distributorwho sold gadgets for halftheir usual price. Myemployees were happy andMister Magazine grew to beworth $5,000. How did myinvestors fare? Quite well.

Those initial $100 sharesbecame $500 shares in oneyear. That’s a 400 percentannualreturn!Clearlytherewasonlyone

thing forme to do. I neededto immediately drop out ofschool and expand MisterMagazine to outlyingcommunities, and then theentire United States. It wastimetocomedownoutofthetreehouse and establish aground-based headquarters,

evolvingasabusinessjustashumanity evolved as aspecies. To fund thisambitious expansion, Idecided to take MisterMagazinepublic.

GoingPublicRaisesEvenMoreMoney

Insteadofsellingshares tojust four parents in mycommunity,mynextstepwas

to sell Mister Magazine tomillions of investors bygetting listed on a stockexchange. Stock exchangesprovide a place for investorsto trade stock. The mostfamousfromU.S.historyarethe New York StockExchange (NYSE, founded1792), the American StockExchange (Amex, founded1842), and the NationalAssociation of SecuritiesDealers Automated

Quotations (NASDAQ,founded1971).In 2007, theNYSEGroup

bought Paris-based Euronextto become the first globalequities exchange, calledNYSE Euronext. The newentitythenwentontoacquirethe American StockExchangein2008,combineitwith the Alternext Europeansmall-company exchange,rename it NYSE AlternextUS with a focus on small

companies, and move all ofits tradingflooroperations tothe NYSE’s Wall Streettradingfloor.Let’s see our chances of

getting Mister MagazinelistedontheNewYorkStockExchange,theNASDAQ,andtheNYSEAlternextUS:

NewYorkStock

Exchange(NYSE)

This is the biggest andoldest of America’sexchanges.Itsfamousfloorislocated along Wall Street inManhattan. It caters to well-established companies likeIBM,Ford, andMcDonald’s.Tobelisted,acompanymusthave at least 1.1 millionshares of stock outstanding,boast pre-tax profits of $10

million ormore over the lastthreeyears,andhaveaglobalmarket capitalization of atleast $750 million. As youcan see, it’s a big deal to belisted on the NYSE.Outstanding, by the way,refers to stock owned byshareholders. To make theNYSE,acompanymusthaveissued and sold at least 1.1millionsharesofstock.

NationalAssociationofSecuritiesDealersAutomatedQuotationsSystem(NASDAQorOTC)

The NASDAQ rose toprominence by trading coolhigh tech companies likeMicrosoft, Intuit, and Dell.It’ssometimescalledtheoverthe counter (OTC) market

because there’s no floor tosee on Wall Street or anyother street. Instead, theNASDAQ comprises brokersnetworked together aroundthe countrywho trade stocksback and forth withcomputers. Some of thebrokersareknownas“marketmakers” because they supplythe stock when you want tobuy it. You’ll never knowwhich broker supplied thestockyou’rebuying,andyou

won’t care. To be listed onthe NASDAQ, a companymust have at least 2,200shareholders, at least 1.25million shares of outstandingstock worth $70 million ormore, and pre-tax income of$11millionormoreover thelastthreeyears.

NYSEAlternextUS

Withitsfocusonemergingcompanies that wantsimplified market access,NYSE Alternext US offersthe most lenient listingrequirements. A companymust have pre-tax income ofatleast$750,000overthelastfiscalyearortwoofthethreemost recent fiscal years;publiclyheldsharesvaluedat$3 million or more;shareholders’ equity of atleast $4 million; and either

800 shareholders with500,000sharesoutstandingor400 shareholders with1,000,000sharesoutstanding.

WorkingwithanInvestmentBanker

Obviously, MisterMagazine didn’t have aprayer of making any of thethreeprimaryexchanges.Butlet’s sayacolossal exception

wasmadeand Iworkedwiththe investment banking sideof a large firm like Bank ofAmerica,Citigroup,GoldmanSachs, JP Morgan Chase, orWells Fargo to make aninitialpublicoffering,orIPO.That’swhatacompany’sfirstofferingofstocktothepubliciscalled.Itoldtheinvestmentbanker how much money Iwanted to raise and thebankerdeterminedhowmanyshares to sell atwhatprice. I

wanted to raise $10 million.Thebankercouldhavesold5million shares at $2 each, 10million at $1 each, or 2millionat$5each.Aslongasthecombinationproducedthetarget amount, it didn’tmatter.The investment banker

committed to buy the sharesifnobodyelsedidandgot tokeepasmallamountofprofitper share for this risk. Thebankerinitiallysoldsharesof

Mister Magazine to theprimary market, whichconsists of the banker’spreferred private accounts.Aftertheprimarymarkethaddibs on the tantalizing newshares of Mister Magazine,theinvestmentbankerofferedthe remaining shares to thesecondary market, whichconsists of everyday shmoeslike you and me who read astock’s price in the paper oronlineandbuyit.

MakingaSecondaryOffering

Once the bankermade theinitial public offering, I hadmy money and a bunch ofnew investors in thecompany.Whenitcametimeto raise more money, I soldadditional shares of stock inwhat’s called a secondaryoffering. No matter howmany additional times I sellmorestock,it’salwayscalled

asecondaryoffering.Iwouldalsohavetheoptionofsellingbonds to investors.When aninvestor buys a corporatebond, he or she is lendingmoneytothecorporationandwill be paid back withinterest. That means bondshavethesamedrawbacksthatbank loans do. MisterMagazinewouldbeforcedtopay interest on the money itborrowed from investorsinsteadof just selling thema

shareofstockinthecompanythroughasecondaryoffering.Secondary offerings are

sometimesnecessarybecausecompanies don’t receive adime in profit from sharesonce they’re being traded onthe open market. After acompany issues and sells ashareofstock,allprofitsandlossesgeneratedbythatstockbelong to the investorstradingit.Evenifthepriceofthestockquadruples invalue

and it’s bought and sold tentimes in a day, the issuingcompany doesn’t make anymoney off it. The reason issimple:theinvestorwhobuysa share of stock owns it. Heor she can sell that share forwhatever price the marketwill pay. The company isn’tentitled to any of the profitsfrom the sale because theinvestor is the sole owner ofthat share of stock until it’ssold to a buyer who then

becomes the new owner.Unless the company buysback its own stock, it won’townthesharesagain.It’s no different than you

sellingyourcar.DoyouoweFordashareof thesalepricewhen you finally get rid ofthatoldPintoinyourgarage?Of course not. You place anad in the paper, deposit thebuyer’s check, and go onyour way. It’s the samesituationifyouownsharesof

Ford Motor Company. Youplace the sell order, take thebuyer’s money, pay abrokerage commission, andgoonyourway.Forddoesn’tevenknowithappened.Now, the shrewder among

youmightbewonderingwhycompaniescarewhathappensto their stock price oncethey’vegottheirdough.Afterall, they don’t see any profitfrom you selling to me andme selling to another guy.

That’s true, but rememberthatcompaniesmightwanttomake another secondaryoffering later, and another,andanother,andanother.Ifacompany issues 1,000,000new shares at $40 it makes$40 million. If it issues1,000,000 new shares at $10itmakes$10million.Doyousuppose most companieswould rather make $40million than $10million?Ofcoursetheywould,andthat’s

why companies like to seetheirstockpriceshigh.Nottomention that a falling stockpricebreedsuglyheadlines.

WhatPeopleMeanby“TheMarket”

Youheareverydaythatthemarket is up or down. Haveyou ever paused to wonder

what “the market” is?Usually, that phrase refers tothe U.S. stock market asmeasured by the Dow JonesIndustrial Average, oftenabbreviated DJIA or calledsimply theDow.TheDow isnot the entire market at all,but rather an average of 30well-known companies suchas Coca-Cola, Exxon Mobil,McDonald’s, Microsoft, andWal-Mart. The companiestracked by the Dow are

chosen by the editors ofTheWall Street Journal. The listchanges occasionally ascompanies merge, loseprominence,orrisetothetopoftheirindustry.The Dow is an average.

Averagesandindexesarejustwaysforustojudgethetrendof the overall market bylooking at a piece of it. TheDowisthemostwidelycitedmeasurement, but not theonly gauge of the market. A

more popular index amonginvestors is Standard &Poor’s 500, or just the S&P500. It tracks 500 largecompanies that togetheraccount for some 75 percentof the entire U.S. stockmarket. The S&P MidCap400 tracks400medium-sizedcompanies while the S&PSmallCap 600 tracks 600small companies. TheNASDAQ 100 follows 100top stocks from the

NASDAQ such as Adobe,Amgen,Apple,Costco,eBay,Intel, Microsoft, Oracle, andStarbucks. It’s one of thehippest indexes around,although, with its focus ontech and biotech, also one ofthe most volatile. Here’s thetotal return of these fiveindexes as of December 31,2008:

Fundecade,eh?What a difference a bear

marketmakes. The subprimecrash of 2008 did all thedamage above. For proof,look at the total return of

those same five indexes justtwo years prior, as ofDecember29,2006:

I want to draw yourattention to the medium and

smallcompanies.Noticehowmuchstrongerthantheothersthey were over the five- and10-year periods. They’regood places to focus, and inChapter4 I’ll showyouhowtousethemtoyourlong-termadvantage.There are dozens of other

indexes that you willencounter as you dig deeperinto the world of investing.Eachisanattempttomonitorthe progress of a market by

looking at a sliver of thatmarket.You probably already use

indexesinotherpartsofyourlife, although you might notknow it. We create them allthe time to help ourselvescomparedifferentvalues.Forexample, let’s say you areinterested in buying a newToyotaCamry.Ifoneofyourmain selection criteria is fueleconomy, how do you knowiftheCamryperformswellin

that area? You compare itsmiles-per-gallon number tothe average miles-per-gallonnumber of other midsizepassenger cars, such as theFord Fusion and the HondaAccord. After severalcomparisons,youknowwhatis a good number, what isaverage, and what is belowaverage. Notice that youdon’tcomparetheCamrytoaHyundai Accent or a ChevySuburban.Thosevehiclesare

in different classes and areirrelevant to yourcomparison. Thus, in thiscase, midsize passenger carscompriseyourindex.Asyouencounterdifferent

market indexes, justrememberthateachlooksatapiece of the market tomonitor how that part of themarketisperforming.

HowtoChooseaBrokertoBuyStocks

You buy stocks through abrokerage firm. A brokeragefirmisabusinesslicensedbythe government to tradesecurities for investors.Brokeragefirmsjoindifferentstockexchangesandabidebytheirrulesaswellastheruleslaid down by the Securities

and Exchange Commission,orSEC.

TwoTypesofBrokerageFirms

There are full-servicebrokerage firms and discountbrokerage firms. Here’s adescriptionofeach:

Full-ServiceBrokerageFirms

Theseare the largest,best-knownbrokeragefirmsintheworld,whospendmillionsofdollars a year advertisingtheirnames.You’veprobablyheard of Bank of America,Goldman Sachs, MorganStanley,SmithBarney,UBS,and others of their ilk.They’re all the same.

Regardless of theiradvertising slogans, the twowords that shouldimmediately come to mindwhen you hear the names offull-service brokerage firmsareexpensiveandmisleading.Otherthanthat,they’regreat.Most full-service brokeragefirms are divided into aninvestment banking division,a research division, and aretaildivision.The investment banking

division is what helps youngcompanies make their initialpublic offering of stock andsell additional shares insecondary offerings. Thebrokeragefirmkeepsaprofiton each share of stock sold.This iswherethefirmmakesmostofitsmoney.Therefore,every one of the full-servicebrokerages wants to keepsolid investment bankingrelationshipswiththeirpubliccompanies.Never forget that

full-service brokerage firmsmake their money by sellingshares of stock for thecompanies they take public.They make their moneywhether investors purchasingthose shares get a good dealorabaddeal.Inotherwords,it doesn’t make a bit ofdifference to the full-servicebroker whether investorsmake or lose money. Thefirm always makes money.To be fair, most brokers do

want to find winninginvestmentsfortheirclientsiffor no other reason thanfuturebusiness.The research division of a

full-service brokerage firmanalyzes and writesevaluations, fact sheets, andperiodic reports on publiclytraded companies.Supposedly this informationis provided to you, anindividual investor, to helpyoumakeeducateddecisions.

However,rememberfromtheprevious paragraph that thebrokerage firm makes itsmoney by maintaining solidrelationshipswithcompanies.There are millions ofinvestors, but only a fewthousand companies. Whomdoyouthinkthebrokerwantsto keep happy? Thecompanies, of course. So,you’ll rarely see arecommendation to “sell” astock. Instead a broker will

recommend that you “hold”it.Nocompanywantstoseeafirm telling investors to sellits stock. The brokerage’ssolution is to justnever issuethat ugly word. The WallStreet Journal revealed howblatant this directive iswhenit discovered a memo fromMorgan Stanley’s director ofnew stock issues stating thatthe company’s policy was“nonegativecommentsaboutour clients.” The memo also

instructed analysts to cleartheir stock ratings andopinions “which might beviewed negatively” with thecompany’s corporate financedepartment.The retail division is what

you and I deal with. It’scomprised of brokers, whoarereallyjustsalesreps,whocall their clients and urgethem to trade certain stocks.They charge largecommissions that they split

with the brokerage firm.Thejustification for the largecommissions is that you’repayingforalltheresearchthecompanydoesonyourbehalf.But as you now know, thatresearch is misleadinganyway. It exists simply tourge you to trade thecompanies that the firmrepresents.So,youarepayingto receive a type ofadvertising! The only reasonfull-service brokerage firms

have a retail division is sothattheyhaveasaleschannelfor the companies theyrepresent.When the investment

bankingdivision takesanewcompany like MisterMagazinepublic,theresearchdivision puts the stock on abuylistandtheretaildivisionbrokers start making theirphone calls. When youanswerthephoneandbuythestock, the broker and firm

make money. It’s aninteresting twist on “fullservice,”don’tyouthink?

DiscountBrokerageFirms

Discount brokerage firmsdo not conduct initial publicofferings or secondaryofferings.Mostdon’thavein-

house research divisions,either. They just handle yourbuy and sell orders andcharge a low commission todo so. The commissions arediscounted because the firmsdon’tshouldertheexpenseofa full-service researchdepartment and a legion ofsales reps in a retail salesdepartment.

Compare

Commissions

If you bought500 shares ofa $40 stockofftheNYSE,here’s thecommissionyou shouldexpect to payat thedifferenttypes of

brokeragefirms:

Full-Service$100-$200Discount$5-$20

Most discount brokersoffer research in the form ofcompany reports, chartingtools, newsletters, news

summaries, and other helpfulmaterial.But theydon’thaveanybody call you to urge abuyorsell.Thedecisionsareyour decisions and thediscount brokerage firmsimply carries out yourorders. Because they don’tmaintain investment bankingrelationships with companiesand because they make thesame commission off anystock you trade, discountbrokersdon’thaveaninterest

insellingyouthestockofanyspecificcompany.Discount brokers used to

befamousforofferingonlineand telephone trading asinnovative ways to furtherreduce costs. Now, onlinetradingisthenorm.Abrokerbragging about its onlinetrading these days is like amovie theaterbraggingaboutitsair-conditioning.By the way, there used to

be a third category of broker

calledadeepdiscountbrokerthat offered nothing morethan cheap trading. Over theyears, discount brokersloweredtheirpricesanddeepdiscount brokers addedresearch and tools, so thedistinction between the twocategories disappeared.Now,lotsofgoodresearchandfineonlineinterfacesareavailablefor low trading fees atcompanies from both formercategories. So, I put them in

the same category: discountbrokers.Discount brokers are very

popular,andyou’veprobablyheard of a couple. CharlesSchwab, E*Trade, Fidelity,Scottrade, and TDAmeritrade are all discountbrokeragefirms.

TheCaseforDiscounters

In this book I’ll show you

howtorelyondiscounters toplace your trades. Here’swhy:

TechnologyHasMadeFull-ServiceBrokersObsolete

Full-service brokeragefirms are anachronisms.They’re left over from the

days when individualinvestors didn’t have accessto the trading mechanismsthat brokers use. To place atradeonanexchangefloorintheolddays,investorsneededbrokers and runners andagentstocarryoutthatorder.Investorswereaccustomedtopaying a commission for allthattrouble.Butall that troubledoesn’t

existanymore.TheNYSEgotrid of the hitching posts on

Wall Street, and floorspecialists receive mostorders via Super DOT, acomputerized order-routingand reporting system thatcompletes the trading loop inseconds. The NASDAQdoesn’t even have anexchange floor! It’s just anetwork of computers andbrokers.Think about that. If you

knowwhatstockyouwanttobuy,shouldn’tyoujusttypeit

into a computer or punch itinto a touch-tone phoneyourself? Of course youshould! It doesn’t make anysense to call a full-servicebroker—or in many cases,they’llcallyou—andpayhimor her a commission to typeyour stock trade into acomputer. The full-servicefirms know this, of course,but they prefer to have youinvest the way you wouldhave in 1897 because they

can get a lot of commissionmoney out of you in theprocess.

YouNeedtoDouble-CheckFull-ServiceInformation

Somewouldarguethat theextensive research and hand-holding you get from a full-

service brokerage firm makeitworththeextracommissionmoney. But the only thingyou’ll hear from analysts intheresearchdivisionofafull-service firm is what themarketing departmentencourages them to tell you.In other words, the stocksthey want to sell in order tofurther their relationshipwitha public company will bepitched as good stocks foryoutobuy.Don’tassumethat

cold call from your brother-in-law the full-service brokerhasyourinterestsforemostinmind. The advice might begood,butitmightnot.ZacksInvestmentResearch

tracked the stocksrecommended by eight full-service brokers over a three-year period and found thatfive failed to beat the S&P500. That’s a 63 percentfailure rate beforecommissions! Even if you

weren’tastatisticsmajor,youknow that a 63 percentchanceoffailuremakesthosehigh commissions hard tojustify.SmartMoney profiled an

investorwhopaid$11,000 infees and commissions toSalomon SmithBarney (nowMorgan Stanley SmithBarney,but49percentownedby Citigroup), with hisaverage stock trade costing$300. He realized he was

doingallofhisownresearchanyway and finally switchedtoCharlesSchwab,wheretheresearch tools were betterthan those offered by SmithBarneyandtheaveragestocktradecostonly$15.Because you can’t just

accept that a broker’s adviceisgood,youneed todoyourown research. So, why notjust place the trade yourself,too?You’llsaveabundle.

YouShouldMonitorYourOwnInvestments

Not only do you need todouble-checkeverythingfull-service brokers tell you, theunsolicited phone calls youreceive from them can beconfusing. If you are a trulyindividual investorconductingyourownresearchand placing trades with a

discounter,youlimityourselfto only what you need toknow.For example, say you

researched a stock anddecided on a suitablepurchase price and a targetsell price. You told yourdiscountbrokerwhatpricetobuy at. Twoweeks later, thestock hit that price and youautomatically picked up 100shares. Then you told yourdiscounter the price you

wanted to sell at, say 30percent more than yourpurchaseprice.That’sit.Youwent about your life and letthe stock run its course. Sixmonths later, it hit your sellprice and you automaticallysoldall100sharesandmade30 percent minuscommissions.Notice that you—and you

alone—decided whathappenedinthecourseofthatstockownership.Unbeknown

toyou,yourstockdropped30percent in value before itmade a roaring comeback toyoursellprice.Ifyou’dgonethrougha full-servicebroker,there’s a good chance he orshe would have called youwhen it was down andprovided every negativeheadline regarding thecompany’s future. Maybe heorshewouldhavecaughtyouat a vulnerable time and youwouldhavesoldata loss,all

because you couldn’t chooseyour own information level.And, of course, the brokerwouldmakeacommissiononyour sale at a loss and yoursubsequentpurchaseofanewstock.When you take care of

your own investments, youchoose what to monitor.Maybe you want to knoweveryuptickanddowntickofyour stocks and every bit ofnews affecting them. But it

might be that you just wantthe big picture by checkingpricesonceamonth,perusingtop stories on the Internet,andkeepinganeyeona fewrelated stocks in the sameindustry. The point is that itshouldbeuptoyou,notuptoabrokerwhostands toprofitoff your frequent buying andselling.Keep thebackgroundnoiselow.

HowtoEvaluateStocks

Evaluating stocks isactually quite easy. Onceyou’ve done it a few timesyou’ll develop a pattern ofresearch that you can repeatwith every new stock thatinterests you. But first, youneed to understand thedifference between growth

and value investing,fundamental and technicalanalysis, know some basicstock measurements, andunderstand how to read thestockpages.

GrowthInvestingvs.ValueInvesting

This is the most basicdivision between investors,akintoNorthandSouth.But,

likeNorth andSouth, there’sa lot of area between eachextreme that’s hard toclassify.Thinkofgrowthandvalue as being on acontinuum. Most investorsfallsomewhere in themiddleandcombiningthetwostyleshas proven to be a greatinvestmentapproach.

GrowthInvesting

Growth investors look forcompanies that are sales andearnings machines. Suchcompanies have a lot ofpotential and growthinvestors are willing to payhandsomely for them. Agrowth company’s potentialmight stem from a newproduct, a breakthroughpatent,overseasexpansion,orexcellentmanagement.Key company

measurements that growth

investors examine areearnings and recent stockprice strength. A growthcompany without strongearnings is like an Indy 500race car without an engine.Dividends aren’t veryimportanttogrowthinvestorsbecause many growthcompanies pay small or nodividends. Instead, theyreinvestprofitstoexpandandimprove their business.Hopefully, the reinvestments

produceevenmoregrowthinthe future. Growingcompanies post biggerearnings each year and theamount of those earningsincreases should be gettingbigger too. Most growthinvestors set minimumcriteria for investing in acompany. Perhaps it shouldbegrowingatleast20percentayearandpushingnewhighsinstockprice.Most new growth stocks

trade on the NASDAQ.Growth companies you’reprobably familiar with areMicrosoft, Intel, Starbucks,and Home Depot. Now youknow what people meanwhen they drive past yetanother Starbucks and say,“Thatplace isgrowing likeaweed.”Growth investors are

searching for hot hands, notgreat bargains. They’ll paymoreforgoodcompanies.As

a result, many growthinvestorsdon’tevenlookatastock’spriceinrelationtoitsearnings or its book valuebecause they know a lot ofgrowth stocks are expensiveandtheydon’tcare.They just lookata stock’s

potentialandgoforit,hopingthat current successescontinue and get even better.Theybuymomentum,inertia,steamrolling forwardmovement. That’s the nature

ofgrowthinvesting.William O’Neil, a top

growth investor whosestrategy you’ll learn on page67, says in his seminar thatgrowth investors are likebaseball teams that pay hugesalaries to top-rankedbatters.They come at a high price,but if they keep batting .300and winning games then it’sworthit.Likewise,youwon’tfind many bargains amonggrowth stocks. But if they

keepgrowingit’sworthit.Because a growth stock

depends on its earnings andthe acceleration of thoseearnings, the expectations ofanalysts and investors arehigh. That creates a riskysituation. If a growthcompany fails to deliver theearnings that everybodyexpects,allhellbreaksloose.Red flags fly left and right,phones start ringing off thehook, the stock price falls,

reports shoot from faxmachines across the world,and nobody’s dinner tastesquite as good as it did thenight of last quarter’searningsreport.

ValueInvesting

Value investors look forstocks on the cheap. Theycompare stock prices to

different measures of acompany’s business such asitsearnings,assets,cashflow,andsalesvolume.Theideaisthat if you don’t pay toomuch for what you get,there’s less chance of losingmoney.ValuestockshavelowP/E

ratios and low price-to-bookratios. They are companiesthathavebeenoverlookedontheirjourneytosuccess,havefallen on hard times after

more successful years, or areinaslumpforanynumberofreasons.Hopefullythey’reona comeback and the valueinvestor purchases shares atthebottomofanuphillclimb.Here’s where value andgrowth are tied together. Inboth cases, investorswant tobuy companies with a brightfuture. The difference is thatgrowth investors usually buythose companies whenthey’re already steamrolling

ahead to that bright future,while value investors usuallybuy those companies whenthey’re still getting ready tostartorarerecoveringfromatumble.Using O’Neil’s baseball

analogy, value investorscomb the locker rooms forbandaged players trying torehabilitate. They don’t costmuch,andyoumightuncovera future star. Of course, youmight get exactly what you

paidfor:abrokenplayer,orabrokencompany.The value investor is a

bargainhunterextraordinaire.From my interviews withprofessionals and novicesalike, I gather that valueinvesting is closer to whatwe’ve been taught from thetimewewerekids.Whatdidyou look at when buyingcandy? Probably which kindyoucouldgetthemostofforyour pocketful of allowance

money. In school, youprobably bought the packageof notebook paper with themost sheets for your dollar.When relatives came by forthe holidays theymight haveswapped stories of the greatbargains or “steals” theypurchased recently. We’reused toexaminingpricewithan eye toward value. It’s nodifferent in the world ofinvesting.Value investors pay

particular attention todividends. A company thatpays dividends contributes toaninvestor’sprofitevenifthestock price does not rise.That’s comforting. Also,among big companies, thedividend yield is a greatindicator of how bargainpricedacompanyis.

CombiningGrowth

andValue

Growthinvestingandvalueinvesting are not mutuallyexclusive. Many growthinvestors use some measureof value to time theirpurchase of growth stocks.Most value investors usesome measure of growthpotential to evaluate atroubled company’s chancesofrecovery.

Growth investors tend togetinwhenthingsareheatingup and bail out at the firstsign of slowing growth.Value investors tend to beverycarefulaboutwheretheirmoneygoesandletitrideoutfluctuations once they decidewhere to invest.The contrastin these two styles is why Ithinkvalue investing ismoresuitable to the averageindividual investor. Mostindividuals do not have the

time or resources to monitorsplit-second changes in theirstocks to act accordingly. Itseems that conductingthorough researchperiodically and letting thechosenstocksdotheirthingisthe best approach for mostindividual investors. Thatbeing the case, why gothrough the hassle of all thetradingthataccompaniespuregrowthportfolios?These are my thoughts

only, and throughout thisbook I try to provide equalspace to each style. I thinkmostofusendupcombiningthe styles in our personalportfolios, but with atendency one way or theother. I’ve enjoyed excellentresults frombothgrowthandvalue investments,althoughItendtowardvalue.

FundamentalAnalysisvs.

TechnicalAnalysis

There are two ways toevaluate a stock. The firstway is using fundamentalanalysis, which examinesinformation about thecompany’s health andpotential tosucceed.Youusefundamental information tolearn about a company. Thesecondwayisusingtechnicalanalysis,whichexamines thepast behavior of the stock

price in different marketconditions and attempts topredict the stock’s futureprice based on current andprojected market conditionsand tradingvolume.Youusetechnicalinformationtolearnaboutacompany’sstock.In this guide, you’ll learn

to use fundamental analysisand technical analysistogether.

FundamentalAnalysis

For individual investors,fundamental analysis shouldform the core of theirevaluations. Choosing goodcompanies iswhat I considerthe foundation of successfulinvesting. Also, healthycompanies make the bestlong-term investments and Iadvocate a long-term

investment strategy. Bylooking at a company’smanagement, its rate ofgrowth, how much it earns,andhowmuchitpaystokeepthe lights on and the cashregister ringing are easythings for you and me tounderstand. After all, weconstantly balance the samethings in our own lives.Youearn a certain amount ofmoney, budget how to spendit, and keep an eye on your

habits.Ifyouconsistentlyrunlowonfunds,youpulloutthestack of bills and figure outhowyoucanchangethat.It’svery similar to running abusiness.Onceyouhaveapictureof

a company’s fundamentals,you can determine itsintrinsicvalue.Intrinsicvalueisthepriceastockshouldsellat under normal marketconditions. The mostimportant fundamental

measure in determining acompany’s intrinsic value isearnings: what the companyisearningnowandwhatyouexpectittoearninthefuture.After that, you’ll want toknow what the company’sassets are, if it’s indebt, andthe history of itsmanagement.Once you havea clear picture of thecompany’s intrinsic value,youexamineitspricetoseeifit’ssellingaboveorbelowits

value.Ifit’ssellingbelowitsvalue, it’s a goodbuy. If it’sselling above its value, it’soverpriced.Of course there’smore to it than that, but fornow let’s leave it black andwhite.

TechnicalAnalysis

Technical analysis, on theotherhand,isalittleharderto

understand.Itspremiseisthatsupply and demand drive allstock prices. Fundamentalinformation doesn’t matteruntil it affects demand, andusuallyshowsuponthestockchartbeforeitbecomesnews.Chartists believe the pricechart tells you what news iscoming, not that the newstellsyouwhatwillhappen tothe stock price. The mainmeasurement technicalanalystsusetogaugedemand

is tradingvolume.After that,they look at chart trends toforecast future direction, andplace their money to benefitfrom the price movement inthatdirection.Technical analysis is

useful, but takesmore thananodding acquaintance to usecorrectly. This little guidewill not provide you with acomplete look at theintricacies of technicalanalysis.

However, there are a fewsimple technical measuresthatyou’llfindhelpfulasyouembarkonyourstock-pickingadventure.You’llusethemtogauge where the overallmarket is trendingandwherestocks of interest to you aretrending against thatbackdrop. You’ll find thosestocks by conductingfundamental research. Seehow the two relate? Youevaluate the company behind

the stock with fundamentalanalysis, then you evaluatethe trend of the stock withtechnicalanalysis.Theideaisto buy the stock of a strongcompany as that stock istrendingup.The bottom line is that

most investors use acombination of bothfundamental and technicalanalysis.

SomeFundamentalStockMeasurements

The annoying thing aboutstock measurements is thateven if every one of themgivesagreen light toa stockyou’re considering, it mightstill end up being a badinvestment. It’s not likemeasuringyourinseam.Onceyou know that number, youknow the length of pants tobuyandifthey’rethatlength,

they fit. Period. It’s not thatsimplewithstocks.Nonetheless,knowinghow

your stocks measure up isimportant. Knowingsomething thatmightmakeadifference is better thanknowing nothing at all. Inmostcases,themeasurementsdo reveal valuableinformation. In thissection, Iexplain the most commonstockmeasurements and alsoafewyouwon’tfindlistedin

many other places. They’remyfavorites.Important Note: This

sectiongivesyouanup-front,nodding acquaintance withthese measurements. I justexplain them here. Later inthe book, I show where tofind them and how to usethemonyourstockstowatchworksheet. Also, you don’tneed to calculatemostof themeasurements on your own.They’realreadycalculatedfor

you in newspapers, referencevolumes, the Internet, andotherplaces.

CashFlowperShare

Cash flow is the streamofcash throughabusiness.Youwant it to be positive andyou’d love it to be big.Sometimes even profitablebusinesses don’t have strong

cash flows because they selltheirgoodsoncredit.You know all those ads

you see to buy nowwith nopayments until next year?Those are just the kind ofbusiness activities that boostprofits without increasingcash flow. It’s true thatsomebody buys the couch ordishwasher or weed zapperand the sale goes on thebooks, but the businessdoesn’t see any money until

next year. That can be aproblemif there isn’tenoughmoney around to keep thelights on and the waterrunning.Billsneedtobepaidon time no matter what acustomer’s payment scheduleis.A well-managed business

can do fine with buy now,pay later plans.With enoughcashinthebank,thebillsarecovered. In the meantime,specialpromosdosellalotof

product that will eventuallybe paid for. Also, the profitsthatarefinallyrealizedmightbe higher than the advertisedpricesdue toaccrued interestandotherfineprint.Cashflowpershare—what

we’reexamining—issimplyacompany’s cash flowdividedby the number of sharesoutstanding.Thatletsyouseewhat price you’re paying forashareofthecompany’scashflow.

CurrentRatio

The current ratio is themost popular gauge of acompany’s ability to pay itsshort-termbills.It’smeasuredby dividing current assets bycurrent liabilities. The ratiorevealshoweasilyacompanycan deal with unexpectedexpensesoropportunities.It’susually expressed in thenumber of times, such as

“currentassetsarethreetimescurrent liabilities.” Thatmight be a company withcurrent assets of $300,000and current liabilities of$100,000. Another way tostate the current ratio wouldbe3-to-1.A company’s assets are

everything it owns: cars,machines,patents,computers,and so on. Its current assetsare things that are used upand replenished frequently

such as cash, inventory, andaccounts receivable. Acompany’s liabilities areeverything it owes: loans,bills, and such. Its currentliabilitiesaretheonesusuallyduewithinoneyear.Asyoucansee,comparing

current assets with currentliabilities shows you if thecompany is prepared forshort-term obligations andable to take advantage ofshort-term opportunities.

That’s what you want. Lookfor companieswith a currentratioofatleast2-to-1.

DividendYield

Astock’sdividendyield isits annual cash dividenddividedbyitscurrentprice.IfMister Magazine paid aquarterly dividend of $.15,you assume that its annual

dividend is $.60—15 centsper quarter times fourquartersinayeargiveyou60cents. Let’s say its currentstockpriceis$15.Divide.60by15togetayieldof .04or4 percent. It’s simple tofigure a stock’s dividendyield, but youwon’t need todo it. It’s printed for you inthenewspapereveryday,anddisplayedconstantlyonline.

What’sa

Quarter?

A quarter issimply a 3-month timeperiod.Calendarquarters areJanuary toMarch, Aprilto June, Julyto September,and October

toDecember.Many

companiesdefine theirown businessyear, whichmight not bethe same as acalendaryear.Company-defined yearsare calledfiscalyears.A

fiscal quarteris still threemonths, butwon’tnecessarily bea calendarquarter. Forinstance, afiscal quartermight beAugust toOctober.

At first, dividend yield

probably looks pretty boring.A lot of stocks don’t paydividends anyway, and whoreally cares what a stockyields in dividends? If youwant steady payouts, you’llgotoyourlocalbank.But alas, amigo, the

dividend yield reveals plentyabout a stock’s price. It tellsyou more about a stock’sprice than it does about astock’s dividend. Why?Because there are only two

numbers involved in thedividendyield.Ifonenumberremains constant then theother number drives anychanges. With mostcompanies, the dividendpayout remains fairlyconstant. That leaves youwith only one other numberto influence dividend yield:stock price. It changes dailyand its relationship to thedividend is immediatelyreflected in the dividend

yield.Look what happens. If

MisterMagazine’spricerisesfrom $15 to $30 but itmaintainsaconstantdividendof $.60, its dividend yielddropsto2percent.Ifthepricethenrisesto$60,thedividendyielddropsto1percent.Ifthedividend remains constantand the yield changes, youknow theprice ismoving. Inthis case, Mister Magazine’sdecreasingyieldtellsyouthat

the stock price is rising andmightbeovervalued.Being the astute person

thatyouare,asevidencedbythe fact that you chose thisbook from a crowded shelf,you might be thinking thatyou could find some bargainstocks by looking for highdividend yields. You arecorrect.Largecompaniesthatmaintainsteadydividendsarejudged all the time by theirdividend yields. You’ll learn

in Chapter 3 that historyproves that high yielding,market leading companiescan be selected by dividendyieldalone.Then, inChapter4, you’ll learn automatedinvestment strategies thatusehigh dividend yield to selectwinnersfromthe30stocksinthe Dow Jones IndustrialAverage.

EarningsperShare(EPS)

This is the king of growthmeasures. Earnings pershare,sometimescalledEPS,takeswhatacompanyearnedanddivides it by the numberof stock shares outstanding.It’s the last thing listed on acompany’sincomestatement,the famous bottom line thateverybody lives anddies for.

Earnings per share is usuallyreportedforeitherlastquarteror last year.Analysts projectfutureearningstoo.Say Mister Magazine’s

earnings were $4,500 lastquarter and there were 10shares of stock outstanding.Mister Magazine’s earningsper share would be $450.That’squitehigh.Inreallife,earningspersharetendtofallbetween $1 and $5 withoccasional spikes to $10 or

$20. But they can beanything, and they gonegative when the companylosesmoney.Forexample,theeconomic

downturn of 2008 hitcompany earnings hard.Aluminum giant Alcoareported that it lost $1.2billion in the fourth quarter,which came to -1.49 pershare,or-0.28excludingone-time items.Thecompanycut13 percent of its workforce,

whichcameto13,500people,andputafreezeonhiringandsalaries.Theproblemwithearnings

pershareisthatit’ssubjecttomanipulation and marketpressure. Notice in thepreceding paragraph thatAlcoa provided two ways tocalculate its earnings in thefourth quarter of 2008(4Q08). That happens a lot.Every company knows thatinvestors examine earnings.

Every company wants toreport the biggest earningsnumberpossible.Sodifferentcompanies use differentaccounting methods. Somededuct the dividends paid topreferred stock holderswhileothers don’t issue preferredstock, some need to worryaboutinvestmentsthatcanbeconverted to common stockwhileothersdon’t,andeverycompany chooses its ownpacetodepreciateequipment.

Sometimes earnings areaffectedbymarketconditionsbeyond a company’s control.For instance, the cost ofgoods sold fluctuates asmarket conditions change. Acomputercompanymightsellthe same computermodel allyear long.But if thepriceofmemorygoesup,sodoesthecompany’s cost of buildingcomputers.OnereasonAlcoacited for its earnings declinewas a 35 percent drop in

aluminum prices during thequarter. You don’t need toknowthedetailsofhoweverycompany determines itsearnings, but you should atleastbeawarethat this isnota cut-and-dried number. It’ssubject to manipulation andmarketpressure.This oft-forgotten tidbit

about earnings becameheadline news back in 2001and 2002. Enron andWorldCom misstated

earnings and declaredbankruptcy when reportersuncoveredthefraud.SalomonSmith Barney (now MorganStanley Smith Barney)telecom analyst JackGrubman had frequentlydescribed WorldCom in hisresearch reports as a “mustown” stock, providinganother example of full-service brokerage advice youcan live without. Enron andWorldCom became delisted

pennystocks.Earningspershareremains

a useful measurement. Thebiggerthenumber,thebetter.Itdoesn’t takeamentalgiantto see why. The more acompany earns, the moresuccessful it is and themoredesirable it becomes toinvestors. That should makethe stock price rise. If thecompany’searningspershareincreasesquarterafterquarterat a faster rate, that’s called

earnings momentum orearningsaccelerationandisapopular way of identifyingsolid growth companies.Some of the best performingmutual fund managers usemomentum investing tochoose their stocks. I’veheard investors say they’researching for “the big mo,”referring to a hiddencompany with incredibleearningsmomentum.Quarterly reports from a

company showing eitherhigher or lower earnings persharethanexpectedarecalledearnings surprises . Theyoftencausea stock to riseorfall sharply. Analysts studysurprises carefully hoping tospotatrendearly.

NetProfitMargin

A company’s net profit

margin is determined bydividing the money left overafter paying all its expensesby the amount of money ithad before paying expenses.So, if a company makes $1millionandpays$900,000 inexpenses,itsnetprofitmarginis 10 percent ($100,000divided by $1,000,000). If acompeting company alsomakes $1 million but paysonly $700,000 in expenses,its net profit margin is 30

percent ($300,000dividedby$1,000,000).All other thingsbeing equal, whichcompany’s stock would yourather own? The companywith a 30 percent profitmargin, of course. It makesthesameamountofmoneyasits competitor but keepsmore. Put differently, itspends less to earn the sameincome.Ahighprofitmargintells you that the company’smanagement is good at

controllingcosts.That’sgreatnews because every dollarfrittered away unnecessarilyisonelessdollarofprofitforshareholders.Highnetprofitmarginsare

the hallmarks of companiesthatdominatetheirindustries.When any industry isthriving, people notice andstart new companies tocompete against the existingones.All thecompaniesneedto buy similar equipment,

similar supplies, hireemployeeswithsimilarskills,market to the samecustomers, and researchsimilarimprovements.Noticehowsimilarthecompaniesinan industry become? Theycan’t all survive forever.When the shakeout comes,companies that are able tomaintain a high net profitmargin will make the mostmoney and will survive.They’ve somehow figured a

way to squeeze more profitfrom sales, a clear sign ofsuperior management. Notonly does the high net profitmargin itself translateimmediately into higherprofits anda strongerbottomline, it also reveals to you amanagement team that isprobably ahead ofcompetitors inmanyareasofrunning a company in theirindustry.

Price/BookRatio

Price/book compares astock’spricetohowmuchthestock is worth right now ifsomebody liquidated thecompany.Inotherwords,ifItookall

of Mister Magazine’s officespace, magazine inventory,telephones, computers, anddelivery bicycles to the localbusiness auction, I’d get a

sumofmoneyforit.Let’ssayI could get $5,000. If thereare currently 10 shares ofMister Magazine stockoutstanding, each one wouldbe entitled to $500 of thecompany’s sale price. Thus,MisterMagazine stock has abookvaluepershareof$500.That’s the“book”partof theprice/bookratio.Explainedinofficialterms,bookvaluepershare is commonstockholders’ equity divided

byoutstandingshares.You’llfind both figures on thecompany’sbalancesheet.Next, divide the current

pricebythebookvaluetogettheprice/bookratio.IfMisterMagazine currently sells for$400ashare,itsprice/bookis.80($400dividedby$500).Ifthe ratio is less than 1, thatmeans you’re paying less forthe stock than its liquidationvalue. That’s good. If thecompany goes bankrupt, you

should still get your moneyback.Iftheratioismorethan1, you’re paying more thanthestock’sliquidationvalue.Of course, a lot of crucial

informationaboutacompanyisn’t reflected in its bookvalue. Who cares about thefaxmachinesanddeskswhenyou’ve got a business thatearns money and a popularbrand name? The value ofMcDonald’s goes waybeyond french fry machines

and drive throughmicrophones. I can buy myownfrenchfrymachines,butcan I serve billions andbillionsofpeoplewiththem?Heck no, so I’m willing topaymorethanbookvalueforMcDonald’s.

Price/EarningsRatio(P/EorMultiple)

This is the king of valuemeasures. The price of astock divided by its earningsper share is called itsprice/earnings ratio, or P/E,or multiple. At cocktailparties, just say “P and E.”EverystockhasatrailingP/Eand a forward P/E. Thetrailing P/E uses earningsfromthelast12monthswhilethe forward P/E uses nextyear’s projected earningsfrom an analyst. A stock’s

P/E ratio fluctuates all thetime from changes in itsprice, which happen everyday, and changes in itsearnings,whichhappeneveryquarter.A stock selling for $40 a

sharethatearned$2lastyearand is projected to earn $4nextyearhasatrailingP/Eof20andaforwardP/Eof10.A stock’spriceby itself is

meaningless. If one stocksellsfor$100andanotherfor

$20,whichwould you ratherbuy?Youhavenoideaunlessyou can put those twopricesin context with companyearnings.OnceyouknowtheP/E for each stock, then youcansee if thestock is sellingfor a good price or not.Suppose the $100 stockearned $10 last year and the$20 stock earned $1. The$100 stockhas a trailingP/Eof 10. The $20 stock has aP/Eof20.The$100stockisa

better value because you’rebuying more earnings powerwithyourmoney.Use a stock’s P/E to

determine how much you’repaying for a company’searning power. If the P/E ishigh,youshouldexpecttogethigh earnings growth for theextramoneyyoupaidfor thestock. It’s riskier to invest ina high P/E stock than a lowP/E because it’s moredifficult for the high P/E to

meet the high earningsexpectations of itsshareholders and analysts.Many of today’s newesttechnology companies tradewith high P/E ratios,generallyover20.Companieswith low P/E ratios usuallyoperate in slow-growthindustries. Also, maturecompanies with low P/Eratios often pay dividendswhile new companies withhigh P/E ratios usually do

not.

Price/SalesRatio(P/SorPSR)

Thisisoneofmyfavorites.P/E compares price toearnings, price/bookcompares price to liquidationvalue,andprice/salesorPSRcompares price to sales

revenue. To determine astock’s PSR, simply take thecompany’stotalmarketvalueand divide it by the mostrecent four quarters of salesrevenue. Sometimes you’llknow thepriceper shareandthesalespershare.Infact,weusebothonthisbook’sstocksto watch worksheet. In thatcase, simply divide the priceper share by the sales persharetogetPSR.Forinstance,ifthereare10

shares of Mister Magazinestock outstanding and thecurrent price is $400,MisterMagazine has a total marketvalue of $4,000. If MisterMagazine has sales of$10,000 in the past fourquarters, its PSR is .40.Running the numbers pershare gives us the sameresult. Mister Magazine’sstock price is $400 and itssales are $1,000 per share.$400 divided by $1,000 is

.40.Inwinter 2009,Coca-Cola

had a market value of $102billion and sales of $32billion. That produced a 3.2PSR. PepsiCo had a marketvalueof$81billionandsalesof$43billion,fora1.9PSR.These numbers revealedsomething important toinvestors considering bothstocks. People were paying$3.20 for each dollar ofCoke’s sales but only $1.90

for each dollar of Pepsi’ssales.Aha!ByPSRmeasure,Pepsi was a better bargainthanCoke.“Sowhat?”youmightsay.

“It’s profits I care about, notsales.” That’s a commonobjection to using PSR. Butremember from theexplanation of earnings onpage 27 that companies canmanipulate earnings all sortsofways.Theyuseaccountingrules that are flexible to

interpret how much it coststhemtodobusinessand thensubtract that number fromrevenue to get earnings. Theflexible accounting can spitout small or big numbers asneeded. But with salesrevenue, there’s not a lot toadjust.It’sjustwhatyousold—endofstory.Ofcourse,itneverhurtsto

see big sales and bigearnings. The two aren’tmutuallyexclusive.

QuickRatio

The quick ratio is verysimilar to the current ratio,which is the firstmeasurementyoureadinthissection. The current ratioevaluates a company’s short-term liquidity by dividingcurrent assets by currentliabilities. The higher theratio, the better the companyis able to deal with unseen

expensesandopportunities.Thequick ratio provides a

more accurate look at acompany’s ability to dealwith short-term needs bydividing only the company’scash and equivalents by itscurrentliabilities.Irememberthe difference between thetwo measures by associating“quick” with easy money,that is, cash on hand.“Current” doesn’t soundnearly as speedy. The quick

ratiolooksathow“quickly”acompany can respond to asurprise bill or suddenopportunity. If it has lots ofcash,itcanjustwriteacheck.But if its money is alreadyearmarked for currentliabilities then it’s notavailable for quick spending.The company might startusing its equivalent of creditcardstopayforthings—verybad.Say a company has

$50,000 cash and currentliabilities of $25,000.Dividing 50 by 25 gives youaquickratioof2,alsowritten2-to-1or2:1.Thatmeansthecompany keeps cash worthtwice its current liabilities. Ifworsecametoworst,itcouldwriteacheckforeverythingitowesinthenextyearandstillhave $25,000 in the bank.That’s a comfort to anyinvestor.Iliketoseeaquickratioof

at least .5. That means thecompanyhascashworthhalfofitscurrentliabilitiessittingsomewhere accessible. Aswith the current ratio,however,biggerisbetter.

ReturnonEquity(ROE)

Some people consider this

the ultimate measure of astock’s success. Return onequity shows you the rate ofreturn to shareholders bydividing net income by totalshareholders’ equity. Biggeris always better with thisnumber because itmeans thecompany is making a lot ofmoney off the investmentsthat shareholders havemade.A good return on equity isanythingabove20percent.Let’s see how this number

changesasfortunesfluctuate.In 1995, Apple Computer(nowjustApple)reportednetincome of $424 million andtotal shareholders’ equity of$2,901million.Dividing 424by 2,901 gave a return onequity of only 15 percent.Addingtothetrouble,incomedropped to a negative $816million in 1996 with totalshareholders’ equity of$2,058 million. That was areturn on equity of -40

percent. Generally speaking,folks,minussigns in frontofinvestmentnumbersarebad.Apple’s iPod-inspired

turnaround worked wonderson the company’s finances.Its 2006 return on equity of23 percent was impressive.The release of the iPhonekeptthemomentumgoing.In2008, Apple’s return onequity reached 27 percent onnetincomeof$2,947million.Its 2008 net income was

bigger than its 1995shareholders’equity.

SomeTechnicalStockMeasurements

AsImentionedearlier,thisbookdoesn’tteachexhaustivetechnical analysis. We’ll usejust five technicalmeasurementstohelpustimeour purchase of stocks. Theidea is that we want to buy

companies with solidfundamentalspertheprevioussection, just as their stockprices show confirmingsignals per the tools in thissection.

SMA

This is a simple movingaverage of the stock’s priceand smoothes out the

bounciness of the raw priceso you can better detect itstrend. The position of thecurrentpriceinrelationtotheSMAprovideshintsonwherethepriceisheadingnext.

MACD

The letters stand formoving average convergencedivergence, which sounds

like a marital relations mapbut is a stock indicatorcreated by Gerald Appel inthe 1960s. It compares theexponential moving averageof a stock’s price from twotime periods, usually 12 and26days orweeks ormonths,and thenplots thatdifferencetoshowatrend.MACD is easier to

understandwhenlookingatachart, so we’ll look at onetogetherlaterinthebook.

RelativeStrengthIndex

RSI alerts you to when astock’spricehasstretchedtoofar in one direction or theother and is due for a snapback toward the middle.When it stretches too far up,it’s calledoverbought.Whenit stretches too far down, it’scalledoversold.RSI fluctuates between 0

and 100. Most commonly,anything higher than 70 isconsidered overbought anddue for a pullback, andanything lower than 30oversold and due for abounce.

RelativePriceStrength

Relative price strengthshows you how a stock’sprice has performedcompared to the prices of allother stocks. In this book,you’ll learn to use relativeprice strength as it’spresented in Investor’sBusiness Daily, a nationalnewspaper that ranks therelative price strength of allstocks from 1 to 99. Stocksthat rank 90 haveoutperformed 90 percent of

all other stocks. Stocks thatrank20haveunderperformed80percentofallotherstocks.Prettysimple.

Volume

This is an easy one.Volume issimply theamountofastockthat’stradedonanygivenday,week,oranyothertime period. A stock’s

volumeisagoodindicatorofhow much interest peoplehave in the stock. That’simportant to know becausethe stock market is greatlyaffected by supply anddemand. If everybody wantsto buy a certain stock, itsprice will rise. If nobodywants it, the price will fall.Some investors like to buystocks with low volumehoping thatmajor institutionswilldiscover themandbegin

trading heavily. Demandsoars and so do prices. Lotsof investors watch stockvolumeinanattempttocatchtrendsearly.Aswithsurfing,youwanttobeinfrontofthewave.Volume is measured in

either the number of sharestraded or the dollar amountthat is moved as a result ofthat trading. If 1,000,000shares of Mister MagazinechangedhandsonTuesdayat

a price of $8, the sharevolume was 1,000,000 andthe dollar volume was$8,000,000.The strongest signal from

volumeoccurswhenitsurgeshigher as the stock pricemoves. Rising volume on arising stock price showssomething good going on atthe company. Rising volumeonafallingstockpriceshowssomething bad. The strongerthe volume, the more

persistent the stock’s pricetrend.

HowtoReadtheStockPages

The Internet is the mostpopular place to get stockinformation these days, butsome people still prefer anewspaper. Your local paperprobablyhasalistingandyoucanalways accessoneof the

national investment paperssuch as Investor’s BusinessDaily or The Wall StreetJournal.The format of stock pages

changes slightly from paperto paper, but if you can readone you can wing it throughany other. Also, most papersinclude a box that explainstheir format. In fact,whyareyou reading about it here?Justturntoyourpaper’sstockpages and read how to use

them right there. On the offchance that youdon’t have apaperhandy,I’llexplainhowto read the stock pages. Onthe following page, there isan excerpt from the January28, 2007 Los Angeles Timesthat includes information forDisney.As you can see, there are

eightcolumnsofinformation.The first two columns showthestock’s52-weekHighandLow prices. Like the names

imply, these are just thehighestpriceandlowestpricethe stock traded for over thepast 52weeks. These figuresare adjusted to reflect anystock splits. The 52-weekhigh and low are handybecause they show the rangea stock has traded in. It’shelpfultoknowifthestockiscurrently selling near thehighest price anybody haspaidforitinthepastyear,orifit’scheaperthananybody’s

seen inayear.Also,youcansee if there’s a huge spacebetween the high and low orif they’re close together.Sometimes the figures arewithin a few dollars of eachother. Such a narrow tradingrangemight appeal to you ifyou prefer quiet stocks thatpay steadydividends.On theother hand, if you’re seekingmajor price appreciation youmight like to see a hugedifferential between the

stock’s high and low.Disney’s 52-week high was35.97 and its lowwas 24.90.Two years later, on January28, 2009, they were 35.02and18.60.The third column, called

YTD%chg,showsthestock’spercentagepricechangesincethe beginning of the year orits initial public offering.You’ll see the abbreviationYTD a lot with investing. Itmeans year-to-date. Disney

had appreciated 0.8 percentsince the beginning of 2007.On January 28, 2009, it haddepreciated1.8percentYTD,and would, less than a weeklater, report a 32 percentquarterly earnings declineamidst what chief executiveBob Iger described as likely“theweakesteconomyinourlifetime.”The fourth column, called

Stock-Div, lists the name ofthe company followed

immediatelyby thedividend.The dividend shown is anannual figure determined bythe last quarterly orsemiannual payout. Disney’sdividendwas31cents.Divideby 4 and you know that thelastquarterlydividendDisneypaidwas7.75cents. Ifyou’downed a single share youcould have almost paid forone photocopy with yourdividend check.The small “f” after Disney’s dividend

meansthatitincreasedonthelast declaration. By the way,in the two years followingthis excerpt, Disney boosteditsdividend from31cents to35.LOSANGELESTIMES

The fifth column providesthe stock’s yield. It’s shownas an annualized percentagereturn provided by thedividend. You can use thefigure tocompare thestock’sdividend performance withyour savings account or CD.More importantly, you canuse it to find undervaluedlarge companies as you’lllearn in Chapter 2 and

Chapter3.Disney’syieldwas0.9 percent. Two years later,itwas1.6percent.The sixth column shows

the stock’s price-earningsratio or P/E. The P/E isfigured by dividing theclosing price of the stock bythe company’s total earningsper share for the latest fourquarters. It’s the mostcommonmeasure ofwhethera stock is a good deal. Allelsebeingequal,you’dprefer

tobuyastockwithalowP/Ebecause it means you’repaying a relatively smallamount toownasharein theearnings. Disney’s P/E was21.Twoyearslater,itwas10.The seventh and eighth

columns show the closingprice and dollar change forthe previous day. Disneyclosed at $34.55, down 95cents. Two years later, itclosedat$22.28,up$1.03.There are footnotes

sprinkled throughout stocktablesthatidentifythingslikepreferred stock shares, ex-dividend dates, and newstocks. These differ frompaper to paper but should bedefined in your paper’sexplanatorynotes.

ThreeStockClassificationsYou

ShouldKnow

People always try tocategorize objects in theirlives to make them easier todeal with. If you hear themodel name of a new caryourfirstquestionisprobably“what typeofcar is it?”Youknowthatsportscarsarefast,minivanshaulalotofpeople,andtruckscarrycargo.Stocks

are categorized hundreds ofdifferent ways. In fact, frommy interviews with brokers,planners, investment clubs,and people on the street, I’mconvinced that there is aclassificationsystemforeachinvestor. Our view of theworld is shaped by ourexperiencesandpersonalities,which is why no two peopleview the same stock in thesameway.

PerceptionIsEverything

A long timeago, Istopped by a localcomputer store tosee the new IBMAptiva. While Itested it out, twomen joined me atthekeyboard.Onesaid, “I used toworkforIBMand

I’d never ownanything from thecompany. It’s thefattest, mostbureaucraticbusiness I’ve everseen.” The othersaid, “I still workfor IBM and I’dnever survivewithout ourproducts.Wehavethe besttechnologyandit’s

reliable.”Interestingly, thefirst man boughtIBMstockwhenittraded around$170 and watcheditdropto$45.Thesecond manbought it at $45andwatcheditriseto$130.Same company,differentemployees. Same

computers,differentexperiences. Samestock, differentprices.

Surprise! You need toknow only three widelyaccepted classifications: thesize of the company, itsindustry classification, andwhether it’s growthor value.Ihatecomplexityasmuchas

youdoandIthinkthesethreeclassifications provide all theinformationweneed.

CompanySize

Acompanyiseitherbigorsmall.Nexttopic.Although it’s not that

simple, company size ispretty straightforward. Toinvestors, company size iscalled market capitalization

or just market cap. Marketcap is determined bymultiplying the number ofoutstanding shares of stockby the current market priceper share. So if MisterMagazine has grown likeJack’sbeanstalkandthereare4 million shares of its stockoutstandingandtheytradefor$10 per share, MisterMagazine’smarketcapis$40million.Is that big or small?

Compared to the treehouseoperation it started as, that’shuge! From its $1,000 initialsale to venture capitalists,Mister Magazine has grown3,999,900 percent. So froman initial investor andcompanyfounderperspective,Mister Magazine isenormous.But compared to Exxon

Mobil it’s a drop of oil in atanker. Exxon’s market capwas about $400 billion in

January 2009. That’s 10,000times bigger than MisterMagazine. As you canimagine, owning shares ofExxon and owning shares ofMister Magazine wouldprobably be very differentinvestmentexperiences.The notion of how to

divide companies alongmarketcaplineshaschangedovertheyears.Takealookatthe five market cap rangesused in the mid-1990s by

Morningstar, the mostpopularfundratingservice,toclassify theholdingsofstockmutualfunds:

In mid-1996, Morningstarlookedatthe50mutualfundsin each category with the

highest concentration instocks of that market caprange, then measured theircombined performance.Here’s how the groupscompared:

The problemwith viewingmarket cap in absolute termsis that market caps changeevery day. Prices fluctuateand companies issue morestockorbuybackoutstandingshares.Moreimportantthanacompany’s absolute marketcapisitsrelativemarketcap,thatis,howbigitiscomparedtoothercompanies.For that very reason,

Morningstarreplaceditsrigidmarket cap table with a

system of only three relativesizes:

In early 2009, largecompanies weighed in at anaverage market cap of $52billion,mediumcompaniesat$4 billion, and smallcompanies at $940 million.The groups posted the

following average annualreturns:

Just two years prior, theend of the first quarter of2007,thegroupslookedalotbetter:

IndustryClassification

You need to knowwhat acompany does to makemoney, otherwise you don’tknowwhichother companiestocompareit to.Also, ifyouknow what industry a

companyoperates inyoucankeep an eye on that industryfortrends.Inmanycases,you’llknow

offthetopofyourheadwhata company does to earn abuck.You’reprobablyawarethat Boeing makes airplanes,Harley Davidson makesmotorcycles,Cokemakessoftdrinks, AT&T providesphone service, andDell sellscomputers. A lot of biggercompanies make money in

several ways, however, andyoushouldknowallofthem.Altriamakescigarettes,butitalsoownspartofSABMiller,brewer of Miller GenuineDraftbeer.You’ll become aware of a

company’s business simplyby getting interested enoughto invest. If somebodymentions to you thatAllamuck Corporation isgoinggangbustersandtripledin size over the past year,

you’ll probably look it up.Once there, you’ll either ruleit out based on a few keymeasures or get excited andwant to learn more. If youcall Allamuck for an annualreport, search theInternet forAllamuckinfo,ormakeatripto your local library, you’regoing to know whatAllamuckdoesforaliving.You’lllearnspecificplaces

to find company profiles inChapter4.

GrowthorValue

The last label youwant toplace on your stocks iswhether they’re growth orvalue. You read all aboutgrowthinvestingversusvalueinvesting on page 19. Whenyou’re examining a potentialcompany, know whether it’sincreasing sales and earningsand is expected to continuedoing so. That’s a growthcompany.

Maybe instead thecompany has had a roughcouple of years and its stockprice is at an all-time low.After reviewing everythingyouknowaboutthecompany,youmightdecidethatit’snotas bad off as everybodythinks. That’s a valuecompany.Growth companies and

value companies behavedifferently. Make sure youknow which type you’re

buying.

2

HowtheMastersTellUstoInvest

Now that you speak thelanguageofstocksandshouldbeabletofollowadiscussion

about them, let’s talkstrategy! When I decided toenter the stockmarket, Iwasnervous. Just abouteverybody is.At firstglance,it looks like there are a fewpeoplemaking lotsofmoneyand a lot of people makinglittle money. Come to thinkofit,thingslookprettymuchthat same way at second,third,andfourthglance.But as long as you follow

aninformedpathandconduct

your own research, you’ll befine. Buying what headlinestellyou tobuydoesn’twork.Buying what your neighbor,friend,orrelativetellsyoutobuydoesn’twork.Butbuyingwhat seems best to you afterthoroughresearchcanwork.This chapter and the next

two contain the mostimportant information in thebook. The rest of the bookdeals with the mechanics ofinvesting:learningthebasics,

choosingabroker,placinganorder, and so on. But thesethree chapters help you formastrategy.Inthischapter,you’lllearn

how the best investors makemoneyandhowyoucan too.Investing is full of legends.Some of their stories involveovernight profits, a lot ofluck, or complex theories.Thoselegendsdon’thelpyouandmewhenwe’resittingatthe kitchen table with a

newspaper trying to figureout a good way to retire.Whathelpedmeandwillhelpyou is studying the masterswhouseanapproachthathasprovenitselfovertimeandisfeasible for individualinvestorstoadopt.

MeettheMasters

BenjaminGraham—Bentothosewho’vereadalotofhisstuff—is one of the mostinfluential investmentwritersever. His hallmarkachievement is a book calledThe Intelligent Investor,which presents a rationalvalue-oriented way to investin stocks. It is to investingwhat Moby-Dick is toAmerican literature: anabsolute must-read foranybody studying the topic.

Graham is the grandfather ofvalueinvesting.Philip Fisher is one of the

first people to reveal growthinvestingstrategies.Hisbook,Common Stocks andUncommonProfits, discussesthecharacteristicsofsuperiorcompanies and how anybodycan identify them. I supposeit is to investing whatHuckleberry Finn is toAmerican literature: thesecond must-read for serious

studentsofthetopic.Fisheristhe grandfather of growthinvesting.Then comes Warren

Buffett, considered by manyto be the world’s greatestinvestor.Buffettisstillactivetoday, running his companyfrom Omaha and continuingto rack up impressiveperformance. Through hiscapitalallocationskillsalone,Buffett amassed a fortunegreater than $50 billion by

achieving an average annualbookvaluegainof21percentfor more than 40 years. Hestudied and admired bothGraham and Fisher, thencombined their teachings inhisownstyle.Next is Peter Lynch. He

managed the FidelityMagellan Fund for 13 yearsand took it from assets ofonly$20milliontomorethan$14 billion. He turned a$10,000 investment into

$190,000 in 10 years. He isconsideredbymanytobethebest mutual fundmanager inhistory.William O’Neil is the

founder of Investor’sBusiness Daily, a newspaperthat a lot of investors preferoverTheWallStreetJournal.Before founding IBD, heenjoyed a successful stockinvesting career that allowedhimtopurchaseaseatontheNew York Stock Exchange

when he was only 30 yearsold. He is a committedgrowth investor and a greatlecturer.Bill Miller is our last

master and one of mypersonal favorites. Hemanages Legg Mason ValueTrust, famous forbeating theS&P 500 fifteen years in arow from 1990 to 2005.Miller did it by discardingtraditional growth and valuefilters to seek bargains of

either stripe based on futurefreecashflows.Thatbuiltaneclectic portfolio of bothexpensive and cheap stocksby traditionalmeasures.He’sacontrarian,unafraidtostandalone when he believes he’sright, which is most of thetime.That’s our lineup. These

six masters cover thespectrum of large companiesto small companies, andgrowth style to value style.

Kick back and spend a littletime learning what themasters have to tell. Don’tworry about knowing everypieceoftheiradvicebyheart.Icloseout thechapterwithasection pulling all theiropinionstogether.

BenjaminGraham

Benjamin Graham wroteThe Intelligent Investor,probably the most widelyrecognized investment bookin the world, and SecurityAnalysis, co-authored withDavid Dodd. GrahammentoredWarrenBuffett,andinaprefacetoTheIntelligentInvestor Buffett wrote, “Iread the first edition of thisbook early in 1950, when Iwas nineteen. I thought thenthat it was by far the best

book about investing everwritten. I still think it is.” Ididn’t read it until I wastwenty, which explains whyBuffett is still slightlywealthierthanIam.

MarketFluctuationandEmotion

Graham teaches thatnobody ever knowswhat themarket will do. I want to

emphasize this innocent-looking observation. Nobodyever knows what the marketwill do. That includesanalysts, your wealthy aunt,every newsletter writer, andevery stockbroker. Grahamisn’t the only successfulinvestortopointthisfactout.WhenJ.P.Morganwasaskedwhatthemarketwoulddo,hereplied, “It will fluctuate.”The nice thing about nobodyknowingwhatthemarketwill

do is that you can profit byreacting intelligently to whatitdoesdo.We are all part of the

generalpublicandthegeneralpublic is usually wrong. Tocounteract our inherentemotionalweakness,Grahamsays we should automateparts of our investmentstrategy. By that he meansuseasetformulatofindgoodstocks. Not a formula likeyouusedinAlgebra,butaset

of measurements that aren’tsubjecttoemotion.Youdon’twant to fall victim to just“feeling good” about acompany’s future. Humanemotions are frail beasts.Nobody’s wealth should rideonthem.Automated, measurable

criteria give us somethingstable to fall back on whenwe get confused by boldheadlines and great stories.Nobody is immune to such

pressures. If your wholeoffice is talking about a newtoy for the Christmas seasonthat’s already breaking retailsales records in Florida,Maine, and New Hampshire,who wants to point out thatthe manufacturer lost moneythepasttwoyears?Afteryouroffice mates buy the stock,they’regoing tostartpinningnewspaper stories about thecompany on their corkboards, displaying the shiny

toy in their offices, andmaybe hanging postcards ofthe exotic travel destinationsthey’ll be visiting with theirprofits. It’s a party! We allwanttogotoaparty.But,bydevelopinganautomaticfilterthatwecanviewsuchpartiesthrough, intelligent investorswon’tsufferlostmoneywhentheparty’sover.

StockValuations

Every stock has both abusiness valuation and amarket valuation. Thebusiness valuation is simplythestock’sbookvalueanditsearnings. Remember frompage 29 that book value isdeterminedbydividingallthecompany’s assets by thenumber of stock sharesoutstanding. In other words,it’stheamountyoucouldgetifyouliquidatedthecompany—sold everything the

company owns, like thedeliverytrucks,faxmachines,and conference tables.However, and this isimportant, investors need tofactor in earnings with bookvalue to fully appreciate acompany’s businessvaluation. It’snotenoughforus to know what we couldsell the place for, we mustalso know what potentialprofittheplaceholds.Wegetthat by looking at earnings

per share, which you readaboutonpage27.The market valuation is

what the stock trades for. Itmightbehigherorlowerthanthe stock’s businessvaluation.You’dmuchratherbuy stocks at prices lowerthantheirbusinessvaluations,ofcourse,because they’reonsale.Just likeyoucanbuyyour

favorite sweatshirt for $10less during a clearance sale,

youcansometimesbuystockin your favorite companiesfor $10 per share less thanthey’re actually worth. InGraham’s language, such astock’s market valuationwould be $10 less than itsbusinessvaluation.Graham recommends that

investorsbuystocksatpricesneartheirbusinessvaluations.That means you’d likeprice/bookratiostobearound1andyouwouldalsolikeP/E

ratios low, preferably below15.Don’t worry about the

specific measures Grahamuses to evaluate stocks.Instead, concentrate on thenature of thosemeasures.Hesuggests measures that showa stock’s value: price/bookand P/E. He also suggestsmeasures that showa stock’sgrowth potential: financialpositionandearningsgrowth.Notice how Graham blends

value and growth measuresbecauseit’sgoingtoformthefoundation of this book’sstrategy.When you buy stocks that

are cheap compared to theirworth,youcanignoremarketfluctuations. Sometimes themarketwill drop thepriceofa stock for no apparentreason. So our job asinvestors is to identifystockswith strong potential andwatch the market for buying

opportunities. In Graham’sown words, we should “usethese vagaries to play themaster game of buying lowandsellinghigh.”

MarginofSafety

Graham’s greatest gift toinvestorswashisconceptofamarginofsafety,whichisthedifference between acompany’sbusinessvaluation

anditsmarketvaluation.Thatdefinition is sometimes toovague to be meaningful.Don’t think of this as a hardnumber.Abetterwaytothinkofitisasaspectrum,sothatastockeitherhasabigmarginofsafetyorithasasmallone.Astockwithabigmarginofsafety can go way down inprice and still be a goodinvestment; a stock with asmall margin of safety canonlydropalittleinpriceand

still be considered a goodinvestment.Graham was deliberately

vague indescribinga stock’smarginofsafety.Hesaidthatinvestment analysis is not anexact science.Therearehardfactors like book value,financial statements, anddebt, but there are subjectivefactors like quality ofmanagement and nature ofthe business.He preferred toexaminemeasurable qualities

of a business because, well,they’remeasurable. If you’repaying less for a companythanitwouldsellforpiecebypiece, there’s a good marginof safety there. If you’repaying a lot more for acompany than it would sellfor and a lotmore thanwhatit’s earning just because thepapers say the new team ofpeople taking over arebrilliant, there’s little marginof safety. What if, just what

if,thosebrilliantfolksmakeamistake? Your losses couldbe extreme. But if hardnumbers limit those losseswhen the brilliant managersmess up, you’re stillrelatively safe. There’s a lotof room for management tomake mistakes becausethere’s value underlying thecompany they’re running.That’s the margin of safety.It’s not reducible to a singlenumber,butthenotionmakes

sense.Graham emphasized the

financialhealthofcompanieswhen discussing margin ofsafety.Long-termdebtisverybad because it reduces thecompany’s businessvaluation. The bills need tobe paid even when brilliantmanagersmakemistakes.The one hard figure

Graham assigned to marginof safety was that investorsshould buy a stock for no

more than two-thirds of itsbook value. Another way ofstating that is that a stock’sprice/bookratioshouldbenomore than .66. So if acompanyhasabookvalueof$50pershare,youshouldpaynomorethan$33forit.Evenat that low price, GrahamwantedtoseealowP/Eratio,which usually accompanies alowprice/bookratio.

WhatYouShouldRetainfromGraham

Graham was a greatinvestor who insisted onpayingafairpriceforastockno matter how bright itsprospects were. That’s avalue approach to investing.However, he recognized theimportance of a company’sabilitytogrowearnings.Thiscombination of value andgrowth is the foundation of

good investing that Irecommend in this book’sstrategy.Otherkeypoints:

✔ Nobody everknows what themarketwill do, butwe can profit byreactingintelligentlytowhatitdoesdo.✔ Becausewe areall members of thegeneral public and

thepublicisusuallywrong, we shouldrely on hardmeasurements tocounteract ouremotions and giveourselvessomething to feelsecureabout.✔ Stocks havebusiness valuationsand marketvaluations.Thefirstis what the

company would beworth if it wasliquidated, thesecond is the pricethe market hasplacedonthestock.✔ We shouldknow a stock’smargin of safety,which is a generalfeel for how muchthat stock can dropinpriceandstillbea good investment.

Central todetermining astock’s margin ofsafety is knowingthe differencebetween itsbusiness valuationand marketvaluation.

PhilipFisher

Philip Fisher wroteCommon Stocks andUncommon Profits. WarrenBuffetwassoimpressedwiththe book that he met withFisher personally to learnmore about his strategies. In1969, Buffet told Forbes,“I’m15percentFisherand85percentBenjaminGraham.”

CharacteristicsofSuperiorCompanies

Fisherwrote that investorsshould buy businesses withthe ability to grow sales andprofitsover theyearsat ratesgreater than their industryaverage. Such companies areeither“fortunateandable”or“fortunate because they areable.” These seem like verysimilar things at first blush,butFisherdistinguishedthemwith examples. A companythat is fortunate andablehasagoodproductrightfromthe

start, solid management, andit benefits from factorsbeyond the company’scontrolsuchasanunforeseenuseofitsproduct.Acompanythat is fortunate because it isable might have a mediocreproducttobeginwith,butthemanagementteamissocleverthattheyadapttheproducttothemarketplaceanddiversifyinto other areas that offeropportunity. Thus “fortunatebecause they are able” refers

to shrewdmanagement morethananything.Shrewd management is

hard to define. To me it’s abit like indecency: I know itwhenIseeitbutcan’tsayinadvancewhatitis.ToFisher,shrewd management alwayslooks past the current set ofproducts to new items thatwill grow sales in the future.That sometimes requirestrading immediate profits forlong-term gains, something

that’s unpopular on WallStreet. Because investorsscrutinize earnings regularly,it’s imperative thatmanagement communicatehonestlywith shareholders ingood times and bad.Management’s integrity wasvitallyimportanttoFisher,asitistomostgoodinvestors.Sales are the key to

prosperity. A company’sextensive research anddevelopment of a superior

product is irrelevant if itdoesn’t sell. Investors shouldexamine the capability of acompany’ssalesorganization,paying particular attention tothe extent of its customerresearch.Of course, profits must

follow sales. Enormous salesgrowth is irrelevant if itdoesn’t producecorresponding profits. Tomake sure a company isprofitable, look at its profit

margins. This stuff isn’t asmysteriousasyou thought, isit? A company’s profitmargins coupled with itsability to maintain andimprove them will tell youeverythingyouneed toknowabout its earning power.You’ll learn later how tocheck a company’s profitmargins.Profits must be realized

soon enough to be useful.This means keeping a

positive cash flow. Badcompanies sell a millionwidgets on credit and thenresorttoborrowingmoneyorissuing more stock to keepalivewhilethecheckisinthemail. Good companies gettheir money soon enough tolive off it. Thatmeans whenit’s time to expand into newmarkets, build new factories,hire more people, or marketto a wider audience, a goodcompany taps its bank

account.The last characteristic of a

superiorcompanyisitsstatusasthelowest-costproducerofits products or services anddedicationtoremainingsuch.Companies with low break-even points and high profitmargins can survive hardtimes. Almost any companylooks good when theeconomyissoaring.Butonlythe leanest operations lookgood when the going gets

tough.ThisisrelatedinspirittoGraham’smarginofsafety.Low cost, high profitoperations are the safestaround because they have anedge in all phases of theeconomy.

CharacteristicsofSuperiorInvestors

To succeed at investing,Fisher thought most people

should concentrate onindustries theyalreadyknow.He called this your circle ofcompetence.Within that circle of

competence, investors shouldconduct thorough andunconventional research tounderstand the superiority ofa company over itscompetitors. The best sourceof information is theindividuals who know thecompany. Customers,

suppliers, former and currentemployees, competitors, andindustryassociationsall havetidbitsofinformationthatareuseful to investors. Fishercalled this informationscuttlebutt, a Navy termdescribing gossip around aship’s drinking fountain.Instead of gossiping aboutyour mate’s late-nightescapades,Fisherthoughtyoushould go out and gossipabout the prospects of

potentialinvestments.Scuttlebutt and other

research are time-consuming.You can thoroughlyunderstand only so manycompanies. Therefore, Fisherrecommended a focusedportfolio. He rarely placedmorethantencompaniesinaportfolio and even at thatmost of the money wasusually concentrated in threeorfourstocks.Afewsuperiorcompanies are better than a

slewofmediocreones.

WhatYouShouldRetainfromFisher

Fisher recommendsinvesting in companies withthepowertoearnaprofitandoutpace their competition.That’s a growth approach toinvesting. To find superiorcompanies,hewaswilling tolookbeyondhardnumbersto

factors that are notmeasurable, such ascapabilities of managementand the perception of thosewho know the company.Otherkeypoints:

✔ Buy businesseswith the ability togrow sales andprofits over theyears at ratesgreater than theirindustryaverage.

✔ Look forcapablemanagement. Thebestmanagement iswilling to sacrificeimmediate profitsfor long-term gainsand maintainsintegrity andhonesty withshareholders.✔ Salesarekeytoeverything. Youshould examine the

capabilities of acompany’s salesorganization,paying particularattention to itscustomerresearch.✔ Profits mustfollow sales. Salesare irrelevant ifthey don’t produceprofit. You shouldknow a company’sprofitmargins.✔ Profits must be

realized soonenough to beuseful. You shouldlook for positivecash flow and ahealthy cashreserve so thecompany can meetobligations withoutborrowing.✔ Lowest-costproducers have anedge in all phasesof the economy.

Combined with ahigh profit margin,low-costproductionis Fisher’s versionof Graham’smarginofsafety.✔ You shouldinvest in areasyou’re alreadyfamiliar with: yourcircle ofcompetence.✔ You shouldconduct thorough,

unconventionalresearch byinterviewingpeoplewho know thecompanybest, suchas employees,competitors, andsuppliers.✔ Because of theextensive researchneeded to uncoversuperiorcompanies,youshouldownjusta handful at any

given time. A fewsuperior companiesbeats a slew ofmediocreones.

WarrenBuffett

You wouldn’t be thrownoutofan investmentclubforsayingWarren Buffett is theworld’s greatest investor.

Some have made moneyfaster,othershavemade it inflashier ways, but few canmatch Buffett’s methodicalinvestment methods or hislong-termrecord.First, somebackground. In

1956,Buffettbeganalimitedinvestment partnership with$100,000 raised from familyand friends. The partnershipremained in existence for 13years, during which timeBuffett produced an average

annual return of 29 percent.As his reputation grew,Buffett accepted moreinvestors into the fold andmovedhisofficesfromhometoKiewitPlazainOmaha.In1969, Buffett disbanded thepartnership, sent hisinvestors’ money to safeplaces, and took control of atextile company calledBerkshire Hathaway.Berkshire became Buffett’sholding company to own

businesses like See’s Candy,Kirby’s, Dexter Shoes, andWorldBookEncyclopedias.Berkshire also bought

insurance companies, whichbecame the cornerstone ofBuffett’s success. Whyinsurance companies?Because premium-payingpolicyholders provide aconstant stream of cash.Buffett invested this cash,called “float,” until claimsneeded to be paid. Because

Berkshire Hathaway islocated in Nebraska, a statewith loose insuranceregulations,Buffettinvestedalotofthefloatinstocks.Mostinsurance companies choosesafe bonds for theirinvestments, usuallyallocating no more than 20percenttostocks.ButBuffettchose stocks—sometimesallocating over 95 percent ofthe float to them—and bothhe and Berkshire grew

wealthybecauseofhispicks.Buffett amassed a personalfortuneof$50billion,giveortakeafewbillion.Your situation is probably

not like Warren Buffett’s.You probably don’t enjoy asteady stream of insurancepremiumstoinvestasyouseefit. You probably can’tacquire companies aspermanent holdings in yourspare time. If you can, youdon’t need this book! But if

you’re like the vast majorityof us and are investinglimited personal resources inthe stock market, read thissectionforpiecesofBuffett’sstrategythatyoucanapplytoyour own program. I’ll pullthemtogetherintothisbook’sstrategylater.One other point beforewe

dive in. A look at Buffett’sstock techniques is a lookback in time. Although he’sstill active today, his

approach tocapitalallocationhas gradually changed focusfrom stocks to wholecompanies as Berkshiresucceeded and its cash flowramped up. Buffett wrote inthe2006annualreportthatheand his partner CharlieMunger continue “to need‘elephants’ in order for us touse Berkshire’s flood ofincoming cash.Charlie and Imust therefore ignore thepursuitofmiceandfocusour

acquisition efforts on muchbiggergame.”Tough problem to have,

eh?

TheStockMarket

In the old days wheninvestors checked stockprices on quote machinesinstead of the Internet,Warren Buffett was famousfor not having one in his

office. The world’s greatestinvestor doesn’t check stockprices because they’reunreliable indicators of acompany’sworth.Somedaysthey’re up, others they’redown.SometimesWallStreetthinksthemarketlooksgood,other times it thinks it looksbad. It’s willy nilly,unreasonable, andunnecessary to know.Remember that Graham feltthe same way: Nobody ever

knows what the market willdo.At some point every

investor needs to knowwhatthestockofacompanyheorshe is interested in sells for.That part’s a given. WhatBuffett’shabitsshowusisthefruitlessness of knowingminute movements, hourlychanges, and dailyaberrations. In the 1993Berkshire Hathaway annualreport, Buffett wrote, “After

webuyastock,consequently,wewouldnotbedisturbed ifmarkets closed for a year ortwo. We don’t need a dailyquote on our 100 percentposition in See’s or H.H.Brown to validate our wellbeing.Why, then, shouldweneedaquoteonour7percentinterestinCoke?”

BuyingQualityCompaniesatBargainPrices

Buffett emphasizedbuyingqualitycompaniesratherthanspeculating about thedirection of a stock price.Good companies are stillgood companies when timesare bad. If you buy a goodcompany and the price of itsstock drops, that doesn’tsignal anything more than achance to pick up additionalshares at a discount. Buffettsays you should alwaysunderstand the businesses in

which you invest. Thesimpler, thebetter.Onceyouunderstand a business, youcanmake a judgment on thecompany’s quality. Youshould exercise the samescrutiny when buying sharesin a company as you’dexercise when buying thecompany itself. In advicereminiscentofFisher,Buffetttold investors in a 1993Fortune interview to “investwithin your circle of

competence. It’snothowbigthe circle is that counts, it’show well you define theparameters.”Buying a quality business

is vital to Buffett, far morevital even than buying at adiscount.Afterall,what’sthepointofbuyingsomethingonsaleifyou’regettingjunk?Itwon’t perform well in thelong term, which leaves youone option: get lucky on aprice runup and sell in the

short term. Time helpswonderful businesses butdestroys mediocre ones,which means you should becomfortablestandingbyyourcompanies over time.Investors must evaluatecompaniesontheirindividualmeritsbeforelookingatstockprices.For example, Buffett

bought GEICO stock after itdeclinedfrom$60to$2.Thecompany faced a possible

bankruptcy and a growingnumber of class-actionlawsuits from shareholders.The world thought the stockwould end up worthless, butBuffett loaded up on itanyway, eventually owninghalf of the company. Buyinga stock that’s declined 96.5percent is clearly a valuemove because by just aboutany measure it’s discounted.In GEICO’s case, Buffettfound a great company at a

colossalbargain.But then there’s Coca-

Cola. Buffett loved the softdrinkfromthetimeheboughtandsold individualcansof itwhen he was five years old.He watched the company’sphenomenal growth overthree decades and in 1986made Cherry Coke theofficial beverage ofBerkshire’s annual meetings.Yethedidn’t invest inCoca-Cola until 1988. The stock

had risen over five-hundredfold since 1928 andover fivefold since 1982. Tomany it looked overpriced,but Buffett invested morethan $1 billion. Buying astock that’s risen fivefold insix years appears to be agrowth move. In Buffett’scase, however, he sawCoca-Colasellingforwellunderitsintrinsic value, so to him itwas still a great company atbargainprices.

In each of these twoinvestment decisions, Buffettwasn’t thinking value orgrowth.Hewasn’tponderinghot tipson the streetbecausein both situations he actedagainst common consensus.Heboughtwhatheperceivedto be quality businesses:GEICO when everybodythought it was dead, andCoca-Cola when everybodythought the opportunity hadpassed. The lesson we can

take from this is that it ismore important to buy solid,qualitycompaniesthanitistobuy stocks at certain pricelevels.ThisisBuffett’suseofGraham’s margin of safety.You should examine abusiness to determine itsvalue, then look at the stockprice to see if itmakessenseto buy now. It might, inwhich case you should. Thepricemight decline after youbuy, but that doesn’t matter.

The fact remains that youbought a solid business at afair price. After that, Buffettadvises you to watch what’son the playing field, notwhat’s on the scoreboard. Aprice decline is the market’sfrenetic, short-terminterpretation of the stock’sworth.Ignoreit.By now it should be clear

thatBuffettadvocatesbuyingquality companies at bargainprices, which is a blend of

Graham and Fisher. Now,let’s delve deeper intoBuffett’s definition of aquality company and abargainprice.

AttributesofaQualityCompany

First, a company’smanagement must be honest

withshareholdersandalwaysact in their interest. Integrityprecedes everything inbusiness because there’s nopoint proceeding with abusiness evaluation if youdon’ttrustthepeoplerunningthe place! Buffett himself isfamous for his candidassessment of Berkshire inthecompany’sannualreports.You should look for clearexplanations of a company’ssuccesses and, more

importantly, its failures inreports to shareholders. Thisis vital to your continuedunderstanding of thebusinesses in which youinvest.Second, a company should

earn more cash than isnecessary to stay in businessand direct that cash wisely.To Buffett this means eitherinvesting in activities thatearn more than they cost, orreturning the cash to

shareholders in the form ofincreased dividends or stockbuybacks. The measurementwe’ll use in this book’sstrategy to determine ifmanagement is investingexcess cash wisely is returnon equity. To Buffett, acompany’s earnings are nomoreimportantthanitsreturnon equity because they don’ttake into account theaccumulation of previousearnings. In other words, I

can take what I earned lastyear and make my companybiggerandbetter.Youwouldexpect a bigger and bettercompany to be able to earnmore, right? Of course. Andifitdoes,everybody’shappy.Everybody but Buffett, thatis.He’smoreconcernedwithwhether or not thatcompany’s earnings grewenough to justify the cost ofreinvesting the previousyear’s earnings, and theones

beforethat,andsoon.That’swhy he looks at return onequity instead of plainearnings. It’s just asimportant to know what acompany does with what itearnsas it is toknowwhat itearns.Third, a company should

haveahighnetprofitmargin.Rememberfrompage28thata company’s net profitmargin is determined bydividing the money left over

after paying all its expensesby the amount of money ithad before paying expenses.So, if a company makes $1millionandpays$900,000 inexpenses,itsnetprofitmarginis 10 percent ($100,000dividedby$1,000,000).

DeterminingaBargainPrice

Buffett determines thevalue of a company byprojecting its future cashflows and discounting themback to the present with therate of long-term U.S.government bonds. I’m surethat sounds about as muchfun as extracting termitesfrom your home withchopsticks,but that’showhedoesit.After determining a

company’s value, Buffett

then looks at its stock price.It’s one of the few times hepays attention to stock price.Hecomparesthevaluetotheprice and determines themargin of safety. In otherwords, if the stock is sellingfor just under what thecompany is worth, there is asmallmarginofsafetyandhedoesn’tbuy.Ifitsellsforwellunder the company’s worth,there is a large margin ofsafety and he buys. The

reasoning is simple. If hemade a small error indetermining the value of thecompany, then the truevaluemight prove to be below thestock price. But if the stockprice is well below what heestimates the company to beworth, the chances of fallingbelow it are less. It’s astraightforward use ofGraham’smarginofsafety.Now, a few caveats and

adjustments. Describing

Buffett’sway of determininga bargain price in two stepsand characterizing it assimpleisabitmisleading.It’saccurate, but it’s not easy tocopy. I can also describeTigerWoods’swayofhittinga long drive in two steps:keep legs loosely in place,swing club swiftly towardball. There, now do yousuppose you can golf like hedoes? Of course you can’tand it’s no different with

Buffett’s determination of abargainprice.He’sgiftedandifyou’reasgiftedasheisyouprobably don’t need thisbook.Arriving at an accurate

assessment using Buffett’smethod requires an accurateforecast of future cash flow.Buffett’s good at it, most ofus aren’t. Even within yourcircle of competence, youprobably don’t feelcomfortable culling the

factors of a company’ssuccess, estimating theirfuturesuccess,andtranslatingitintotoday’sdollars.So, in this book we’re

goingtofocusontheintentofBuffett’s method instead ofthe technique. We want tobuy quality companies atbargainstockprices.

ManagingInvestments

Like Fisher, Buffettbelieves in a focusedportfolio. Because he buysbusinesses instead of tradingstocks,Buffett insists that heunderstands those businessesthoroughly. That meansowning justa fewcompaniesat a time. In 1985, half ofBerkshire’s common stockportfolio was in GEICO. In1987, Berkshire owned justthreestocksand49percentofits portfolio was in Capital

Cities/ABC. In 1990, 40percent of Berkshire’sportfolio was in Coca-Cola.In 2001, 33 percent was inCoke and 19 percent was inAmerican Express. Focusedinvestments in areas youunderstand are superior toblanket investments acrossdozensof stocks in thenameof diversification. If youresearchthirtycompaniesandfindtwothatareclearlybetterthan the rest,whyplaceyour

moneyinthe topfiveor ten?Fordiversification,youmightsay. But diversifying acrossmediocrecompaniesisriskierthanfocusingongoodones.Buffett also discourages

the common practice amonginvestors of selling their topperformers.Ifastockrunsup100percent,manysell it andtake the profits. But Buffettbelieves in managing hisportfolio the same way hemanages his business. How

wouldyou react if adivisionof your business consistentlyshowed a profit? Youwouldn’t sell it off. Youwould probably invest morein it. In the 1993 BerkshireHathaway annual report,Buffett wrote, “An investorshouldordinarilyholdasmallpiece of an outstandingbusiness with the sametenacity that anownerwouldexhibitifheownedallofthatbusiness.”

Finally, Buffett disregardsthe opinions of others oncehe’s made up his mind.Groupthink is what killsinstitutionalinvestorsbecausethey’d rather make average,safe decisions than whatBuffett identified inBerkshire’s 1984 annualreport as “intelligent-but-with-some-chance-of-looking-like-an-idiot”decisions. Do your ownresearch,doitwell,andstand

byyourdecisions.

WhatYouShouldRetainfromBuffett

Above all else, WarrenBuffettbelievesinexaminingbusinesses, not stock prices.Once he finds a qualitybusiness, he buys it at abargainprice.His investmentstyle combines the best ofGraham and Fisher because

hebuysthrivingcompaniesata discount. That’s acombination of value andgrowth investing. Other keypoints:

✔ Ignorethestockmarket because it’sfickle. Neverspeculate about thedirection of prices.Look instead atindividualcompanies and

what makes themsuperb.✔ Buy stock in acompany with thesame scrutinyyou’d exercisewhen buying thebusiness itself.Buywithin your circleof competence andthoroughlyunderstand yourinvestments.✔ After choosing

your investmentswell, you shouldstand by themthrough thick andthin. Time helpswonderfulbusinesses butdestroys mediocreones.✔ Buy qualitycompanies atbargainprices.✔ Qualitycompanies:

•Havehonestmanagementteamsthatcommunicatewithshareholdersinacandidfashionand

alwaysactwiththeinterestsofshareholdersinmind.•Earnmorecashthan

isnecessarytostayinbusinessanddirectthatcashwisely.Theyeitherinvest

inactivitiesthatearnmorethantheycost,orreturnthecashtoshareholders

intheformofincreaseddividendsorstockbuybacks.Todeterminehowwiselya

companyhasdirecteditscash,we’lllookatitsreturnonequity.•Have

highnetprofitmargins.•Increasetheirmarketvaluebymorethanthevalue

ofearningstheyretain.

✔ Determinebargain prices bycomparing acompany’s value toits stockprice.Buywhen the stock isconsiderably lowerthan the company’svalue. This is a

straightforward useof Graham’smarginofsafety.✔ Focus yourportfolio on a fewgood companies.Concentrating ongoodstocksissaferthan diversifyingacross mediocreones.✔ Just as abusiness puts moremoneyintoitsmost

successfulventures,you should investmore money inyourstocksthatareperformingwell.✔ Do yourresearch,doitwell,and disregard theopinionsofothers.

PeterLynch

Peter Lynch managed theFidelityMagellan Fund from1977 to 1990. The fund heldonly$20millionwhenLynchtook over and grew to $14billion during his tenure. InthelastfiveyearsofLynch’smanagement, Magellan wasthe world’s largest mutualfund and still outperformed99percentofallstockfunds.If you had invested $10,000inMagellanwhenLynchtookover, ten years later you

wouldhavehad$190,000.Afterretiring,Lynchwrote

Beating the Street and OneUponWallStreet.Thesetwobooksexplainhisapproachtoinvesting. One Up on WallStreet targets individualinvestors and is the title Icondense in this section.Lynch, like my grandfather,refers to winning stocks as“tenbaggers,”onesthatreturn10timesyourmoney.

UseWhatYouAlreadyKnow

Using what you alreadyknow is the cornerstone ofLynch’s advice. This shouldbe familiar to you by now.Fisher advised us to investwithin our circle ofcompetence and Buffettseconded that notion, addingthat we must thoroughlyunderstand our investments.NowLynch adds his support

to the idea. I think we haveenough reason to payattention.From your position as an

employee or competitor in afield, you’re conducting thebest research on goodinvestments. Professionalmoney managers fly tens ofthousands of miles to talkwithpeopleyouinteractwithevery day. Your manager,your supplier, yourcustomers, your coworkers—

and you yourself—haveinformationthat’sworthalotto other investors. Here’s ashocking revelation: It’sworthjustasmuchtoyou!Also,asaconsumeryou’re

conducting research all thetime. You know whatproducts you’re buying andprobably have a pretty goodidea of what your neighborsare buying. Is there a trendafoot? Possibly, and youmightseeitlongbeforeWall

Streetdoes.It has always amazed

Lynch that peoplewhoworkin the aerospace industryinvest in the auto industry;peoplewhowork in the autoindustry invest in thecomputer industry; peoplewho work in the computerindustry invest in theentertainment industry;people who work in theentertainment industry don’thave any money to invest.

Wellokay,thetop.25percenthavealittle.Thepointisthatthis grass-is-always-greenerapproach is ludicrous. Investwhere you already spendmostofyourtime.Lynch recalls severalgood

investmentshediscoveredbyjust living his life. He foundTacoBellbyeatingaburritoon a trip to California. HefoundLaQuintabytalkingtopeople at the rival HolidayInn. He found Apple

Computer when his childreninsisted on owning one andthe systems manager atFidelity bought a bunch forthe office. His wife likedL’eggs pantyhose fromHanes. L’eggs wasconvenient to purchase rightat the checkout counter ofmost grocery stores. Theyresisted tearing anddeveloping runs. They fitwell.Whatmoreresearchwasneeded to conclude that this

was a superior product?None, in Lynch’s estimation.HeboughtHanesanditgrewsixfold before being boughtoutbySaraLee.Lookwhereyouwork,pay

attention to what you buy,andobservethebuyinghabitsofthosearoundyou.

KnowYourCompanies

Like Graham, Fisher, and

Buffett, Lynch says tothoroughly understand thecompanies you’reconsidering. He recommendslookingatcompanysizefirst.Big companies make smallstock moves, smallcompanies make big stockmoves.It’simportanttoknowthe size of companies you’reconsidering.

CategorizeYourCompanies

Onceyouknowthesizeofyour companies, Lynch saysto divide them into sixcategories: slow growers,stalwarts, cyclicals, fastgrowers, turnarounds, andassetplays.Slowgrowersareusually large, old companiesthat used to be small, youngcompanies. Electric utilities

are typical slow growers.Expect them to barelyoutpaceinflationbuttopayagood dividend. Stalwarts arelargeandoldtoo,but they’restill growing strong. Coca-Cola is an example of astalwart company. Cyclicalsarecompanieswhosefortunesrise and fall along with theeconomy. Airlines and steelcompanies are cyclical. Fastgrowers are small, youngcompanies that grow at 20

percent ormore a year. Thisis the land of tenbaggers to200-baggers.LynchidentifiedTaco Bell, Wal-Mart, andThe Gap as fast growers.More recently we’ve seenGoogle and Research InMotion. Turnarounds aregood companies that havebeenbeatendown.ChryslerisLynch’s example and one ofthe best buys he made forMagellan in the early ’80s.Those who bought Chrysler

at$1.50enjoyeda32-bagger.Asset plays are companieswith something valuable thatWall Street missed. PebbleBeachinCaliforniaandAlicoin Florida owned amazinglyvaluable real estate thatnobodypaidattentionto.Thetelecommunications industrywas an asset play 20 yearsago.Don’t be concerned with

the six categories per se.Don’t set out to buy a

stalwartcompanybecauseit’sstalwart. Instead, useselection criteria to turn upattractive companies and usethesecategoriestoknowwhatyou’re buying. The intent ofLynch’s categories is simplyto know what kind ofcompanyyou’re investing in.Don’t expect fast growthfromaslowgrower.Ifyou’rebuyingastockthat’sdowninprice because you think itmeets all ofBuffett’s criteria

ofaqualitycompany,knowifit’sdowninpricebecauseit’sacyclicalinadowncycle,anoverlooked asset play, or aturnaround. You’ll knowfrom the extensive researchyou’ve conducted on thecompanies you invest in, awise approach taught byGraham, Fisher, Buffett, andLynch.

ComponentsofaPerfectCompany

To Lynch the perfectcompany is simple tounderstand. That should befamiliar to you by now. Hewrites,“Thesimpler it is, thebetter I like it. Whensomebody says, ‘Any idiotcould run this joint,’ that’s aplus as far as I’mconcerned,because sooner or later any

idiot probably is going to berunningit.”If its name is boring or

ugly and something about itsbusiness turns people off, somuch the better. Latelythere’s been a move towardhip companies with nameslike TerraGyro Navigationand Internetica. Mostinvestorssteerclearofboringcompanies with boringnames. Not Lynch. To himthey’re fortunes. He cites

SevenOaksInternationalasacompany that engages in aboring business. It processesgrocery store coupons.Yippee! Put that Googlesearchasideandlet’stake10cents off your next purchaseof Grape Nuts. That’ll getyour blood pumping. Thestock rose from $4 to $33.That really will get yourblood pumping. Somecompaniesengageinbusinessthat is disgusting, such as

sewage and toxic waste.Lynch remembers theexecutives of WasteManagement, Inc. who worepolo shirts that said “SolidWaste.” Disgusting, right?The company became a 100-bagger.The business should be

ignored by institutions andanalysts. Not surprisinglywith businesses thisunattractive, a lack ofinstitutional ownership is

almostagiven.Lynchlovesitwhenacompanytellshimthelastanalystvisitedthreeyearsago. Look where othersrefusetolook.It’snotalwaysjust boring, unattractivebusinesses that areoverlooked, either.RememberChrysler?Nobodywantedthatstockwhenitfellto$1.50.Theyallwaiteduntilitwaspricedata respectabledouble-digitfigureagain.Thesmart money isn’t always so

smart.Fast-growing businesses

arebest insideaslow-growthindustry or, better still, a no-growth industry. It keepscompetition away. Just thinkhowmany thousands of hot-headed business studentswant to conquer SiliconValley. How many do youthink want to conquer thefuneral business? Not many.Burials aren’t a growingindustry, plus they’re boring

anddepressing.Companies that occupy a

niche have a distinctadvantage. Warren Buffettbought the Washington Postpartly because it dominatedits market. Most newspaperowners think they profitbecauseofthequalityoftheirpaper.ButBuffettpointedoutthatevenacrummypapercanprosperifit’stheonlyoneintown. Lynch writes,“Thinking along the same

lines,Iboughtasmuchstockas I could in AffiliatedPublications,whichowns thelocalBostonGlobe.SincetheGlobegetsover90percentofthe print ad revenues inBoston,howcould theGlobelose?” Patents, trademarks,and strong brand loyalty allconstitute a type of niche.Good luck starting a softdrink company and trying togetasmanypeopletosaythename of your product before

they say Coke. Even Pepsican’t do it. Owningsomething unique is anothertypeofniche.Lynchsumsupthis advantage perfectly:“Once I was standing at theedge of the Bingham Pitcopper mine in Utah, andlooking down into thatimpressivecavern,itoccurredtomethatnobodyinJapanorKorea can invent a BinghamPit.”Get yourself a double-

whammy by purchasing acompanythathasanicheandaproduct thatpeopleneed tokeepbuying.Steadybusinessis powerful stuff. What doyou do when you percolateyour lastcupofcoffee in thekitchen?Buymore.What doyou do after smoking yourlast cigarette? Buy more.What do you do when yourgas tank goes empty? Buymore.What do you dowhenyou hit the plastic stopper at

thebottomofyourdeodorantstick?Please,buymore.Thatphrase, “buy more” drivesprofits to the moon. It’s thewind in the sales of Coca-Cola, McDonald’s, Gillette,andStarbucks.Microsoft isacompany with both a nicheand repeat business. It ownsthe Windows operatingsystemusedonmostpersonalcomputersandissuesperiodicupgrades that everybodyneeds to own. Also, guess

what everybody needs afterthey own Windows?Applications to run.Microsoft just happens tomakealotofthosetoo.Protect against trouble by

investingincompanieswithalot of cash and little debt.This can be seen as Lynch’smargin of safety. If acompany has accumulatedcash,youcansubtractthepershare amount from thestock’ssellingpricetoseethe

bargainyou’regetting.LynchdidsowithFordin1988.Thestock sold for $38 but thecompany had $16.30 pershare in cash. “The $16.30bonus changed everything,”Lynchremembers.“ItmeantIwasbuyingtheautocompanynotfor$38ashare,thestockprice at the time, but for$21.70ashare($38minusthe$16.30incash).”Debtworksin theoppositedirection. If acompany owes a ton of

money, you’re shoulderingthatburdenwhenyoubuythestock. In a crisis situation,which comes everybody’swayatsomepoint,companieswith no debt can’t gobankrupt. These twocomponents together—a lotofcashandlittledebt—meanthe same thing to a companythattheymeantoyou.Wouldyou rather have a big bankstatementorabigcreditcardbill?Duh,thinkasecond.The

bankstatement,ofcourse.It’sthe same for companies.Thosewith a lot of cash andlittledebtaresecure.Lynch advises paying

attention to the stock pricerelative to the company’svalue. You’ve read a lot onthisalreadysoIwon’trehashit except to point out thatevery one of the masterinvestorsinthissectionoffersthe same advice: Don’t paytoomuch for a stock. Check

the P/E ratio and othermeasures of value. I thinkwe’re on to somethingimportant. Lynch’s rule ofthumb is that a company’sP/E ratio should equal itsearnings growth rate. Hewrites, “If the P/E of Coca-Cola is 15, you’d expect thecompany to be growing atabout 15 percent a year. Butif the P/E is less than thegrowth rate, you may havefoundyourselfabargain.”

The last two componentsofaperfectcompanyinvolvethehandlingofitsstock.Youwant two things to be goingon. First, youwant companyinsiders buying stock andsecond, you want thecompany itself buying backshares.When employees and

managers in a company buythe stock, they becomeshareholders like anybodyelse. If managers are

shareholders they’re morelikely to do good things forthestock.Iftheyjustcollectapaycheck,they’remorelikelyto use profits to increasesalaries.Lynchwrites,“Wheninsidersarebuyinglikecrazy,you can be certain that, at aminimum, the company willnot go bankrupt in the nextsixmonths.”He’salsocarefultopointoutthatwhileinsiderbuying is a good thing,insider selling is not

necessarily a bad thing.Remember,companyinsidersare people too. They need tobuy new cars, send kids tocollege, and take vacations.Selling stock is a quick wayfor them to raise money.Thereareallkindsofreasonstosellstockthathavenothingtodowiththeseller’soutlookon the stock’s future. “But,”Lynch writes, “there’s onlyone reason that insiders buy:They think the stock price is

undervalued and willeventuallygoup.”On an even bigger scale,

you want the company itselfbuying back shares. If acompanythinksithasabrightfuture, it makes sense toinvest in itself. After acompanybuys its own stock,there are fewer sharescirculatingamongthegeneralpublic. Assuming everythingremains healthy at thecompany, those fewer shares

in circulation are morevaluable than before thebuyback. Earnings per sharego up and the stock is moreenticing to investors. If youown some of the shares stillin circulation, you’ve got ahotter hand than you hadbefore the buyback. Lynchexplains,“Ifacompanybuysback half its shares and itsoverall earnings stay thesame, the earnings per sharehave just doubled. Few

companiescouldgetthatkindof result by cutting costs orsellingmorewidgets.”

KnowWhytoBuy

Lynchusesaniftyexercisetoforcehimselftounderstandwhyhe’sinvestinginastock.He calls it the two-minutedrill. “Before buying astock,”hewrites,“Iliketobeable to give a two-minute

monologue that covers thereasons I’m interested in it,what has to happen for thecompany to succeed, and thepitfallsthatstandinitspath.”The script should change fordifferent types of companiesbecause you’ll want toemphasizedifferentstrengths.Lynch offers severalexamples, one of which Ishow here. It’s for Coca-Cola, a stalwart company.Keep in mind that this

situation might not existwhenyoureadthis:

Coca-Cola isselling at thelow end of itsP/Erange.Thestock hasn’tgoneanywherefor two years.The companyhas improveditself inseveral ways.

It sold half itsinterest inColumbiaPictures to thepublic. Dietdrinks havesped up thegrowth ratedramatically.Last year theJapanesedrank36 percentmore Cokesthan they did

the yearbefore,andtheSpanish uppedtheirconsumptionby 26 percent.That’sphenomenalprogress.Foreign salesare excellentin general.Through aseparate stock

offering,Coca-ColaEnterprises,the companyhasboughtoutmany of itsindependentregionaldistributors.Now thecompany hasbetter controloverdistribution

and domesticsales. Becauseof thesefactors, Coca-Cola may dobetter thanpeoplethink.

Isn’tthisagreattechnique?You become your ownanalyst when forced toprovide a two-minutesummary to yourself or aninvestment club. Of course,

your knowledge runs fardeeper than what’s revealedin two minutes. All thatknowledge is on your sidewhen making goodinvestmentdecisions.Lynch explains that the

real benefit of two-minutedrills is that they make youknowyourcompanies.That’shandy no matter which waythe stock price movesbecause you can make yourbuy and sell decisions from

information about thecompany instead ofinformation from themarket,the most fickle of allmeasurement tools. If youbuyCoca-Colabecauseit’satthe lowendof itsP/E range,is growing its businessoverseas, and has greatercontroloverdistribution,doesanyofthatchangeifthestockdrops 10 percent after youbuy? Probably not. Howabout if the stock rises 20

percent after you buy? Still,probably not. Price itselfshouldnotbe theonly factoryou look at when buying orselling. The company behindthe stock should be yourfocus.

WhatYouShouldRetainfromLynch

Peter Lynch believes inusingwhatyoualreadyknow

to find “tenbaggers.” Onceyouknowwhyyou’rebuyingacompany,you’llknowhowto behave as its stock pricefluctuates. Given thisapproach, Lynch findsopportunities in both valueandgrowthstocks.Otherkeypoints:

✔ Use what youalready know tofind stocks. As anemployee, you

know the details ofyour company andits industry betterthan most analysts.As a consumer,you’re constantlyresearching theproducts andservices ofcompanies.Usethatknowledge wheninvesting.✔ Categorize yourcompanies. The

exact categoriesyou use aren’timportant, butknow the types ofcompanies you’reinvesting in. Areyou considering afast grower, astalwart, or aturnaround?Companies movefrom category tocategoryovertime.✔ Perfect

companies:•Aresimpletounderstand.It’sgreattoknowthatanyidiot

canruntheplacebecausesoonerorlateranyidiotwillruntheplace.

•Turnpeopleoffbybeingunattractiveinsomeway.Maybethey’reboring,ugly,

ordisgusting.MorepeoplewanttoinvestinthelatestInternetcompanythanthe

latestgrocerycouponcompany.Lookwhereotherswon’t.•Arefastgrowersinslow-

growthindustriesor,betterstill,no-growthindustries.Thiskeepscompetitionaway.Everybodythinks

theycanmakemoneyinSiliconValley,fewthinktheycanmakemoneyin

thefuneralbusiness.•Occupyaniche.Iftheyownsomethinguniqueordominate

atinymarket,it’shardforcompetitiontomuscleinside.•Sellsomethingthat

peopleneedtokeepbuying.Whatdoyoudowhenyoudrinkyourlast

Coke?Buymore.Useyourlastdisposablerazor?Buymore.Steadybusinessispowerful

stuff.•Havealotofcashandlittledebt.Companieswithnodebt

can’tgobankrupt.•Sellatastockpricethatisagoodvalue

relativetothecompany’sworth.ThiscanbemeasuredinseveralwaysincludingP/E

ratiosandprice-to-bookratios.•Arerunbymanagersandemployeeswho

investinthecompany’sstock.Whenpersonnelownastakeinthecompany,they’ll

workhardertomakeitsuccessful.•Buybacksharesoftheirowncompany

stock.Thisisashowoffaithinthecompany’sfutureanditalso

decreasesthenumberofsharesincirculation,therebyincreasingtheirworth.

✔ Knowwhy youbuy.Delivera two-

minute monologueto yourselfsummarizing thereasons you’rebuying. This forcesyou to understandyourcompaniesandfocus on theirfundamentalinformation as thestock market batstheir prices around.When in doubt,refer to the reasons

you bought in thefirstplace.

WilliamO’Neil

William O’Neil is bestknown as the founder ofInvestor’s Business Daily,national competitor of TheWallStreetJournal.Whenhewas 30, O’Neil used profits

he made trading stocks topurchase a seat on the NewYork Stock Exchange and tofound his own investmentresearch organization nowbasedinLosAngeles.In1988,O’NeilwroteHow

to Make Money in Stocks,which presents everythinghe’s learned about growthstockinvesting.

UsetheCANSLIMSystem

toFindGrowthStocks

Not another diet plan,O’Neil’s strange-soundingsystem for finding growthstocksisactuallyanacronymfor the attributes of greatcompanies. O’Neil stressesthat every one of theattributes must apply to acompanyforhimto invest init. This is not an electionwhere if a company boastsfourof the sevenattributes it

wins. No, it must boast allseven attributes to be awinner. The seven attributesare:

C:Currentquarterlyearningspershareshouldbeaccelerating

O’Neil wants to see anincrease in the current

quarterly earnings per sharewhen compared to the samequarter from the prior year.He writes plainly, “Thepercentage increase inearnings per share is thesingle most importantelement in stock selectiontoday.” Bigger increases arebetter than little ones, butinvestors should be carefulnot to be misled by hugeincreasesovertinyonesfromthepreviousyear.“Tencents

pershareversusonecentmaybea900percentincrease,”hewrites, “but it is definitelydistorted and not asmeaningfulas$1versus$.50.The 100 percent increase of$1 versus $.50 is notoverstated by comparison toan unusually low number intheyearagoquarter.”

A:Annualearnings

pershareshouldbeaccelerating

Similar to the quarterlyearnings increases, O’Neilwants to see each year’sannualearningsper share forthepastfiveyearsbiggerthanthe prior year’s earnings. Acompany should be growingat least 25 percent per year,preferably 50 percent or 100percent. O’Neil gives this

example: “A typicalsuccessfulyearlyearningspershare growth progression fora company’s latest five-yearperiodmight look somethinglike$.70,$1.15,$1.85,$2.80,$4.” A nice bonus is anearnings estimate for nextyear predicting yet anotherincrease.

N:Newsomethingor

othershouldbedrivingthestocktonewhighs

On this attribute O’Neil isflexible but he wants to seesomething new that ispositively affecting thecompany’s future. In hisfirm’s study of the greateststocks from 1953 to 1993,O’Neil found that 95 percentof them had either a new

product or service, newconditions in the company’sindustry, or a newmanagement team. Mostimportantly, O’Neil likes tobuy stocks pushing newhighs. Cheap stocks areusuallycheapforareason.

S:Supplyofstockshouldbesmalland

demandshouldbehigh

Supplyanddemandaffectsthe price of everything,including stocks. If twostocksaresteamingupwardatthe same pace, the one withfewer sharesoutstandingwillperform better. Why?Because there are fewershares for the people whowant to buy it. O’Neil

provides the example of acompany with 10 millionshares outstanding and onewith 60 million. All otherfactors being equal, thesmaller company should bethe“rip-roaringperformer.”

L:Leadersinanindustryshouldbeyourtarget

When O’Neil talks aboutleaders in an industry, hemeans the stocks with thebest relative price strengths.Investor’s Business Dailyshows the relative pricestrengths of NYSE, AMEX,and NASDAQ stocks everyday on a scale from 1 to 99with99beingthebest.Usingan interesting mnemonicdevice, O’Neil writes, “Apotential winning stock’srelativestrengthshouldbethe

same as a major leaguepitcher’s fast ball. Theaveragebigleaguefastballisclocked about 86 miles perhour and the outstandingpitchers throw ‘heat’ in the90s.”Thereyouhaveit:Lookfor stocks with relative pricestrengthsof90orbetter.

I:Institutional

sponsorshipshouldbemoderate

Demand needs to be highto drive stock prices higher.Institutional buying is thebest sourceofdemand in thestock market. Mutual funds,pension plans, banks,government bodies, andinsurance companies are allinstitutional investors. Theybuy millions of shares at

once.O’Neil likes his stocksto be owned by a fewinstitutions. Too many canmean that the stock isoverowned. In that case, somany institutions own thestockthatiftheyallreactthesameway to news, the stockmight get dumped and itspricewilldrop.

M:Marketdirection

shouldbeupward

O’Neil says that even ifyougetthefirstsixfactorsofCANSLIMrightandchooseagreatportfolioofstocksbutbuy when the market as awholeisdeclining,75percentof your picks will sink withthemarket. To get a feel forthedirectionofthemarket,hesuggests watching marketaverages every day.Keep an

eyeondailypriceandvolumecharts of several differentmarket averages such as theDow, S&P 500, andNASDAQ composite.Investor’s Business Dailypublishes major marketindicators on a single pageeveryday.

IgnoreValuation

This is a radical departure

from the previous fourmasters.O’Neil believes thatyou get what you pay for inthe market. He’s thequintessential growthinvestor, ignoring P/E ratioscompletely and focusing onearnings acceleration. Headvises, “Don’t buy a stocksolely because the P/E ratiolooks cheap. There usuallyare good reasons why it ischeap,andthereisnogoldenruleinthemarketplacethata

stock which sells at eight orten times earnings cannoteventuallysellat fouror fivetimes earnings. . . .Everything sells for aboutwhatitisworthatthetime.”The N in CAN SLIM

specifies that a stock shouldbe pushing new highs. Thatnotion runs contrary toeverythingwe’vebeentaughtas consumers. Most peopledon’t want to buy a carselling for more than it ever

has before, or a house, or apair of shoes. Yet O’Neilcalls it the stock market’sgreat paradox that “whatseems too high and risky tothe majority usually goeshigher and what seems lowand cheap usually goeslower.” His firm studiedstocks listed on either thenew-high or new-low list inthenewspaperandconfirmedthat stocks on the new-highlist tend to go higher while

stocks on the new-low listtendtogolower.“Therefore,” O’Neil

summarizes, “your job is tobuywhen a stock looks highto the majority ofconventional investors and tosell after it movessubstantially higher andfinally begins to lookattractive to some of thosesameinvestors.”Beyond price acceleration,

O’Neil looks at management

stock ownership and acompany’s debt. He agreeswith Lynch that it’s a goodsign formanagement to owna large percentage of stockand that great companiescarry little debt. He writes,“A corporation that has beenreducingitsdebtasapercentofequityover thelast twoorthree years is well worthconsidering.”

ManagingaPortfolio

O’Neilsaysathisseminarstomanageyourportfoliolikearetailbusiness.Pretendyousell stuffed animals. AsChristmas approaches, Babethe stuffed bull is outsellingSmokeythestuffedbearthreetoone.WhichanimaldoyoustockuponfortheChristmasseason? Babe the bull, ofcourse, because he’s givenyou the most profit and will

probably do so in the future.AccordingtoO’Neil,itworksthe same way in yourportfolioofstocks.“Sellyourworst-performing stocks firstand keep your best-actinginvestments a little longer.”That means you shouldn’taverage down, a commonpractice of adding moremoney to your stocks thathave fallen in price to buyadditional shares at adiscount.

AutomateBuyingandSelling

LikeGraham,O’Neil likesautomation. His CAN SLIMmethod is one way ofautomatingyour investments.Another is to set a place tostop losses. O’Neil stops hislosses at 8 percent of newmoneyplacedinastock.He’sspecific on the new moneyrequirement. If you own a

stock that’s risen 50 percentanditslidesback10percent,that’s not necessarily a timetostoplossesbecauseoverallyou’re ahead 40 percent. It’sonlywiththeadditionofnewmoney, when a loss meansyou’re actually behind, thatO’Neil advocates stoppinglosses. Even if it’s moneyadded to a rising position,O’Neil recommends stoppinglosses on that money if thestock slides back while

keeping your initialinvestment money in thestock.It’swisetolimitlossesbecause it takes a greaterpercentgaintoovercomeanygiven percent loss. Forinstance, if you lose 33percent, it takes a 50 percentgain to recover. O’Neilwrites, “The whole secret towinninginthestockmarketisto lose the least amountpossible when you’re notright.”

StopCountingTurkeys

One of O’Neil’sbest examplesshows the fallacyof hoping torecover lossesfrom a fallingstock. It’s thestory of an oldman and histurkeytrap.

There was anold man with aturkey trap thatconsisted of a boxheldupbyaprop.Wild turkeyswould follow atrailofcornunderthe box. Whenenough turkeyswere inside, theold man wouldpull a stringattached to the

prop, therebydropping the boxover the turkeysinside. The goalwas to trap asmany turkeys aspossible.Onedayhehad

12 turkeys in thebox. Onewandered out,leaving 11 behind.“Gosh, I wish Ihad pulled the

string when all 12were there,” saidthe old man. “I’llwait aminute andmaybe the otherone will comeback.”But while he

waitedforthe12thturkey to return,two more walkedout. “I shouldhavebeensatisfiedwith 11,” the old

man said. “Assoon as I get onemorebackI’llpullthe string.” Butthe turkeys keptwandering out.The old mancouldn’t give upthe idea that someof the originalnumber wouldreturn. With asingle turkey left,the old man said,

“I’ll wait until hewalks out oranother goes in,thenI’llquit.”Thelast turkey joinedthe others and theold man returnedempty-handed.O’Neil writes

thattheanalogytothe psychology ofthe normalinvestor isamazinglyclose.

Whileheabhors averagingdown, O’Neil advocatesaveraging up, also calledpyramiding. This practice helearned from JesseLivermore’sHowtoTradeinStocks.Theplan is simply tomove more money into yourstocks that are increasing invalue.This is theoppositeofstopping losses when you’rewrong.Pyramidingmagnifieswinnings when you’re right,which is precisely what

Livermore teaches. O’Neilrecalls, “From his book, Ilearnedthatyourobjectiveinthemarketwasnottoberightbut tomakebigmoneywhenyou were right.” I supposeyou could relate pyramidingto the turkey analogy in theabove textbox by suggestingthat the old man placeadditional turkey traps in thefield where he’s been mostsuccessfulbefore.After studying his

successesandfailures,O’Neildevised an automated profitand loss plan for prosperinginthestockmarket:

✔ Buy exactly atthe pivot pointwhere a stock ismoving to newhighs after a flatarea in an upwardtrend. O’Neil callssuch flat areasconsolidation

periods.✔ If the stockdrops 8 percentfrom thebuypoint,sell.✔ If the stockrises,pyramidmoremoney into itup to5 percent past thebuypoint.Soifyoubought a stock at$50 and it rose to$51, O’Neil wouldsuggest adding

more money.However, youshouldn’t addmoremoney after thestock reaches$52.50 because atthat point it’s risen5percent.✔ Once a stockhas risen 20percent,sell.✔ If a stock rises20 percent in lessthan eight weeks,

commit to holdingatleasteightweeks.After that timeperiod, analyze thestock to see if youthink it will riseevenhigher.

Focus,MakeGradualMoves,andTrackYourWinners

Because he’s found fewpeople who do more than afew things well, O’Neilbelieves that a focusedportfolio is better than adiversified one. He asks ifyou’dbecomfortablevisitinga dentist who’s also a part-time engineer, music writer,and auto mechanic. O’Neilsees diversification as adilutionofyourstrengths.Hewrites, “The best results areachieved through

concentration: putting allyour eggs in just a fewbasketsthatyouknowagreatdeal about and continuing towatch those baskets verycarefully.” He emphasizesthat “the winning investor’sobjective should be to haveoneortwobigwinnersratherthan dozens of very smallprofits.”It’s best to make gradual

movesintoandoutofastock.O’Neilsays toomanypeople

are hesitant to move theirmoney. To overcome thishesitation, he recommendsbuyingandsellinginparcels.If you own a stock you loveand it starts dropping invalue, sell part of it as aninsurance policy. If itrebounds, fine. You madebackpartof thelosswiththemoneyyoukept in thestock.Like all insurance policies,youwon’talwaysneedtousethis one. O’Neil asks his

seminar audiences, “Are youangry when you buy autoinsurance and then go a yearwithout wrecking your car?No!” He reasons that youshouldn’tbeangrytosellpartof a losing position only toseethepositionfullyrecover.Ask yourself how muchworse it would have been ifyou hadn’t sold part of theposition.To help overcome the

inherent tendency to buy

more of the stocks in yourportfoliothathavegonedownin price, O’Neil suggestskeepingrecordsinadifferentway.At theendofeachtimeperiod, he says to rank yourstocks by their performancefrom the previous evaluationperiod. “Let’s say yourTektronix is down 8 percent,your Exxon is unchanged,andPolaroidisup10percent.Your list would start withPolaroid on top, then Exxon

andTektronix.”Afterrankingyour portfolio this way forseveral time periods, you’llsee which stocks are laggingthe group. O’Neil’s intent isto force you to ignore thepriceyoupaidforeachstockand concentrate instead oneachstock’sperformance.Hewrites, “Eliminating theprice-paid bias can beprofitable and rewarding. Ifyou base your sell decisionsonyour cost and hold stocks

that are down in pricebecause you do not want toacceptthefactyouhavemadean imprudent selection andlost money, you are makingdecisionsexactlytheoppositeof those you would make ifyou were running your ownbusiness.”

WhatYouShouldRetainfromO’Neil

William O’Neil believesearnings acceleration ismoreimportant than buying stockscheap. He advocates buyingand selling in short timeperiods,stoppinglosseswhilethey’re small, and addingmore money to winningstocks. He is an unmitigatedgrowth investor. Other keypoints:

✔ Use the CANSLIM system to

find growth stocks.CAN SLIM is anacronym for theseven conditionsthat indicate anexcellentinvestment:

•C:currentquarterlyearningsper

shareshouldbeaccelerating•A:annualearningspershareshouldbeaccelerating•

N:newsomethingorothershouldbedrivingthestocktonewhighs•

S:supplyofstockshouldbesmallanddemandshouldbehigh•L:

leadersinanindustryshouldbeyourtarget•I:institutionalsponsorshipshouldbe

moderate•M:marketdirectionshouldbeupward

✔ Ignorevaluation. Low P/Eratiosoftenindicatestocks that arecheap for a reason.

They can alwaysgetcheaper,too.✔ Look forcompanies with alarge percentage ofmanagement stockownershipandlittledebt.✔ Contrary towhat’s taught toconsumers,investors shouldbuy stocks pushingnew highs. What

seems too highusuallygoeshigher,whatseemstoolowusuallygoeslower.✔ Manage yourportfolio like aretail business: getrid of unpopularproducts andacquiremoreof thepopular ones. Withstocks, sell yourlosers and keepyourwinners.

✔ Automate yourinvestmentstrategy.Stop losses at 8percent and addmore money towinners up to 5percent above thebuyprice.✔ Focus on a fewgood stocks. Don’tdiversify acrossmany mediocreones.✔ Make gradual

moves into and outofastock.✔ To overcomethe desire to buymore of the stocksthat have declinedinprice,rankstocksby theirperformance over atimeperiod.Afterafew trackingperiods, sell thelosers and add tothewinners.

BillMiller

Bill Miller is the managerof Legg Mason Value Trust(LMVTX),where he becamefamous for beating the S&P500 fifteen years in a rowfrom 1990 to 2005. At theendof2006,ValueTrusthadbeaten the S&P 500 on arollingtwelve-monthbasis72percent of the time. On a

rolling five-year basis, it didso100percentofthetime.From the beginning of

2005 to October 2007, thefund gained a modest 19percent to the S&P 500’s 31percent. Then the 2008recession blew into town.From October 2007 to theNovember2008low,theS&P500fell49percent,butValueTrust fell 72 percent.Financial stocks were toblame.ValueTrustheldAIG,

Bear Stearns, and FreddieMac. In that infamousthirteen-month period, AIGdeclined 98 percent, BearStearns disappeared entirelywhen the Federal ReserveBank of New York tried tosave it with an emergencyloanbutendedupsellingittoJPMorganChase for $10 pershare, and Freddie Macdeclined99percent.Why, then, do I still

include Miller as one of our

master investors? Becauseeverybody makes mistakes,and his impressive historysuggests thathewill reboundfrom the setback and emergeanevenbetterinvestorforthelessons he learned. Studyingdifficult periods often yieldsmore insight than studyingcarefreeones.The name of his fund is

Value Trust, so you mightexpect Miller to be a valueinvestor on the hunt for low

P/E ratios, low price-to-bookratios,andothermainstaysofthe typical value investor’stoolbox. That he doesn’tsearch only for suchcharacteristics in hiscompanies makes himfascinating, and worthstudying.Let’s see how Bill Miller

beat the market for 15 yearsin a row and howhe reactedto his fall from grace in therecessionof2008.

RedefineValuebyLookingAhead

Itshouldseemobviousthatinvesting is an exercise inlooking ahead, but noteverybody approaches it thatway.A lotofvalue investorscheckastock’shistoricaldatato see if it’s currently cheapbycomparison.For instance, if a stock’s

P/Eratiohasaveraged20forthe last10yearsbut it’snow

15, it’s historically cheap.Miller would say, so what?Unlessit’scheapcomparedtowhat he expects from itsfuture performance, he’s notinterested.Isthereareasontoexpect trouble? If so, maybethe lower P/E is justified. Ifthere’sa recoveryaheadorareason to believe that cashearningswillgrowfasterthanthe market thinks, thenperhapsMillerwillagreethatthecompanyisabargain.The

way he arrives there,however,isbylookingahead.Whenyouthinkaboutthat,

ithelpstoexplainwhyMillersometimes owns stocks thatothervalueinvestorsshun.In the mid-1990s, most

value investors were lookingat beaten down cyclicalstocks of companies thatmakesteel,cement,paper,oraluminum. Those were theclassiclowP/E,lowprice-to-bookstocksofthetime.

Miller,however,loadedupontechnologycompanieslikeAmazon.com and Dell. Hethought their prices werebettervalueswhenviewedasastartingpoint toa futureofstrong growth and highreturns on capital. He wasright, andmore so than evenhe expected when his techbargains skyrocketed in thetechmaniaof the late1990s.From June 1997 to April1999, Amazon.com gained

6,600 percent. From early1995 to early 2000, Dellgained7,000percent.Yearslater,inanarticleon

thehistoryofvalueinvesting,SmartMoney describedMiller’s holding on to high-flying Dell in 1998 as “abetrayal equivalent to BobDylan’sgoingelectric.”In November 1999,

Barron’s ran an article byMiller called “Amazon’sAllure: Why a famed value

investor likes—yipes!—astockwithoutearnings.”Init,Miller wrote, “It’s true thatsome of the best technologycompanieshaverarelylookedattractive on traditionalvaluation methods, but thatspeaksmore to theweaknessof thosemethods than to thefundamental risk-rewardrelationships of thosebusinesses. Had weunderstood valuation better,we would have owned

MicrosoftandCiscoSystems.Microsoft has gone up about1 percent per week, onaverage, since it has beenpublic. Companies don’toutperform year in and yearout for over a decade unlessthey were undervalued tobeginwith.”He then pointed out that

youdon’tfindundervaluationby comparing a stock’s pricewith its trailing earnings,book value, or cash flow.

Instead,youneedtocompareits price to the current valueof the free cash that thebusiness will create in thefuture. That’s the same wayWarren Buffett determines abargainprice.This approach has

remained a hallmark ofMiller’s style through theyears. In a February 2003interview with Barron’s, heused the phrase “valuationillusion” to refer to stocks

that look expensive bytraditionalmeasurements,butare actually bargains in lightof their bright futures. Heagain spoke ofMicrosoft’s 1percent per weekperformance, and added theexampleofWal-Mart.“Fromthe day they came public,they looked expensive,” hesaid. “Nonetheless, if youbought Wal-Mart when itwent public at an expensive-looking 20 plus times

earnings, you would havemade returns of manythousand percent on that.”Understanding the growthahead ofMicrosoft andWal-Mart would havemade clearthattheywerebargains.Millerwrote in his fourth-

quarter 2006 shareholderletter, “We realized that realvalue investing means reallyasking what are the bestvalues,andnotassumingthatbecause something looks

expensive that it is, orassumingthatbecauseastockisdowninpriceandtradesatlow multiples that it is abargain.”Hepointedout that“value funds tend to havealmostalltheirmoneyinlowP/E, low price-to-book orcash flow, and growth fundshave the opposite. . . . Thequestion is not growth orvalue, but where is the bestvalue?” Stocks with low P/Eratiosandvaluestocksarenot

necessarilythesamething.Don’t think that his

targeting technology was aflukeof the1990s,either.Ata Manhattan conference inMay 2005, he told theaudiencethat“thecorepartofall of those businesses—andby ‘all of those,’ I meanGoogle, Yahoo!, Amazon,eBay, and to a lesser extent,IAC/Interactive—is that theyrequire very little marginalcapital in order to generate

huge amounts of free cashflow. And their ongoingbusiness models can sustain,at the margin, returns oncapitalnorthof100percent.”When an attendee asked

why he liked the veryexpensive Google inparticular, Miller replied,“What’s not to like? It’s gothugeprofitmargins. Itgrowsvery rapidly. Themanagement has executedbrilliantly.And it sitsexactly

in the nexus of where all ofthe long-term trends aregoing in media. . . . WhatGoogle is doing is using theoldmedia network televisionmodel—which is, ‘We willdeliver content to you, theviewer, and because it’sadsupported, you don’t havetopay for thecontent at all.’AndwhatGoogle is doing isusing that model to start todeliver actual content. . . . Imean actual products like

Gmail—and maybe anoperating system and maybeapplications.”Thekeytogettingbargains

is lookingahead,not lookingback.Millerparticipatedinanevent called Conversationwith a Money Master at the50th anniversary FinancialAnalysts Seminar hosted bythe CFA Society of Chicagoin July 2006, and thetranscript appeared in theAugust 2006 edition of

OutstandingInvestorDigest.About looking ahead

instead of back, Miller toldthe moderator, “So they say,‘Oh, Toys “R” Us’s historicmultiplewasX.Andnowit’s.8X—and so there’s anopportunity here.’ Or, ‘Lookat what the pharmaceuticalcompaniesdidfor the last50years.Andnowthey’recheapcompared to that. So nowthey’re a good value.’ Theproblemis that inmostvalue

traps, the fundamentaleconomics of the businesshave deteriorated, and themarket’s gradually markingdown the valuation of thoseto reflect the fundamentaleconomic deterioration. Sowhat we’ve always tried tofocus on is, in essence,whatthe future return on capitalwill be, not what the pastreturn on capital has been.What’s our best guess at thefuture return on capital and

how the management canallocate that capital in acompetitive situation that isdynamic sowe can avoid, inessence,thosevaluetraps?”He ends up owning some

ofthisandsomeofthat,withthe only common themebeing good value by hisdefinition. His stocks lookwildly different to onlookersbecause they sportmeasurements at oppositeends of the spectrum. Are

they value stocks or growthstocks? It doesn’t matter.They’re stocks bought atbargain prices compared towhattheirfutureshold.Millerwrote in his fourth-

quarter 2006 shareholderletter, “When some look atour portfolio and see high-multiple names such asGoogle residing there withlow-multiple names such asCitigroup, they sometimesask what my definition of

value is, as if multiples ofearnings or book value wereall that was involved invaluation. Valuation isinherently uncertain, since itinvolvesthefuture.AsIoftenremind our analysts, 100percent of the informationyou have about a companyrepresents the past, and 100percent of the value dependsonthefuture.”

FutureFreeCashFlowonSale

If forced to distill hisdefinition of a bargain stockdown to a singlemeasurement, Miller wouldlikelychooseacheappresentvalueoffuturefreecashflow.Tohim, that factorhas it all.It trumps lowP/E ratios, lowprice-to-book ratios, loweverything else. If you canbuyfuturefreecashflowata

cheap price, you foundyourselfabargain.Let’s see if we can

understandwhy he takes thisapproach.Net income is the money

left after a company pays itsbills, taxes,interestexpenses,and such. Free cash flow isthe money left after acompany uses its net incomefor capital expenditures,known as CAPEX, which isbuying new equipment,

buildings,or land to improveits business. So, free cashflowiswhat’sleftwhenthereare no more expenses.Everythingispaidandthere’sjust a pile of cash in a bankaccount that’s free for otheruses. The regular stream ofsuch cash into the account istheflow.Miller told Barron’s in

February 2003, “One of themost important metrics wefocus on is free cash flow—

the ability to generate it andwhat it yields: that is, freecash flow per share dividedby the stock price.” Forexample,astockwithapriceof$30andanexpected$3.00of free cash flow this year isyielding 10 percent on freecashflow.On the same amount of

freecash flow,acheapstockhas a higher yield than anexpensive stock. If theabovestock had $3.00 of free cash

flow per share but a sharepriceofjust$20,itsfreecashflow yieldwould be an evenmore impressive 15 percent.That’sjust3dividedby20toget.15,or15percent.Withasharepriceof$50,thestock’sfreecashflowyieldwouldbealessattractive6percent.Miller explained to

Barron’s in April 2001, “Bythetimeacatalyst isevident,the stock price has alreadymoved. For us, the main

catalyst is a cheap stockprice.Thekeytoourprocessis trying to buy things atdiscountstointrinsicbusinessvalue, which, from atheoretical standpoint, is thepresent value of the futurefree cash flows. . . .We arelooking for things that arestatistically cheap. . . .Ideally, what we want is acompanythatisaleaderinitsindustry, that has thecapability of earning above-

averagereturnsoncapitalforthelongterm,acompanythathas tremendous long-termeconomics and thoseeconomics are eithercurrently obscured bymacroeconomic factors,industry factors, company-specific factors, or just theimmaturityofthebusiness.”

DoWhatIsUnpopular

It should be clear by nowthat Miller has achieved hissuccesses by doing thingsdifferently, going against thecrowd. In investing, such amaverickiscalledcontrarian.He invests in a way that’scontrary to whatmost othersdo. He thinks differently, helooks different places, hereachesdifferentconclusions,and he achieves betterperformance.

ATrueContrarian

The funny thing aboutcontrarianismisthatsomanypeople claim to embrace it.By definition, that can’t be.Almost all value fundmanagerssay they’re lookingfor bargains “that othersmiss”as theymerrilybuildaportfolio of the same stocksthatothersfound.Miller is not one of them.

He’s a true contrarian, to theextent that he sometimesfinds himself disagreeingwith the findings of his ownanalysis. He says that “mostfundmanagersownwhattheyliketoown.Weownwhatwehatetoown.”Most investors focus too

muchontheshortterm,reactto dramatic events, andoverestimate the importanceof widely covered newsstories. Miller tries to take

advantage of that by findingstocks that have beenoversold by mistakeninvestors. That’s why hefrequently owns stocks thathe and others both hate, likeAmazon.com when peoplethought its low operatingmarginswouldlastforever.Millerwrote in his fourth-

quarter 2006 shareholderletter, “It is trying to investlong-term in a short-termworld, and being contrarian

when conformity is morecomfortable, and beingwilling to court controversyandbewrong,thathashelpedus outperform. ‘Don’t youread the papers?’ oneexasperated client asked usafter we bought a stock thatwasembroiledinscandal.AsI also like to remind ouranalysts, if it’s in thepapers,it’sintheprice.”Hesaysthattherearethree

types of competitive

advantages: analytical,informational, andbehavioral.You have an analytical

advantagewhenyou take thesame information that othershave, but process itdifferentlyandreachdifferentconclusions than they reach.With Miller, this is mostevident in the way heredefines value, as shownabove.Hewrote inhis third-quarter 2006 shareholder

letter, “The most importantquestioninmarketsisalways,what is discounted? Whatdoes the market expect, asreflected in prices, and howdomyexpectationsdiffer?”Youhavean informational

advantage when you knowsomething important thatothers don’t. Suchinformation is hard to knowbecause inside information isillegal and regulators arestrict. There are, however,

legal types of informationaladvantages such aswhat youcan observe that othershaven’t, the timeyou take tocontact people that otherswon’t, and lucky breaks likeoverhearingthepresidentofapharmaceutical companymake a cell phone call froman airport about receivingFDAapprovalonanewdrug.Don’t laugh.Ithappens.Stayalert.

BehavioralFinance

You have a behavioraladvantage when youunderstand human behaviorbetterthanothersandcanusethat understanding to exploitstock price movements. Thisadvantage is the mostinteresting to Miller becauseit lasts. He wrote in hisSeptember 2006 shareholderletter,“Untillargenumbersof

people are able to alter theirpsychology (don’t hold yourbreath), there ismoney to bemadefromprospecttheory.”Thisisnottheplaceforan

in-depth look at behavioralfinance,but it’sagoodplacefor a glance at prospecttheory. It shows thatwehatelosses twice as much as welovegains.A 1979 study by Daniel

Kahneman and AmosTversky showed this in an

interestingwaywhentheysetout to find why people areattracted to both insuranceandgambling,twoseeminglyoppositefinancialideas.Subjects were told to

choose between these twoprospects:Prospect1:A100percent

chanceoflosing$3,000Prospect2:An80percent

chanceoflosing$4,000,buta20 percent chance of losingnothing

Whichwould you choose?In the study, 92 percent ofsubjects chose prospect 2.Thechanceoflosingnothing,even though it wasimprobable, was compellingenough to risk losing more.Prospect1,however,islikelytoloseless.Next,subjectswere told to

choose between these twooptions:Prospect1:A100percent

chanceofgaining$3,000

Prospect2:An80percentchanceofgaining$4,000,buta 20 percent chance ofgainingnothingWhichwould you choose?

In the study, 80 percent ofsubjects chose prospect 1.The guarantee of gainingsomething was moreappealingthantheprobabilityof gaining more. Prospect 2,however, is likely to gainmore.People hate risk when it

threatensgains,but they loverisk when it could preventlosses. We’re odd creatures,sointentonavertinglossthatwe’re willing to risk losingeven more to do so.We arenot bold enough when theodds favor gaining, and weare too timid around evensmall levels of risk. That, inabbreviated form, is whatKahneman and Tverskyfound and what is calledprospecttheory.It’sonetenet

of behavioral finance thatMillerfindsuseful.Hewrote inhisSeptember

2006 shareholder letter that“people are too risk averseand therefore systematicallymisprice risky assets moreoften than not. . . . Loss ispainful, on average twice aspainful asgain ispleasurablein matters financial. That is,peopleonaverageneedabouta 2 to 1 payoff on an evenodds bet to take the bet. But

even a modest advantageyields big gains over time,whichiswhycasinosmakesomuch money. People getmorebullish aspricesgoup,and more bearish as they godown. They overweightrecent trends relative to theirlong-term significance, andtheir emotions give greaterweight to events the moredramatic they are, often outof all proportion to theprobability of their

occurrence. All of thesefeatures of how our beliefsaffect our behavior areactionable if they aresystematically incorporatedintoaninvestmentprocess.”Another of Miller’s

favoriteideasfrombehavioralfinance is calledmyopic lossaversion. Richard Thaler atthe University of Chicagoused it to explain the equitypremiumpuzzle.Stockshavereturned about 7 percent per

year after inflation whilebondshavereturnedlessthan1 percent. The puzzle’squestion is, if stocks returnmore than bonds over thelong term, why would anylong-term investor choose toownbonds?Because,Thaler explained,

most investors are “myopic”inthattheyfocusontheshortterm. Combine that with ourinherentaversion to loss,andyou understand why people

own investments that don’tperformwellinthelongtermbecause they are steadier intheshortterm.Theshort-termsteadiness gives the illusionof safety but over the longhaulrunsahigherriskofnotearningenough.InhisN-30Dfilingfor the

period ending March 1995,Millerwrote:

The moreshort-term-

orientedone is(the more“myopic”), thegreater one’swillingness toreact to theriskof loss. . ..Since one’s

perception ofthe risk ofstocks is afunction ofhow often you

look at yourportfolio, themore awareyou are ofwhat’s goingon, the morelikely you areto do thewrong thing.“Whereignorance isbliss, ’tis follyto be wise,”said the bard,

whounderstoodmyopic lossaversioncenturiesbefore theprofessors gotholdofit.Suppose

you buy astock onMonday, andon Tuesday,while you are

engrossed inthe O.J.Simpson trial,it dropsdue tobad news. OnWednesday,though, itrecovers toclose higherthan yourpurchaseprice.If you hadbeen glued toCNBC on

Tuesday whenthe news hit,and hadobserved thestock falling,you may havebeenpromptedto act on thenews,especially ifthe stock wasreacting to it.If you missedthe news until

Wednesday,whenthestockhad recovered,you are muchless likely tosell it then,even thoughthefundamentalsarethesameasthedaybefore.That is

myopic lossaversion at

work. Putdifferently,you are notworried thatIBM droppedovernight inTokyo whileyou slept, if itclosed up twopointstodayinNew York.You areworried if itdrops today in

New Yorkthough it’s setto rise twopoints inTokyo tonightwhile yousleep....For most

investors,Thaler thinks,theappropriateadvice is“Don’t just dosomething, sit

there.”Our

investmentapproach inthe ValueTrust has beento use themyopic lossaversionexhibited byothers to ourshareholders’long-termbenefit.Wetry

to buycompanieswhose sharestrade at largediscounts toourassessmentof theireconomicvalue. Bargainprices do notoccur whenthe consensusis cheery, thenews is good,

and investorsare optimistic.Our researchefforts areusuallydirected atprecisely thearea of themarketthatthenews mediatells you hasthe leastpromisingoutlook . . .

and we aretypicallyselling thosestocksthatyouare readinghave thegreatestopportunityfornear-termgain.

MoneyManagement

Miller believes in what hecallsfactordiversification.Heowns high P/E stocksalongsidelowP/Estocks,andconsidersthattobeastrengthbecause “we own them forthe same reason: We thinkthey are mispriced.”Sometimesgrowthfactorsarefavored, other times valuefactors are favored. Byowning stocks in each factorgroup, he smooths hisportfolio’sfluctuations.

Hedoesn’tthinkthere’saninherent advantage in eitherconcentrated or diversifiedportfolios.Itdependsonwhatyou’re considering.Hewrotein his fourth-quarter 2006shareholder letter, “If I amconsidering buying three $10stocks, two of which I thinkare worth $15, and the thirdworth$50,thenIwillbuytheone worth $50, since myexpectedrateofreturnwouldbediminishedbysplittingthe

money among the three. Butif I think all are worth $15,then I should buy all three,sincemyriskisthenloweredbyspreadingitaround.”Because he researches his

companies carefully andtrusts his analysis,Miller’s abelieverinbuyingmorewhenthe price drops. He doesn’tusually buy all at once, andhe’s said that after the firstbuyhehopes the stock startsgoingdown—a lot, and right

away because he doesn’twant it to drop two yearslater.If itdropsimmediately,he can begin lowering theaverage price he pays pershare.That leads to his famous

quote, “Lowest average costwins.” He told Barron’s inFebruary 2003, “It’s rare forustopayupforanything,andit’scommonforusthatifthestockgoeslowerafterwebuyit—and it always does—we

willbuymoreofit.”

Thoughtsonthe2008Recession

After Value Trust lost 55percent in 2008, Millerchanged his portfolio fromconcentrated bets in a fewsectors,suchasfinancialsandtechnology, to a morediversified one with anemphasis on dividends and

freecashflow.He wrote in his January

2009commentary, “Wehavebeen investing in banks andother financials for over aquarterofacentury,andwereinvolved in putting newcapital into them during thelast crisis around 1990. Thatworked out very well. Wehave also been part of theprivate capital that has putmoney into financials in thiscrisis, and that has been a

disaster, for us and for everyother investor who has doneso. If we are typical, theappetite for private capital togo into banks nowapproacheszero,unless thereare substantial changes inpolicy that are capitalfriendly.”He stood steadfast at the

tiller:I remain

optimistic that

the newadministration,which isstaffed withfirst ratefinancialtalent, coupledwith the Fed,will craftpolicies thatwill beeffective instabilizing thefinancial

system andrestoring theflowofcredit.Despite the

raggedystart,Ialso think thiswillbeaprettygood year forequityinvestors. Lastyear was theworst for U.S.(and mostother) stocks

since the1930s.Pessimismandgloomabound.Short-termtrading hasreplaced long-term thinking.The consensusis foreconomicgrowth toresume in thesecond half of

theyear,butofcourse no oneknows. Butgrowth willresume, andwhen it doesequity priceswill be muchhigher, in myopinion.Valuationbasedstrategies hada strong

December andearly Januaryand weperformedvery well, asone wouldexpect whenthat ishappening.The sell-off infinancials andthe market inthe past twoweeks has

interruptedthat trend, andthe S&P 500has now hadits worst startto a new yearever. Fear hasreturned to thefore.This too

shallpass.He expected performance

toimprovefromthemarket’s

lowvaluations:During the

fourth quarterwe added 15new names tothe fund,which is nowexposed toeverysectorofthe market forthe first timeinmanyyears.Valuesabound

andwebelievewe canbroaden anddiversify theportfoliowithoutsacrificingfuture rates ofreturn. . . . Inmy opinion,the long-termopportunitiesfor the fundhave never

been betterandtheoverallquality of theportfolio hasnever beenhigher.Financials arenow under 10percent of themarket’scapitalizationfor the firsttime since1992, which

was a greattime to buyfinancials.Thisisalsothebest time tobuy quality inmy investingcareer; it hasnever beencheaper andwecontinue tolook for, andto find, nameswith excellent

financialstrength, goodand growingdividends,leadingpositions intheir industry,and trading atfive- or 10-year lows andat historicallylowvaluations.Webelieve this

should lead toquitesatisfactoryresults overthenextfiveto10years.

To see how Miller hasfared since, follow ValueTrust on any financialwebsite by entering itssymbol,LMVTX.

WhatYouShouldRetainfromMiller

Bill Miller finds bargainsby comparing a stock’scurrent price with its futureprospects. He does not lookonly at historical data to seewhether it’s cheap based onits past. This sets him apartfrom traditional valueinvestors. He is contrarian,oftengoingagainstthecrowdtobuywhat is hatedbecause

it is misunderstood orbecause others are unable tosee through their fear of lossto a great opportunity. Otherkeypoints:

✔ Look forward,notback.Don’tjustcompare a stock’scurrent valuationwith its pastvaluation. The pastdoes not determinethe future. Look

ahead at its futureprospects to see ifit’scheapcomparedtothose.✔ He says, “Thequestion is notgrowth or value,but where is thebest value?” Iftraditional growthstocks are cheap,buy them. Iftraditional valuestocks are cheap,

buythem.✔ Cheap doesn’tnecessarily meanbargain. It couldmean worthless or,in stock jargon,value trap. Inmanycases, a stock’sdropping price isjust the marketnoticing itsdeterioratedprospects. It mightbe cheap compared

to its past for areason, and that’swhy youmust lookahead. He tells hisanalysts, “100percentofthevaluedepends on thefuture.”✔ Use the presentvalue of future freecash flow todetermine whetherastockisabargain.✔ Becontrarianby

looking at the longterminashort-termworld.✔ There are threetypes ofcompetitiveadvantages:

•Analytical,whenyoutakethe

sameinformationthatothershave,butprocessitdifferentlyandreachdifferentconclusions.•

Informational,whenyouknowsomethingimportantthatothersdon’t.•Behavioral,whenyouunderstand

humanbehaviorbetterthanothersandcanusethatunderstandingtoexploitstockprice

movements.✔ Prospect theoryshows that peoplehate losing morethan they lovewinning. Thatmakesthemtooriskaverse so they“overweight recenttrends relative totheir long-termsignificance” andgive greater weight

to dramatic events“often out of allproportion to theprobability of theiroccurrence.” Usethese tendencies tofindbargains.✔ Myopic lossaversion afflictsmost investors,making them focuson the short term.However, a lot ofshort-term

information isirrelevant in thelongterm.Ifyou’vebought solidcompanies, thebestadvice is often“Don’t just dosomething, sitthere.”✔ If you must dosomething, though,buyagoodvalueasit gets evencheaper. Miller

hopes that stockshe’s started buyingdrop quickly anddramatically, so hehasachancetobuyadditional shares atlower prices.“Lowest averagecostwins,”hesays.

WheretheMasters

Agree

Nowthatyou’vereadalotof advice from six greatinvestors,let’stakeamomenttoboilitdown.YoustillhavefurtherreadingaheadbeforeIpresent this book’s strategy,but pausing here to reviewwhatyoushouldhavepickedupsofaristimewellspent.

AutomateYourStrategywithProvenCriteria

Nomatterwhatinvestmentstrategy you create over theyears, it should be clearlydefinedandmeasurable.Thishelpsyouinstantlyseparateacompany from its story, thelatestbuzz,andyourinherenthumanfrailty.Noneofusareimmune to emotion, but wecanusesuperior reasoning tocounteract our emotions and

make good decisions. Everygreat investor, from themostinsistent value types to themost aggressive growthtypes, relies on a set ofspecific criteria to findsuperior companies. Youshouldtoo.

LookforStrongIncomeStatements

andBalanceSheets

Every company is helpedbyhighprofitmargins,lotsofcash, and little or no debt.Each investor in this bookwants to see these factors.They assure value investorsthat a beaten down companyhas the wherewithal torecover, and they assuregrowth investors thata risingstarwillkeeprising.

A high profit marginmeans the company keepsmore of what it earns, plainandsimple.Iftwocompanieseachsell$10millionworthofproducts and one companyspends $8 million to do itwhile the other spends only$4million, you’d rather ownthesecondcompany.You would rather own a

company that has a lot ofcashonhandthanacompanythat has a little. A big bank

account means the companycanexpandeasily,buybetterequipment, pay offunexpected expenses, andbuy back shares of its ownstock.Avoiddebt.Thisappliesto

nearly every walk of life.Don’t invest in companieswith a lot of debt, don’t gointo debt yourself. Debt is amonster. It eats companiestrying to prosper and it eatsthefuturesofpeoplelikeyou

and me. A company can gobankrupt only if it’s in debt.Debt and death sound a lotalike, and that’s nocoincidence. You don’t evenneedafinancebooktoarriveat this conclusion, all youneedisagoodliteratureclass.Emerson wrote in May-DayandOtherPieces,“Wilt thouseal up the avenues of ill?Pay every debt, as if Godwrote the bill.” As aninvestor, you want those

avenues of ill sealed upbeforeyoubuythestock.

LookforInsiderStockOwnershipandCompanyBuybacks

Not everybody places ahigh value on this, butenoughmention it tomake itimportant.Itmakessensethat

managersandemployeeswillwork harder to make theircompany successful if theyownstockinit.Plus,nobodyknowsthefortunesandfolliesof a companybetter than thepeople who run it and workthere. If a hot product isgoing to trounce everycompetitor,company insiderswill know about it first. If anewservicehasproducedthehighest focusgroupscores inhistory, company insiders

willknowaboutitfirst.Philip Fisher liked

management teams thatwerehonestwith shareholders andwere willing to sacrificeimmediate profits for long-term gains. Like Fisher,Warren Buffett looks for amanagement team thatcommunicates honestly andmakes all decisions in thebestinterestsofshareholders.There’s a compelling reasonto do so when managers

themselves are shareholders.Peter Lynch writes, “There’sonly one reason that insidersbuy: They think the stockprice isundervaluedandwilleventuallygoup.”In addition to insider

ownership, you want thecompany buying back sharesofitsownstock.Investinginitself indicates that thecompany believes in itsfuture. The action alsodecreases the number of

shares in circulation, whichincreases the earnings pershare—as long as thecompany’s earnings remainconstant or grow. All in all,investors are left with morepotent stocks after thebuybackthantheyhadbeforethebuyback.Lynchexplains,“Ifacompanybuysbackhalfits shares and its overallearnings stay the same, theearnings per share have justdoubled. Few companies

could get that kind of resultby cutting costs or sellingmorewidgets.”

CompareStockstoaProvenProfile

In addition to the factorsabove, you should comparestocksyou’reconsideringtoaprofile of key measures that

have uncovered winners inthe past.Warren Buffett andBillMillerlookatthepresentvalueoffuturefreecashflow,Peter Lynch emphasizesvalue measures such as P/Eand price-to-book, WilliamO’Neil focuses on earningsacceleration.We’lldevelopasetofspecificcriterialaterinthis book that you’ll fill inafteryou...

ConductThoroughResearch

Every great investorbelievesinthoroughresearch.Warren Buffett says toexercise the same scrutinywhen buying shares in acompany as you’d exercisewhen buying the companyitself. When conductingresearch, don’t forget yourown circle of competence.Youworkinanindustry,you

consume products, and youtalktootherconsumers.Yourlife experience counts asresearch—use it! Your baseknowledge is a great way tofindleads.Followthoseleadsto more thorough researchconducted through yourlibrary,theInternet,companyinvestor relationsdepartments, magazines,newspapers, and otherinvestors.Yourstyleof researchwill

vary based upon yourpersonality and what you’relooking for. Philip Fisherinterviewed a company’scustomers, suppliers, formerand current employees, andcompetitors to learn vitalinformation. Peter Lynchlikes to eat burritos, kicktires, watch consumers instores, and feelhotel linen toconfirm his interest incompanies.Whatever your research

approachbecomes,makesurethat you conduct thoroughresearch to find theinformation you need. Onceyou’ve assembled theinformation, you candetermine whether to invest.Then you’ll be prepared forthenextsection...

KnowWhytoBuy

It’s important to know the

reasons that ledyou tobuyastock so you know the righttime to sell. If you have noidea why you bought, theonlyinformationyoucanrelyon to decide when to sell isthe current price, which issubject to a millionmysterious factors, and thecurrent word on the street,which is about as reliable askindergarten romance. Thinkof Warren Buffett, PeterLynch, William O’Neil, and

BillMiller.IfIaskedanyoneof themwhy they held stockX, they would be able toanswermeinasecond.Ifyouownastockbecause

of the company’s excellentearnings acceleration andhigh expectations for thefuture, know so. If it’sbecause the company hasbeenunfairlypunishedbythemarket and is selling for aridiculously low P/E ratio,know so. If it’s because you

think the marketmisunderstands a company’sfuture, know so—and knowwhat you consider to be thereal story. Then you canwatch those earnings, watchthatP/E,andwatchthatstoryforachange.Astheychange,you can reevaluate yourdecision to own the stock. Ifyou’re like Buffett, thefactorsmaynotinvolvepriceatall.Ifthat’sthecase,knowso and watch the company’s

management team, return onequity, and other non-pricefactors to make sure theydon’terode.I think the best way of

forcingyourselftoknowwhyyou buy is to recite a two-minute stock script, as PeterLynch suggests on page 64.In two minutes, you shouldbe able to run down thefactors that made the stockattractive to you. That wayyou’ll alwaysknowwhyyou

own your stocks and you’llavoid making rash decisionstoeitherselloutorbuymore.Onceyouknowthereasons

toinvestinacompany,tryto...

BuyataPriceBelowtheCompany’sPotential

At first this looks likeadvice for value investorsonly, but it’s not. Every

investor, whether value orgrowth,must buy stocks at aprice lower than they sellthem. Value investors try tobuy low, sell high. Growthinvestorstrytobuyhigh,sellhigher.Bothlookatastock’scurrent price and compare itto what they see as thecompany’s potential to drivethat price higher. Thedifference between the twotypes of investor lies in theinformation they use to

determine a company’spotential.Avalueinvestorlooksata

company’s assets, howmuchit’s sold, its profit margins,and other factors beforedeterminingwhetherthepriceis more or less than thecompany isworth.A growthinvestorlooksatearningspershare, the acceleration ordeceleration of thoseearnings, analystexpectations, and positive

surprises.WarrenBuffettandBillMiller,investorswithonefoot in value andone foot ingrowth, look at future freecashflow.William O’Neil relies on

the components of his CANSLIM system to selectwinning stocks.Oneof thosecomponents—the N—wantsthe stock to be pushing newpricehighs.However,heonlybuys if the other factors ofCAN SLIM apply too. The

company must haveacceleratingearnings,asmallsupply of stock and highdemand, a leading industryposition, and moderateinstitutional sponsorship.What are these other factorslooking at? The company’sgrowth potential. O’Neildoesn’t simply flip throughthe paper looking for stocksthat are expensive. He looksfor stocks that are expensivefor a reason, and that reason

isthattheyhavethepotentialto grow and produce evenmoreexpensiveprices.Warren Buffett, the

investor who blends growthand value better thananybody, bought GEICOafter it declined from $60 to$2. He saw it being worth alot more than $2 because ofthe company’s unrewardedpotential. He bought Coca-Cola in 1988 after it rosefivefoldovertheprevioussix

years. Many thought it wasoverpriced, but he boughtmore than $1 billion worthbecause he saw that it heldplenty of unrealized growthpotential. He was right inboth of these purchases,which appear to employcontradictory investmentstrategies.Digalittledeeper,though,andyouseethattheydon’t.Buffettisactuallyquiteconsistent. In both decisions,he projected the company’s

performance into the future,determined the company’spotential, and bought at aprice well below thatpotential. It’s incidental thatGEICO was on a path torecovery and Coca-Cola wason a roll. Both had potentialbeyondtheircurrentprice.Bill Miller also ignores

growth and value labels. Ashe puts it, “The question isnot growth or value, butwhere is the best value?”

Sometimes, stocks that looktoo expensive are justvaluation illusions becausethey’re bargains in light oftheirbright futures.HenotedthatbothMicrosoftandWal-Mart were never cheap bytraditionalmeasures,buteachproduced tremendous gains.On the other hand, Kodak’sP/Ewent from21 in1997 to12 in 2000, when Millerstarted buying it in the $50sandkeptbuyingasitdropped

to the $20s. He sees valuewhenthefutureisbetterthanthe stock price reflects. Thatcouldbe a futureofdazzlinggrowth as in the cases ofMicrosoftandWal-Mart,orafutureofreinventionasinthecaseofKodak.Whether you tend toward

value investing or growthinvesting,youmustbeabletoestimatethepotentialofyourinvestments.Ofcourse,you’llnever be able to do it

perfectly, but by conductingthorough research andunderstanding a company’sstrengths,youshouldbeableto form a decent forecast.Once you’ve assembled aportfolio of companies thatyouown...

KeeporBuyMoreofWhat’sWorking

Businessownersconstantly

evaluatethedifferentpartsoftheir operation to see what’sworkingandwhat’snot.Theyput more money into thesuccessful parts and slowlyphase out the unsuccessfulparts. Eventually, thebusiness becomes astreamlined collection ofwinning pieces. Successfulinvestors manage theirportfoliointhissamefashion.However—and this is key—different investors define

workingindifferentways.For Warren Buffett, a

company is doing everythingright if its fundamentalstrengths remain healthy. Hewatches things like thecompany’sprofitmargins, itsreturn on equity, and honestcommunication withshareholders.Buffettdoesnotlookatdailyorweeklystockprice fluctuations becausethey’re too fickle. He wrote,“Wedon’tneedadailyquote

onour100percentpositioninSee’s or H.H. Brown tovalidateourwellbeing.Why,then,shouldweneedaquoteon our 7 percent interest inCoke?”Ifheboughtaqualitycompanyanditstillboastsallof its quality attributes,Buffett considers it a successand keeps it in his portfolio.Hedoesn’tthinkofhimselfasan investor inhiscompanies,he thinks of himself as anowner. He wrote, “An

investor should ordinarilyhold a small piece of anoutstandingbusinesswiththesame tenacity that an ownerwouldexhibitifheownedallofthatbusiness.”For William O’Neil, the

onlymeasure of a successfulstock is its performance. Hewatches the prices of hisholdings, pyramids moremoney into the winners, anddumpsthelosers.O’Neilsaystheobjective in themarket is

nottoberightallthetimebuttomakebigmoneywhenyouareright.While you hope the stock

ofeverystrongcompanyyouown rises in price, it ain’talways thecase,noteven forthe pros. Every investor canrecall a list of failures thattaught them a lesson. Ilearned growing up inColoradothat“therearethosewhohavefallenfromahorse,those who will fall from a

horse, and those who don’tridehorses.”Theonlypeoplewhoneverfalloffahorsearethose who don’t ride. Theonlypeoplewhoneverownafalling stock are those whodon’t invest. The good newsis that if you’ve chosenqualitycompaniesyoucan. ..

TakeAdvantageofPriceDips

Well now, doesn’t thisseemlikeanoddbitofadvicefollowing the previoussection? I just finishedshowingthattheexpertskeeporbuymoreoftheirwinners,now it looks like I’m tellingyoutobuymoreofthelosers,too. Bear with me a secondandyou’ll see that these twopieces of seeminglyincompatible wisdom canactuallycoexist,likedarknessand light, or Democrats and

Republicans.Everything depends on

your buying qualitycompanies in the first placeand knowing why youbought,asyoureadin“KnowWhy to Buy” on page 64. Ifyou bought a companybecause of its outstandingnew products, high profitmargins, and acceleratinggrowthrateand thecompanystill boasts those attributes,there’s no reason to sell. In

fact, there’s every reason tobuy more—regardless ofprice.Ifthestockismarchingsteadily upward and thecompany is still a greatcompany, the previoussection advises you to takeadvantageofthatbyinvestingmore money. What thissectionpointsoutisthatifthecompany is still great but itsstockisdropping,thatcanbejust as good a reason to buymore. You’re getting a

discount on additional sharesof a great company.Remember, though, that thereasonsyouboughtmuststillapply.Don’tputmoremoneyinto a falling stock that alsohas falling profit margins,falling sales, employees onstrike, and a managementteamthatsoldallof itsstockand quit the company for anextended vacation in Negril.Invest only in qualitycompanies, whether buying

your first shares in them oradding more shares toexistingpositions.Benjamin Graham was a

stickler on this point. Heemphasized that nobody everknows what the market willdobut thatyoucanprofitbyreacting intelligently to whatit does do. Good companiesdropinpriceeveryday,oftenfor no apparent reason. Alawsuit perhaps, maybe amanufacturing glitch, or

maybe just because themarket’saweirdplacewhereyou’dneverwanttohangoutif there weren’t so darnedmany ways to make moneythere.Warren Buffett points out

that time helps wonderfulbusinesses but destroysmediocre ones. Even if thestock price is a bit downtoday—or this week, or thismonth, or this year—if thecompany is still the great

company you bought, thenthis momentary price dip isanopportunitytoinvestmoremoney at a bargain price.Robert Hagstrom, Jr., wrotein The Warren Buffett Waythat you’ve approachedBuffett’s levelof investing ifyou look at the market andwonder only if somethingfoolish happened to allowyoutobuyagoodbusinessata great price. That couldeasilybeadditional sharesof

a good business you alreadyown.Bill Miller claims that he

wants his stocks to drop inprice so he can buy moreshares to reduce his averagecost. “Lowest average costwins,”heexplains.Ifyouareconfident in your research,buymorewhenthepricegetscheaper.This section and the one

before it underscore whatshouldbeclearbynow:You

mustunderstandthestrengthsof your companies and thereasonsyoubought shares inthe firstplace.Only thencanyou decide if rising pricesmean you’ve got a winnerandshouldinvestmoreontheway up, or falling pricesmean you’ve still got awinner and should investmoreatadiscount.I know it’s a fine line.

Nobodysaidthiswaseasy.

WhatYouShouldRetainfromThisSection

When excellent investorswith different styles ofinvestingagreeonafewbasictruths, it’s worth payingattention. This sectionoutlined powerful advicetaken from the six masterinvestors profiled.Specifically:

✔ Automate your

strategy withproven criteria.Don’t select stockswithyouremotions,current hype, orstories from yourfriends. Usemeasurableinformation tocomparestockstoaprofile of keymeasures that haveuncovered winnersinthepast.

•Lookforstrongincomestatementsandbalancesheets.•Lookforinsiderstock

ownershipandcompanybuybacks.•Comparestockstoaprovenprofile.

✔ Conductthorough research.

Warren Buffettsums it up bestwhen he says toexercise the samescrutiny whenbuying shares in acompany as you’dexercise whenbuying thecompanyitself.✔ Know why tobuy. Afterconducting yourthorough research

on a company,outlineexactlywhyyou want to investin it. Later you’llmonitor thecompany to see ifthe factors that ledyou to buydeteriorate.✔ Buy at a pricebelow thecompany’spotential. Thisapplies to both

value and growthinvestors becauseboth look at astock’s currentprice and compareit to what they seeas the company’spotential to drivethat price higher.The differencebetween the twotypes of investorslies in theinformation they

use to determine acompany’spotential. WarrenBuffett and BillMiller look atfuture free cashflow. WilliamO’Neil looks atearningsacceleration. Usingyour own thoroughresearch, youshould estimate acompany’s

potentialandbuyatapricebelowit.✔ Keep or buymore of what’sworking. Like abusiness ownerlooking at thedifferent parts ofyour business, youshould constantlyevaluate thedifferent stocks inyour investmentportfolio to see

what’sworkingandwhat’s not. Putmore money intothe successfulstocks and phaseout theunsuccessfulstocks.✔ Take advantageof price dips. If allthe reasons youbought a stock arestill present but theprice is dropping,

that can be a goodtime to buy more.You’re getting adiscount onadditional shares ofa great company.AsBillMillersays,“Lowest averagecost wins.” Makeabsolutely sure,however, that it isstill a greatcompany. Don’tbuymore shares of

a stock that’sfalling due tocompanyfailings.

3

HowHistoryTellsUstoInvest

In 1946, Benjamin Grahamobserved, “It is amazing toreflect how little systematic

knowledgeWallStreethastodraw upon as regards thehistorical behavior ofsecurities with definedcharacteristics. . . .Where isthe continuous, ever-growingbody of knowledge andtechnique handed down bythe analysts of the past tothose of the present andfuture?” More than 60 yearslater, you can finally benefitfromthatperspectiveGrahamdesired.

Among the countlessstudies of stock market datacompleted since Graham’sobservation,oneeffortstandsalone and is documentedbetweenthecoversofasinglebook: What Works on WallStreet by JamesO’Shaughnessy, now in itsthird edition. His studyexplored 52 years of resultsfrom1952 to2003containedin Standard & Poor’sCompustat database. In the

preface to the third edition,O’Shaughnessy writes thatCompustat is “the largest,mostcomprehensivedatabaseof U.S. stock marketinformationavailable.”O’Shaughnessy gathered

popular stock measures likethe P/E ratio, price-to-bookratio, and relative pricestrengthtoseehowtheyfaredover the years when used tofind both large and smallcompanies. Then he

combined the successfulmeasures in ways that aren’toftenused.What he found—and what I’m delighted toshare—is going to give youan advantage that has beenavailable only since 1996.You,asanewcomer formingyourownstockstrategy,havemore than five decades ofresearch to help you developthecorrecthabits.Let’s have a look inside

WhatWorksonWallStreet.

TestingPopularMeasurements

Rather than take youlaboriously through eachmeasurement thatO’Shaughnessy tested, I’mgoing to cut straight to theconclusions. Before I getstarted, though, you need tounderstand the ground rulesofthesestudies.Bearwithme

if this gets complicated. Theattention to detail shouldmake you a believer in theresults.O’Shaughnessy separated

the universe of stocks intotwogroupsbycompanysize.Thefirstgrouphecalled“AllStocks.” It consisted of allcompanies with an inflation-adjustedmarketcapitalizationof at least $185 million.Inflation-adjusted means thatfor any given year the

companies were worth $185million of 2003’s dollars.After all, a $185 millioncompany in 1955 wascolossal. But by 2003’sstandardsitwassmall.SotheAll Stocks group containedjustthat:allstocksofinteresttothisstudy.Hedefinedasecondgroup

of larger, better-knowncompanies with market capsgreater than the Compustataverage. This second group

usually consisted of the top15percentofthedatabasebymarketcapinanygivenyear.These companies went intothe “Large Stocks” group aswellastheAllStocksgroup.As you can see, the All

Stocks group included bothsmaller companies and thosecompaniesfoundintheLargeStocks group. The LargeStocks group contained onlythelargestocks.In each of his tests,

O’Shaughnessy began with$10,000 hypotheticallyinvestedin50stocksfromtheAll Stocks group and 50stocksfromtheLargeStocksgroup. He chose the 50 byapplying the measurementbeing tested and thenrebalanced every year in thestudy to capture the current50 best meeting themeasurement.For instance, when testing

P/E ratios O’Shaughnessy

selected the 50 stocks withthe lowest P/E ratios fromeach group. He thenrebalanced the hypotheticalportfolioseachyear to investinthenew50stockswiththelowest P/E ratios. He usedthissamemethodtotesteachmeasure.O’Shaughnessy’s study

covered December 31, 1951to December 31, 2003.During that time period, theAllStocksgroupaveraged13

percent per year and theLargeStocks group averaged11.71 percent, which isalmostexactlytheS&P500’saverage of 11.52 percent.O’Shaughnessy used thesegroup returns as benchmarkstotesteachmeasure.

TheBestValueMeasures

First, O’Shaughnessyexamined measures of value

to see how they fared in themarket. The most reliablemeasure turned out to beprice-to-sales for companiesofallsizesanddividendyieldforlargecompanies.

Price/Sales

The 50 lowest P/S stocksfrom the All Stocks groupreturned15.95percentayear,

better than thegroup’s returnof 13 percent.The 50 lowestP/S stocks from the LargeStocks group returned 14.30percent, better than thegroup’s return of 11.71percent.The 50 highest P/S stocks

from the All Stocks groupreturned 1.25 percent a year,muchworse than thegroup’sreturn of 13 percent. The 50highest P/S stocks from theLarge Stocks group returned

7.01 percent a year, againmuchworse than thegroup’sreturnof11.71percent.P/Sworkswithboth small

companies and largecompanies.Inrolling10-yearperiods, the 50 lowest P/Sstocks beat their group 88percent of the time with AllStocks and 95 percent of thetime with Large Stocks. Thehighest P/S stocks from theAll Stocks groupunderperformed Treasury

bills.Nowthat’slousy!It’s interesting to note that

O’Shaughnessy found P/Smore reliable than P/E, themost popular stockmeasurementaround.CONCLUSION: Look forstockswithlowP/Sratios.

DividendYield

The 50 highest dividendyielding stocks (excludingutilities) from the All Stocksgroup returned 13.35 percenta year, a tad better than thegroup’s return of 13 percent.The 50 highest dividendyielding stocks (excludingutilities) from the LargeStocks group returned 13.64percent, better than thegroup’s return of 11.71percent.WithAll Stocks, the high-

dividend strategy entailedmore risk than the overallgroup, and it beat the groupjust 28 percent of the timeover rolling 10-year periods.That’s crummy. With LargeStocks, however, the high-dividendstrategyentailedlessrisk than the group, and itbeat the group 86 percent ofthe time over rolling 10-yearperiods.That’simpressive.O’Shaughnessy writes that

“the effectiveness of high

dividend yields dependsalmostentirelyon thesizeofthe companies you buy.”Dividend yield is such aneasy way to screen largecompanies that on page 119you’lllearnanautomaticwayto harness its predictivepower.The reason dividend yield

works for large companiesandnotforsmallonesis thatsmallcompanies rarelypayadividend. Obviously not

every small company with ayieldof0isabadbuy.CONCLUSION: Don’t usedividend yields with smallstocks. Look for highdividend yields among largestocks.

TheBestGrowthMeasure—RelativePriceStrength

Next, O’Shaughnessy

examined measures ofgrowth. “Generally, growthinvestors like high whilevalue investors like low,” henotes. “Growth investorswant high earnings and salesgrowth with prospects formoreofthesame....Growthinvestors often award highprices to stocks with rapidlyincreasing earnings.”O’Shaughnessy’scharacterization of value andgrowthinvestorsisconsistent

with the styles of ourmasterinvestors profiled in thepreviouschapter.Icouldrunyouthroughthe

studies O’Shaughnessyconducted on a variety ofgrowth measures includingearnings-per-share change,profit margin, and return onequity.Butguesswhat?Onlyrelativeprice strengthprovedto be a useful measure, solet’sfocusonjustthatone.Remember from page 34

that relative price strengthlooks at a stock’s pricehistory.Diditriseorfall lastyear? Momentum growthinvestors think you shouldbuy stocks that have risen,many value investors thinkyou should buy stocks thathavefallen.The50stockswiththebest

one-year price appreciationfrom the All Stocks groupreturned12.61percentayear,alittleworsethanthegroup’s

return of 13 percent. The 50stockswith thebestone-yearprice appreciation from theLarge Stocks group returned14.73 percent, much betterthan the group’s return of11.71percent.The 50 stocks with the

worst one-year priceappreciation from the AllStocks group returned 4.06percent a year, much worsethan thegroup’s returnof13percent. The 50 stocks with

the worst one-year priceappreciation from the LargeStocks group returned 9.11percentayear,worsethanthegroup’s return of 11.71percent.How about that? In the

shortterm,Newton’sfirstlawof motion seems to apply tolarge stocks as well asphysical objects: Prices inmotiontendtostayinmotion.The winners keep winningandtheloserskeeplosing.

Note, however, that overfive-yearperiodstheoppositewastrue.Starting on December 31,

1955 this timeandextendingto the usual December 31,2003, the 50 stocks with theworst five-year priceappreciation from the AllStocks group returned 16.77percentayear,farbetterthanthe group’s return of 12.55percent. The 50 stocks withthe worst five-year price

appreciation from the LargeStocks group returned 14.16percent,muchbetter than thegroup’s return of 11.18percent.CONCLUSION: Amonglarge companies, look forstockswithhighrelativepricestrengths. Among all stocks,avoid at all costs last year’sbiggestlosers.That’sforone-year time periods. Over the

previousfiveyearsamongallstocks, look for laggardsbecause they’re probablyabouttorecover.

CombiningtheMeasurements

People rarely makedecisionswithasinglefactor.A woman in search of an

eveninggownprobablyhasacertaincolorinmind.Perhapsall black dresses are prettiertoherthanallreddresses,butwithin the black dressuniverse thereare stillplentyofchoices.Shenarrowsdownthe field by specifying acertaincut,acertainfabric,acertainoverallpanache.Soonshe’s presented with ahandful of choices fromwhich to make her finalselection.

Soit iswithstocks.Singlemeasurementsarea start,butthat’s all. Combiningmeasurements yields farbetter results by eitherreducing risk, increasingperformance, or both.O’Shaughnessyexperimentedwith several differentcombinations to come upwith an ideal value strategyand an ideal growth strategy.I’mgoingtoskiptheresearchprocessand jumpto thefinal

winningcombinations.

IdealValueStrategy

O’Shaughnessy found thatvalue measures, particularlydividend yield, work bestagainst market-leading largestocks. Remember from theresearch on page 99 that ahigh dividend yield does notfind good small companystocks but does find good

large company stocks. Bylimiting his target group tomarket-leading largecompanies, O’Shaughnessyobtained even better resultswith a screen that includeddividendyield.For O’Shaughnessy’s

purposes, market-leadingstocks came from the LargeStocks group, had a marketcapitalization greater thanaverage, had more commonshares outstanding than

average, had cash flows pershare greater than average,and had sales that were atleast 50 percent greater thanaverage. That was only 6percentofthedatabase.Theseare your household nameslike Bank of America, Ford,IBM, Microsoft, andStarbucks.After establishing the

market leaders,O’Shaughnessy screenedthem with a measure called

shareholder yield. Itcombines the value ofdividendswiththebenefitsofa company buying backshares of its own stock. AsyoulearnedfromPeterLynchinChapter 2, company sharebuybacks leave fewer sharesin circulation, so each sharehas a higher earnings-per-share than before thebuyback.Both dividends andbuybacksbenefitinvestors,soit’s useful to combine them

into one measure. Here’sO’Shaughnessy’sexplanation:

. . . to createshareholderyield, you addthe currentdividend yieldof the stock toany netbuybackactivity thecompany has

engaged inover the prioryear. If, forexample, acompanytrading at $40a share ispaying anannualdividendof$1,the companywould have adividend yieldof 2.5 percent.

If that samecompanyengaged in nostockbuybacks overthe year, itsshareholderyield wouldequal 2.5percent, thesame as thedividendyield.If, however,the company

had 1,000,000sharesoutstanding atthe beginningoftheyearand900,000 at theend of theyear, thecompany’sbuyback yieldwould be 10percent.Adding this tothe dividend

yield of 2.5percent, youwould get atotalshareholderyield of 12.5percent. Thisformulaallowsus to captureall of acompany’s“payments” toshareholders,and it is

indifferent asto whetherthosepaymentscome in theform of cashdividends orbuybackactivity. Thisis importantbecause, likeallotherthingsin life, trendscome in and

outoffavoronWall Street.There aretimes whenbuybacks areall the rage,and timeswhen cashdividends arein favor.Shareholderyield capturesthemboth.

Starting on December 31,1952andendingontheusualDecember 31, 2003, the 50stocks with the highestshareholder yield from themarketleadersgroupreturned16.49 percent a year, muchbetterthanthemarketleadersgroup itself, which returned13.49 percent. Ten thousanddollars invested in the 50stocks grew to $24,071,481compared toonly$6,345,763in the market leaders group.

The50stocksbeatthemarketleadersgroupin67percentofrolling one-year periods, 85percent of rolling five-yearperiods, and 90 percent ofrollingten-yearperiods.While shareholder yield is

notameasurementcommonlyfound in publications or onwebsites, its twocomponentsof dividend yield and sharebuybacks are. Following thespirit of O’Shaughnessy’sidealvaluestrategyiseasyto

do. One way is to look forhigh dividend yields amongthe biggest, best companieson the market, and then seewhichofthoseareengagedinstockbuybackplans.You may be wondering

how to locate the biggest,bestcompaniesonthemarketyourself. After all, you don’thaveaccesstotheCompustatdatabase from your livingroom. You’ll be thrilled toknow that a tinygroupof30

successful largecompanies islisted everywhere you look.The returns of this group areaveraged every day andposted for the world to see.Can you guess what I’mreferringto?ThestocksoftheDow Jones IndustrialAverage.Onpage119you’regoingtolearnhowtousetheDow with high-yieldstrategies.

IdealGrowthStrategy

While value measureswork best against the LargeStocks group, growthmeasures work best againstthe All Stocks group. Afterexperimenting with severaldifferent combinations ofgrowth factors, a few valuefactors, and differentcompany characteristics,O’Shaughnessy developed agrowth model that

outperformsthemarket.His winning combination

selected the 50 stocks fromtheAllStocksgroupthathad:

• A market capgreater than aninflation-adjusted$200million• A price-to-salesratiobelow1.5• Earnings higherthaninthepreviousyear

• A three-monthprice appreciationgreater thanaverage•Asix-monthpriceappreciationgreaterthanaverage• The highest one-year priceappreciation

From December 31, 1963to the usual December 31,2003, the 50 stocks returned

20.75 percent a year,dramatically better than theAll Stocks return of 12.02percent.Tenthousanddollarsinvested in the 50 winninggrowth stocks grew to$18,860,926 compared toonly $936,071 in the AllStocks group. This strategyreturned more than othergrowth strategies and did sowithlessrisk.ItoutpacedtheAll Stocks group in 78percent of rolling one-year

periods,98percentof rollingfive-year periods, and 100percent of rolling ten-yearperiods.Reflecting on this

successful approach,O’Shaughnessywrote:

It’s worthnoting thatourbest growthstrategyincludes a lowprice-to-sales

requirement,traditionally avalue factor.The best timeto buy growthstocks iswhentheyarecheap,not when theinvestmentherd isclamoring tobuy. Thisstrategy willnever buy a

Netscape,Cybercash, orPolaroid at165 timesearnings.That’s why itworks sowell.Itforcesyoutobuystocksjustwhen themarketrealizesthe companieshave beenoverlooked.

That’s thebeauty ofusing relativestrength asyour finalfactor. It getsyoutobuyjustas the marketis embracingthe stocks,while theprice-to-salesconstraintassures that

they are stillreasonablypriced. Indeed,theevidenceinthis bookshows that allthe mostsuccessfulstrategiesincludeatleastone valuefactor, thuskeepinginvestors from

paying toomuch for astock.

O’Shaughnessy’s growthfindingconfirmsanimportantconclusion we arrived at bystudying the six masterinvestors: Always buy at aprice below the company’spotential.At first this soundssilly. It doesn’t take muchthoughttodecidethatbuyingstocks whose prices will rise

is a good idea. But forcingyourself toevaluatewhyyouthinkastock’spricewill riseis another story altogether.O’Shaughnessy’s criteria area good way to take theemotion out of the decision.Ifastock’searningsgainsareincreasing, its price is stillcheap compared to its sales,anditspriceisrising,historysuggests that you have goodreason to believe you’rebuying below the company’s

potential.

CombiningtheStrategies

O’Shaughnessy’s idealvalue and ideal growthstrategies are greatcomplements to each other.The first provides goodreturns with little risk whilethe second providesoutstandingreturnswithmorerisk.Combining the two in a

50-50mix provides excellentreturns with moderate risk.O’Shaughnessy recommendsa greater allocation to thegrowth strategy in youryounger years and moretoward the value strategy asyou near retirement. But fortesting,he settledonaneven50-50mix.Over the 40 years from

December 31, 1963 toDecember 31, 2003,O’Shaughnessy split a

portfolio of $10,000 evenlybetweenhisvalueandgrowthstrategies. He rebalanced themixture every year tomaintain the even split, with50 stocks chosen using theideal value strategy and 50chosenusingtheidealgrowthstrategy, for a 100-stockportfolio. For a comparisonbenchmark, he used a 50-50mix of the All Stocks andMarketLeadersgroups.The 100-stock portfolio

returned19.21percentayear,much better than thebenchmark’s return of 12.46percent.Tenthousanddollarsinvestedintheportfoliogrewto $11,275,830 compared toonly $1,097,513 in thebenchmark. The portfoliooutpacedthebenchmarkin91percent of rolling one-yearperiods and an impressive100 percent of rolling five-yearandten-yearperiods.Ofthispotentcombination,

O’Shaughnessy explainedthat the 100-stock strategydoes well because when onestrategy iscoasting, theotherisoftensoaring.Puttingthemtogether evens out the peaksand valleys into a steadyupward trend. He noted thatin 1967, a year of runawayspeculation, the valuestrategy alone gained 26.3percent, better than theMarket Leaders’ return of24.7 percent, but nowhere

near the 39.2 percent gainedby All Stocks. The growthstrategy, however, gained78.5 percent. Uniting thevalue and growth strategiesproduced a gain of 52.4percent that year, better thanevery benchmark. That’sgreat performance for aportfolio half in large,conservative companies thatpay dividends. When thegrowth strategy getsclobbered as it did in the

1973-1975bearmarket,thosebig, conservative companiestake away some of the heatandkeepreturnssteady.About the dot.com bubble

burst,O’Shaughnessywrote:. . . thecombinedstrategiesallowedyoutoparticipate inthe marketduring the

bubble years,but, far moreimportant,protected youduringthebearmarket yearsof 2000through 2002.Had youinvested$10,000 in thecombined100-stock portfolioon December

31, 1996, yourportfoliowould havegrown to$21,007bytheend of March2000, acompoundaverageannualreturnof25.66percent. Overthose samebubble years,$10,000

invested in theS&P 500would havegained 26.07percent peryear, turningthe $10,000into $21,233.Thus, for eventhe mostextreme yearsof the bubble,you wouldhavekeptpace

with thesizzling S&P500.Far more

important ishow much ofyourinvestmentyou wouldhave held inthe ensuingbearmarket.Ifyou had themisfortune of

putting$10,000 in theS&P 500 onMarch 31,2000—the endof the bubble—yourinvestmentwould havedeclined to$6,696 at theendof2002, acompoundaverageannual

returnof -13.2percent peryear. Yet, thesameinvestment inthe 100-stockcombinedstrategyactually grew4.23 percentover that time,turning$10,000 into$11,246. Over

the entireperiodbetweenDecember 31,1996 andDecember 31,2002, aninvestment inthe S&P 500would haveturned$10,000into$12,950,again of 4.40percent per

year, whereasan investmentin the 100-stockcombinedportfoliowould havemore thandoubled to$21,906, again of 13.96percent peryear. Even inone of the

most volatilemarkets of thelast 40 years,the strategycontinued toprovide good,steadyreturns.

Here’s a breakdown ofbenchmarks and strategiesover the 40 years fromDecember 31, 1963 toDecember 31, 2003, rankedbyreturn:

Standard deviationmeasures the amount aninvestmenthasdeviatedfromits normal, or standard,

return. A low numberindicatessteadyreturnswhilea high number indicateswidelyvaryingreturns.Thus,a high standard deviationmeans high risk. Looking atthe table above, notice thatthe value strategy returnedalmost six times as much astheAllStocksgroupwithlessrisk. The growth strategyreturned over 20 times asmuchastheAllStocksgroupby taking more risk. The

combined strategy returned12 times as much as the AllStocks group with justslightly more risk.O’Shaughnessy’s work paidoff.Tosomebodylookingfora

way to win in the stockmarket,thistableshouldhavebrought the crescendo fromBeethoven’s Ode to Joyflooding to your ears. If youneedtopauseyourreadingtodab thecornersofyoureyes,

Iunderstand.Thesemomentsinlifearerare.

WhatYouShouldRetainfrom

History’sLessons

Benjamin Graham wishedforahistoricalperspectiveonthestockmarket.Nowwe’ve

got it, thanks to the work ofJames O’Shaughnessy andthe meticulous datamaintained by Standard &Poor’s.NeartheendofWhatWorks on Wall Street,O’Shaughnessy wrote that“the data prove the stockmarket takes purposefulstrides. Far from chaotic,random movement, themarket consistently rewardsspecific strategies whilepunishing others.” Here are

the prevailing lessons ofthosepurposefulstrides:

✔ The best all-purpose valuemeasureisprice-to-sales.✔ Dividend yieldis a great valuemeasure againstlarge, market-leadingcompanies.✔ Thebestgrowthmeasure is relative

strength.Specifically:

•Amonglargecompanies,lookforstockswithhighrelativeprice

strengths.•Amongallstocks,avoidatallcostslastyear’sbiggestlosers.•

Overthepreviousfiveyearsamongallstocks,lookforlaggardsbecausethey’reprobably

abouttorecover.

✔ Avoid payingtoo much for anycompany. Evengrowth strategiesneed to includesome measure ofvalue. Price-to-salesisthebestall-purpose valuemeasure.

✔ The simplestandoneof thebestvalue strategies isto buy large,market-leadingcompanies withhigh dividendyields. You’ll learna way to automatethis strategy in thenextchapter.✔ Shareholderyield combines thevalue of dividends

with thebenefitsofcompany sharebuybacks. Large,market-leadingcompanies withhigh shareholderyields outperformtheir low-yieldpeers.✔ Thebestgrowthstrategy is to buycompanies thathave:

•Amarketcapgreaterthananinflation-adjusted$200million.•Aprice-

to-salesratiobelow1.5.•Earningshigherthaninthepreviousyear.•

Athree-monthpriceappreciationgreaterthanaverage.•Asix-monthpriceappreciation

greaterthanaverage.•Thehighestone-yearpriceappreciation.

✔ Combining avalue and a growthstrategy is an

excellent way toboost your returnswhile keeping risktolerable.

4

PermanentPortfolios

Ourgoalistobeatthemarketover time.Thischapter looksat various approaches todoing so and will form thecoreofyourportfolio.

Valueaveragingprovidesaframeworktolockinconstantgrowth from themarket, andwe’ll use it against an indexof smallcompanies togain3percentperquarter.That’s20percent more than the S&P500’slong-termaverage.Once you have that going,

it’s time tomoveon tootherpermanent techniques toboost performance evenmore. The Dow dividendstrategies are methods of

beatingtheDowbyinvestingin its most undervaluedcompanies, so we’ll startthere. Then we’ll examinehow leveraging the entireDow to double its dailyperformance outperforms theDow dividend strategies inmost markets. Next we’llapply that same approach tothe S&P MidCap 400 indexof medium-sized companiesfor even better results.Finally, we’ll look at the

downsideofleverageandusecharts to limit losses andincreasereturns.

ValueAveragingforSteadyGrowth

Themarketfluctuates.Canwe accept that and devise awaytoputthefluctuationstowork in our favor, instead of

fearingthem?Yes.ThebestwayI’vefoundis

called value averaging, orVA. It was introduced in a1988 article by MichaelEdleson, who later expandedtheconceptinhisbookValueAveraging: The Safe andEasy Strategy for HigherInvestmentReturns.The most popular way to

invest periodically is calleddollar-cost averaging, or

DCA. It’s simply investingthe same dollar amount on aregularbasis,suchas$50perweek or $100 per month or$500 per quarter. It forcesyour money to buy moreshares when they’re cheapand fewer shares whenthey’reexpensive.Your$100spent in January when thepriceis$20buysfiveshares.Your $100 spent in Marchwhen the price is $10 buystenshares.Overtime,buying

more cheap shares thanexpensive shares lowersyouraverage cost to less than theaverage price of theinvestment during the timeperiod.Simplicity makes DCA

appealing, because it can beautomated. Tell your brokerto transfer $100 per monthuntil otherwise instructed,andyou’redone.However, value averaging

is better. It’s a little more

complicated but well withinyour grasp and worth theeffort.VA poses this question: If

buying more shares whenthey’re cheap is a good idea,then isn’t it an even betteridea to send extra moneywhen the price is cheap andless when it’s expensive? Ofcourse, and that’s what VAdoes, even to the point ofselling shareswhen the pricerisesbeyond theperformance

levelyouwant.In the DCA example

above, you spent $100 permonth no matter theinvestment’s price. Youbought five shares at $20 inJanuaryandtensharesat$10in March. It would besmarter, however, to spendless than $100 to buy onlytwo shares in January andmore than $100 to buy 15sharesinMarch,wouldn’t it?Then you’d have even fewer

of the expensive shares andevenmoreofthecheapones.The way you achieve that

with VA is by specifying arule for howmuch youwantyour investment togrow inatime period. Monthly iscommon, but I preferquarterly because it requiresless work and gives themarkettimetomovearound.My rule is for my

permanent portfolio to growat3percentperquarter.That

becomes an annual growthrateof12.6percent,whichis20 percent higher than theS&P 500’s long-term rate of10.5 percent. That level ofoutperformance—thanks tothemagicof compounding—turnsasubstantialprofitovertime.Unlike DCA, which just

sendsmoremoney nomatterwhat’s happening, VAsometimes sells shares whenthe investment’sperformance

exceeds the growth rule. Ifthefirstquartersees5percentgrowth, you would sell therequired number of shares togetyouraccountdowntothevalue needed to be 3 percenthigher than at the end of theprevious quarter. If, on theother hand, the quarter goesbadly and your account doesnotgrow3percent, thenyouwould buy the requirednumber of shares to bringyour account up to the value

neededtobe3percenthigherthan at the end of thepreviousquarter.In choosing what

investment to use with VA,we look for one that bringsenough potency to meet andsometimes exceed the 3percent quarterly growthtarget. A bank account, forexample,wouldn’twork. It’sessentiallyflat,sotheentire3percent quarterly growthwould come from new

money. That’s not investing,it’ssaving.So, the plan needs

firepower. The idealinvestment tousewithVAisone that’s reasonablyvolatileandascheapaspossible.Oneidea is the Vanguard TotalStock Market exchange-traded fund (ETF), symbolVTI. It has the lowestexpenseratioofanyETF,just0.07 percent. However, ittracksthe1,300stocksonthe

MSCI US Broad Marketindex and therefore providesreturnssimilartothoseoftheDowandS&P500.A better bet, and the one

we’lluse, is theiSharesS&PSmallCap 600 ETF, symbolIJR, which charges a higher0.20percentbutmakesupforit with more kick. Also, itsexpense ratio may be higherthan VTI’s but is still wellbelow the median ETFexpenseratioof0.50percent.

As you saw back on page13, small- andmedium-sizedcompanies outperform largecompanies over time. Youcan see that in the historicalrecord of these two ETFs.From mid-April 2002 to theend of September 2002,VTIfell28percentandIJRfell30percent—about the same.From there to early July2007,however,VTIrose103percent while IJR rose 144percent.That’stypical,andis

the reason that we’re usingIJR. We’ll tap medium-company strength in adifferentstrategylater.Let’s run IJR through a

real-world value averagingexample from December 29,2006, toDecember31,2008,anasty time frame thatwe’llusethroughoutthischaptertocompare strategies. Say youdecided to start your planwith an initial investment of$10,000. On the next page,

IJR’sclosingpricesattheendof each quarter, adjusted fordividends and splits as ofearly 2009, and the actionyouneeded to take tosustaina 3 percent quarterly growthrate.See how the plan forces

youtoaddmoneyasthepricedrops and to take profits astheprice rises?Themore theprice falls, the more moneyyouspendtobuya lotof thecheap shares. The more the

price rises, the more sharesyousell to takeprofitoff thetable.

Lookatthethirdrow,June2007. In the previous threemonths,your$10,313grewtoa current value of $10,837.That’smorethanthe$10,622you needed to achieve 3percentgrowthinthequarter.Dividing$10,622bythethen-current IJR price of $70.37showed that you needed just151sharestobeatavalueof$10,622.Becauseyouowned154 shares, you could sell 3and still be on track at 3

percent.Bytheway, thenewvalue

figures don’t show precisely3 percent growth becausewe’re rounding shares towhole numbers. Roundinggets us close enough and isprobably what you’ll do inreal life anyway. Fractionalshareamountsareahassle.Later, in the fourthquarter

of 2008 when the marketperformeditscliff-divingact,the plan fell far behind the

goal of 3 percent quarterlygrowth and needed muchmoremoneytostayontrack.The December contributionbought81shares, thankstoadirt-cheap price. A full IJRrecovery back to its June2007 price would see the$3,562 invested inDecember2008become$5,701.Of course, you may not

havehadaspare$3,562lyingaround the house. The timeperiod we used here was a

particularly bad one in themarket and doesn’t happenoften.It’spossibleinabysmalquarters like the one endingDecember 2008 that youwouldlackthecashneededtokeeptheplangoingprecisely.You could have run thenumbers, though, seen that itwasatimetoaddasmuchasyoucouldafford,andkepttheplangoinginspirit.Over long time periods,

you’lltapproceedsfromprior

quarterly sales to fund mostof your later quarterlypurchases. That didn’t workat the end of this two-yearspan but does for most of alonger time frame. Bearmarkets like the one in 2008are rare enough that you’llhave time between them tosave cash from your job orbusiness, and you could usethat capital to jump onextremely cheap priceswhentheplansaystodoso.

In Appendix 3, I presenttheabovetablestartingattheendof2002andcontinuingtotheendof2008.Itshowsthatafter an initial investment of$10,021 in December 2002and an addition of $881 inMarch2003, theplan fundeditself until June 2008. Thebuy that June required newmoney, as did the buys inSeptember and December.All told, the plan needed$6,710 more than its cash

balance to keep on trackthroughthelastthreequartersof2008.You probably would have

beenabletofundit.WhydoIthink so? Because you hadmore than five years to savethe money needed. Just anaverage $112 per monthwould have worked. Peopleinterested enough in financesto buy this book set asidecapital from their incomeover time. You’re one of

thosepeople,andthat’swhyIthinkyouwouldhavehadthecash.IJRwithvalueaveragingto

guarantee 3 percent quarterlygrowth is a great coreportfolio strategy. Itautomates the process ofbuying low and selling high.That gives your emotions arest as the market fluctuatesandheadlinessensationalize.Once you have your core

portfolioinplace,it’stimeto

trypotentiallymoreprofitablestrategies, which we’llexplorenext.

AShort,SweetLookattheDow

The Dow Jones IndustrialAverage, or DJIA, wascreatedbyCharlesH.Dowin1884. He chose 11 very

active stocks, 9 of whichwere railroads.At the end ofeach trading day, he simplyadded up their closing pricesanddividedby11 toget thatday’smeasureof themarket.In 1896, The Wall StreetJournal published the firstrealindustrialaverage,whichmeasured a whopping 12companies. One of them,General Electric, remains onthe Dow today. In 1916, theDow increased to 20 stocks

and in 1928 it grew to 30stocks.The Dow is a benchmark

for the entire stock market.It’s an imperfect one, butpopular because of itssimplicity.Otherindexeslikethe S&P 500, NASDAQComposite, and Wilshire5000 capture larger crosssections of the market andprovidebetterbenchmarksforcomparing the performanceofmutualfunds,hedgefunds,

andotherstockpools.ButtheDow persists. It’s listed inevery paper, reported bytalking heads on the newsevery evening, and whizzespastlightscreensinbrokerageoffices every few minutes.When the Dow broke 3,000forthefirsttime,then4,then5, then6, then12, thewholeworld knew about it. FewcouldtellyouwheretheS&P500stoodonthosedays.And, impressively, the

Dow keeps pace with theS&P 500. They’ve bothreturned an average annual10.5percentover thepast75yearsorso.MorerecentlytheDow has performed better.Over the 10 years endedDecember31,2007,theS&P500 returned 51 percent, buttheDowreturned68percent.Want to see the difference ayear can make? Over the 10years ended December 31,2008, the S&P 500 returned

-27 percent, but the Dowreturned-4percent.The2008recession was a doozy. TheDow’s outperformanceduring both good and badtimes provides rousingtestimony to the dominanceof the 30 Dow companies.Each is powerful enough inits industry to stand for itscompetitors not listed on theDow.ThinkoftheDowasamini

senate representing the

variouspartsofoureconomy.The senators vote daily onhow the market is doing.There are senators from thecomputer industry (CiscoSystems, Hewlett-Packard,IBM, Intel, Microsoft), thefood industry (Coca-Cola,Kraft, McDonald’s), thehealth care industry (Johnson& Johnson, Merck, Pfizer),the retail industry (HomeDepot, Wal-Mart), theentertainment industry

(Disney), the aerospaceindustry (Boeing), thefinancial industry (AmericanExpress, Bank of America,JPMorgan Chase, Travelers),andsoon.Here are the 30 current

Dow companies and theirtickersymbols:

Heard of any of them? Ifnot,putdownthisbook,pickup your wooden staff, andheadbacktothemountaintop.You’ve risen to a plane of

existencebeyondtheneedsofcommerceandprofit.The defining characteristic

of all 30 Dow companies istheirgargantuansize.Totakeone example, Wal-Mart hadsalesof$405billionin2008,a full3percentofAmerica’sgross national product. Itemploys more than twomillion people worldwide.Each Dow company doesbillions of dollars in annualsales, most are diversified

into a bunch of differentbusinesses, and they’reinternational contenders.Even though the list readslikeawho’swhoinAmericanbusiness,youprobablyspendevenmoremoneywith thesecompaniesthanyouthink.Let’s say you created

invitations toyourdaughter’sbirthday party usingMicrosoft Windows andMicrosoft Word on yourHewlett-Packard computer

running Intel inside. Afteryou knew how many kidswere coming, you went toWal-Mart to buy supplies onyour Bank ofAmerica creditcard. You received a phonecall from a mother on yourVerizon Wireless phone, butit cut out so you called backon your AT&T land line.Then, one little boy spilledhis glass of Powerade and alittle girl spilled her glass ofHi-C.PoweradeandHi-Care

owned by Coca-Cola. YouservedupHappyMeals fromMcDonald’s. The kidsfinished their Happy Mealsand went outside to playwhile you spruced up thekitchen with Mr. Clean. Athalftime of the backyardfootball game, you passedaroundafewcansofPringleschips, patched up someskinned knees with Band-Aids, and rubbed Bengay onthe quarterback’s shoulder.

All the excitement left youwithaslightheadache,soyoupoppedacoupleofTylenols.Johnson & Johnson makesBand-Aids at its consumerproducts division, andBengay and Tylenol at itsMcNeil operating company.Next, your daughter openedher presents and poweredeach of the electronic oneswith Duracell batteries. Thefinaleventofthepartywastowatch the newestDVD from

Disney. After the kids wenthome, you wrapped theleftover food in ReynoldsWrap aluminum foil. That’sowned by Alcoa. Yourdaughter washed her facewith Noxzema, brushed herteethwithCrest, andwent tobed.Youlaunderedhergrass-stained shorts with Tide, fedthe dog some Iams and thecat some Eukanuba, andfinally relaxedwith a cup ofFolgers coffee. After that,

you washed your face withOlay if you’re a woman orOld Spice soap if you’re aman, and brushed your teethwithanOral-Bbrush.Procter& Gamble owns Mr. Clean,Pringles,Duracell, Noxzema,Crest, Tide, Iams, Eukanuba,Folgers,Olay,OldSpice,andOral-B.I’d bet my bottom dollar

that your grandchildren willdo business with Dowcompanies. In fact, I’m sure

of it because editors of TheWall Street Journalperiodically update the Dowby eliminating laggards andwelcoming current marketleaders. For example, onApril 18, 2004, AmericanInternational Group, Pfizer,andVerizonreplacedAT&T,Eastman Kodak, andInternational Paper. OnDecember 1, 2005, AT&TreturnedwhenitmergedwithformerDowcomponentSBC

Communications and thecombined company begantradingwithAT&T’ssymbol,T. On February 19, 2008,Chevron and Bank ofAmerica replaced AltriaGroup and Honeywell. OnSeptember 22, 2008, formerAltria subsidiaryKraftFoodsreplaced AmericanInternationalGroup.On June8, 2009, Cisco Systems andTravelers replaced CitigroupandGeneralMotors.Atmost

points in history, the Dowrepresents thebestof thebigguns.There you have it. Dow

companies are enormous,pervadeallpartsofourlives,treadinternationally,andtheydon’t easily disappear. Ifyou’relookingforbattleshipsin a market full of kayaks,looknofurtherthantheDow.Ofcourse,evenbattleships

can be sunk, as 2008reminded us. Former Dow

component General Motorssaw its stock fall 91 percentfromOctober2007totheendof 2008, before goingbankrupt in 2009 and seeingits stock delisted. From justSeptember 8, 2008, toSeptember22,2008—thedayitwasremovedfromtheDow—AIG’s stock lost 78percent.

TheDowDividendStrategies

Dowcompaniesarestrong.Not invincible, but strong.(See: “School of HardKnocks, Year 2008.”)Because of their strength,buying them when they arecheap is usually a way tosafelygetagoodprice.Withweaker companies, buying

cheap can be dangerousbecause there’s a goodchancethat thecompanywillfail. With Dow companies,thechanceoffailureissmall.Notzero,butsmall.

UsingDividendYieldtoFindBargains

So, how should youdetermine if a Dow stock ischeap? By looking at its

dividend yield. As you readin Chapter 3, JamesO’Shaughnessy’s studyof52years on Wall Street foundthatoneofthemosteffectivestrategies was to buy large,well-established companieswithhighdividendyields.When applied to theDow,

thatapproachisknownastheDow dividend strategy.Although the idea has beenaround fordecades, thebasicstrategyisbestpresentedand

validated in the 1991 bookBeatingtheDow,byMichaelO’Higgins with JohnDownes. Here we go withanotherO’lessonfromoneofthoseguys.FirstO’Neil,thenO’Shaughnessy, and nowO’Higgins. That’s O’kay,though.Theyallknowhowtomakemoney.All Dow companies pay a

steadydividend,whichmakesthe dividend yield a reliableindicator of how good a

bargain their stock prices areatanygiventime.Rememberfrom page 25 that youdetermine a stock’s dividendyield by dividing its annualdividend by its price. So a$100 stock paying $5 a yearin dividends has a yield of 5percent (5 divided by 100gives you .05, or 5 percent).Even though it’s a piece ofcake to calculate dividendyield, you’ll be pleased toknow thatyouwon’t need to

do it. It’s printed for you inthe paper each day and iswidelyavailableonline.Becausethereareonlytwo

numbers involved in thedividendyield,ifonenumberremains constant then theother number drives anychanges. With Dowcompanies, the dividendpayout remains fairlyconstant. These bigcompaniesdon’tliketoshockpeople by reducing the

dividend and they don’t liketo throw their books out ofwhack by giving too muchmoney away. So they sitcomfortably within a narrowrange. That leaves us withonly one other number toinfluence dividend yield:stock price. It changes dailyand its relationship to thedividend is immediatelyreflected in the dividendyield.Now, watch the magic as

our30Dowdarlingsfluctuatein price. Say IBM is tradingat$86ashareandispayingadividend of $.35 per quarter,or$1.40peryear.Youcouldlook up its dividend yield inthe paper or online, orcalculate it yourself: $1.40divided by $86 equals .016,or1.6percent.Inthenextfewmonths, IBMdeclines to$42a share but maintains thesame $1.40 dividend: $1.40divided by $42 equals 3.3

percent. Aha, it’s a higherdividend yield because thestockpricedropped.A lowerstock price for the samecompany is a bargain andcould indicate that aturnaroundisontheway.DoyouthinkIBMisgoingoutofbusiness because its stockdropped over 50 percent?Probably not. Dowcompanies don’t usually staydownandoutforever.IBMisgoing to find away to climb

back up to its former gloryprices andyoumight aswellaccompany it on the journeyby purchasing a few shares.When it reaches high pricesagain and its dividend yieldgoesdowntoreflectthat,youknow it’s time tomove yourmoney to one of IBM’s 30Dow brethren with a lowprice and a high yield toaccompany it on the path torecovery.

HowtoInvestinHigh-YieldDowStocks

Now you’re thoroughlyconvincedofthereliabilityofDow companies and youunderstand why highdividend yields are a goodindicator of bargain stockprices. It’s time to look athow the Dow dividendstrategiesseektoharnessthatinformationforprofit.Theplanistospendfifteen

minutes once a year findingthe 10 highest-yield Dowstocks, then invest ineachofthe 10 or a select number ofthe10.Everyyear thereafter,you repeat the process andadjust your portfolio byselling the stocks that nolongermake the select groupand buying the ones thatreplaced them. Your eyeshaven’t failed you—this is,indeed, an investmentstrategy requiring15minutes

of research once per year.O’Higgins wrote that eachDow strategy “involvesreviewing and updating yourportfolio once a year andfastidiously and deliberatelyignoring it in between.” Forconvenience, historic returnstracking the Dow dividendstrategy begin on January 1,but you can begin your planonanydayoftheyear.First, I’ll show how to list

the 10 highest-yielding Dow

stocks. Then I’ll review fivepopularstrategies.Onthedayyoubeginyour

Dow dividend strategyinvestment program, pull outThe Wall Street Journal. Ifyou’re not sure whichcompanies comprise the 30current Dow stocks, checksection C of the Journal.There it charts theperformance of the DowJones IndustrialAverage andshows how each component

stock did the day before. Inthestocktables,highlightthelistingforeachofthe30Dowstocks.Oneofthecolumnsinthe stock tables is titled Yldpercent. That’s the dividendyield. Using your keenfacultiesofobservationandaprocess of elimination, circlethe ten highest-yield Dowstocks. If there’sa tieamongthe dividend yields, choosethe stock with the lowerprice. Rank the ten circled

stocks1to10fromlowesttohighest stock price andwritethe rank beside each stock’slisting in the paper. Thecheapest stock will have a 1besideit,thesecondcheapesta2,andsoon.Anevenquickerwaytoget

the information isbyvisitingthe websitewww.dogsofthedow.com,whichshowseachcompany’sdividend yield, price, and soon.Itevenranksthem,soyou

don’thaveto.Listonasheetofpaperthe

company names, symbols,dividendyields,andpricesofall10stocksintheorderyoujust ranked them. OnDecember31,2008,mysheetlookedliketheoneshownonthenextpage.All Dow dividend

strategies are based oninvesting in the 10 Dow

stockschoseninthismanner.Let’s discuss stock 2 for a

second. Michael O’Higginscalls the second-lowest-priced stock the PenultimateProfit Prospect, or PPP. IncaseyourSATstudysessionshave worn off, penultimatemeans next to last. It’s thestock that has historicallyreturned more than all theother Dow stocks. Thelowest-priced stock is oftenfacinggenuinetrouble,which

isthereasonforitslowprice.The second-lowest-pricedstock, on the other hand, isnot usually in trouble. It’ssimply the most bargain-priced of the high-yieldersthat are faring well, andtherefore has the bestprospects for stockperformance. As you’ll see,however,whenitdoesbadly,itdoesverybadly.

Here’s how you would

allocate $10,000 among the10 stocks according to fourpopular Dow dividendstrategies:

• Dow 10 simplybuys an equalamount of eachstock. You wouldinvest $1000 ineach of the 10stocks.•DowHigh5buysthe five highest-

yielding of the 10stocks. You wouldinvest $2000 ineach of Bank ofAmerica, GeneralElectric, Pfizer,DuPont,andAlcoa.•DowLow5 buysthe five lowest-priced of the 10stocks. O’Higginsadvocates thisstrategybecausethelowerprices should

lead to higherpercentage gains.You would invest$2000 in each ofstocks1to5.•Dow1 puts all ofyour money onstock 2, thepenultimate profitprospect. Youwould invest$10,000 in stock 2,which is Bank ofAmerica in this

case.

Performance

The table below, frominvestment advisor MarkPankin at www.pankin.com,summarizes how the fourDow dividend strategiesperformed in the 37 yearsendedDecember31,2008. Itdetailspricechangeonlyanddoes not take into account

income from dividendpayouts:

Threeofthefourstrategieswere effective at beating theDowover time.Theone thatwasn’t, the Dow 1, killed

itself by owning GeneralMotors in 2008 andBank ofAmericain2009.GMfell87percent in 2008; Bank ofAmericafell82percent fromthe end of 2008 to itsFebruary2009low.TheDow1isusefulforfindingaplacetospeculatewithpartofyourmoney but is not a goodportfolio strategy. The bestapproach is the original, theO’HigginsLow5.The strategies show

dividend yield to be a goodwaytofindundervaluedDowcompanies.

DoublingtheDow

As good as the Dowdividendstrategieshavebeen,there’sawaytobeatthemall.First,somebackground.When I began researching

Dowstrategies,itoccurredtome that an easy way tooutperform the Dow wouldbe through leverage, atechnique that magnifies aninvestment’s performance.Thereseemedtobenoreasonto go through the process ofwinnowing out the highdividend yielders when Icould just own the wholeDow and magnify itsperformance to a biggerreturn than any of the

dividend strategies hadachieved.However, at the time of

this book’s first publication,therewasnopracticalwayfortheindividualinvestortoownthe whole Dow. You couldhave bought all 30 Dowstocks and constantlyrebalanced them, but thatwould have been too muchwork. You could havematched the Dow with anindex mutual fund, but your

return would have been lessthan the return posted by thedividend strategies. So thedividend strategies were thebest way for individuals tobeat the Dow and, therefore,the only strategies I showedinthebook’sfirstedition.The introduction of two

investment products sincethenhasmade leveraging theDow not only possible, buteasy.Theproductsare:

✔ The UltraDow30 (ETF) fromProShares. Thesecurity, symbolDDM, is availablethroughanybroker.It trades exactly asa stock, and usesleverage to achieveroughly twice theperformance of theDow.✔ The UltraDow30 mutual fund

fromProFunds.Thefund, symbolUDPIX,isavailablethrough mostbrokers. It usesleverage to achieveroughly twice theperformance of theDow.

Both of these productsmake it easy to double theDow. Doing so producesresults better than the

dividend strategies in mostmarketenvironments.Inthissection,Ishowhow

leverage works and thenexplain threeways to doubletheDow.

ProsandConsofLeverage

Most people are familiarwith leverage because theyuse it when buying a house.Let’ssayyouboughtahouse

for $200,000 with a downpayment of $40,000. Fiveyears and two lawn mowerslater, you sell the house for$250,000. The value of thehouse increased 25 percent.Not bad. But the value ofyour $40,000 investment inthe house increased 125percenttoatotalof$90,000.How did that happen?

Through the use of amortgage. You borrowed$160,000 from a lender and

put just$40,000ofyourownmoney into the house. Youcontrolled a $200,000investmentwithjust$40,000.Itworksthesamewaywith

stocks, except that youborrow money from yourbroker instead of from amortgage lender. Theborrowedmoneyisnotcalleda loan, it’s called margin.You would say, “I bought250 shares of GeneralElectriconmargin,”bywhich

you would mean that youborrowed the money fromyour broker to buy the 250shares.You could buy $5000

worthofGE,borrowanother$5000, and then control a$10,000 investment inGeneral Motors.Without theleverage, a20percent rise inyour$5000investmentinGEwouldgiveyou$1000profit.Withtheleverage,however,a20 percent rise would give

you $2000 profit, which is a40 percent return on yourinvestment.What’s the catch? That

leverage magnifies losses aswellasgains. IfGE loses20percent, your $10,000position is now worth just$8000. You lost $2000 ofyour $5000 investment,which is - 40 percent. Inadditiontothatloss,youneedtopayinterest toyourbrokerwhenyouborrowmoney.For

example, Fidelity’s marginrateat thebeginningof2009for amounts under $10,000was8.6percent.Ialmostalwaysdiscourage

leverage. Everybody choosesthewrongstocksatthewrongtime at least once in theirinvestment career.Magnifying the losses inthose cases can bedevastating.Why, then, would I

advocate leveraging the

Dow? Because it’s not onestock, it’s 30 of the beststocks available. That doesnot mean that leveraging theDow won’t produce biglosses at times—it will—butover the long haul, the Dowwillrise.Magnifyingthatrisewillbeprofitable.

ThreeWaystoLeveragetheDow

Youcan leverage theDowby following the exampleabove. Apply for a marginaccount at your broker andthen buy shares of theDiamonds Trust, symbolDIA, just as you would buyany stock. It’s an ETF thattracks the Dow. You mightwant to just buy itwith cashto get used towatching yourmoney fluctuate along withtheDow.Later,whenyou’vehad a chance to feel the

Dow’s performance in yourbonesasyouwatchthegainsand losses, youmight decidethat doubling the behavior isright foryou. Inyourmarginaccount, you would simplydouble the number of sharesyouownbypurchasingmorewith money borrowed fromyourbroker.However, I recommend

that you take advantage ofeither the ProShares UltraDow30ETFor theProFunds

UltraDow 30 mutual fund.Instead of borrowing themoneyfromyourbroker,youjust invest your cash. Leavethedetailsofleveraginguptothe fund to double theperformanceoftheDow.Of the two, I suggest the

ETFasthebetterapproachifyou’ll be selling sharesmorethan a couple of times peryearinanattempttotimethemarket, as we’ll discussbelow. I suggest the mutual

fundasthebetterapproachifyou plan to make frequentcontributions and stayinvested most of the time.Many people continueinvesting every month orevery quarter. Doing so in amutual fund results in noextra commissions. It’s freeto addmoney.With anETF,you pay a commission eachtime you buy more shares,justasyoudowithastock.UltraDow 30 doubles the

Dow by using leveragedinvestmenttechniquessuchasfutures, options, and swaps.Explaining those techniquesis beyond the scope of thisbook and irrelevant to thediscussion anyway. All youreallyneedtoknowisthatthefund returns roughly twicewhat the Dow returns eachday, whether positive ornegative.Thefundisnotprecise,but

it strives to be and it comes

close in the short term. Thelonger the time frame, themore its performancedegrades because magnifiedlosses addup.Tooffset that,we’ll look at ways to guardagainstextremeloss.On thefollowingpage isa

table from my websiteshowing how the Dow, theDow1, andDouble theDowperformed from December31, 2002, to December 31,2008,andincludesthegrowth

of an initial $10,000investment. You can see acurrentversionofthetableatmywebsite.Thefirstthingyou’llnotice

is the ferocity of the 2008recession.Asyoureadabove,theDow1stockthatyearwasGeneral Motors, whichdeclined 87 percent as itteetered on the edge ofbankruptcy. GM single-handedlyinvalidatedtheDow1 strategy, because in one

year it wiped out decadesworth of gains. I keeptracking it for purposes ofcomparison but don’trecommend it for thebulkofyour portfolio, and neverhave.After2008, it’seasy toseewhy.UltraDow didn’t do much

betterthatyear.Its63percentloss erased more than fiveyears’ worth of gains andprovedtheneedfordownsideprotection in the strategy.

Moreonthatbelow.UltraDow 30 is cheaper

than seeking your ownleverage through a marginaccount. At the beginning of2008, Fidelity’s interest onamounts under $10,000 was8.6 percent. The annualexpenseofUltraDow30wasjust1.6percent.UltraDow 30 is also safer

than seeking your ownleverage through a marginaccount. Why? Because

investing in the mutual funddoes not require borrowingmoney. With margininvesting, you can losemorethan 100 percent of yourinvestment by losingnot justyour own money but alsolosing the money youborrowed. That cheerfulsituation leads to yourneeding to pay back theborrowed money that youlost, with interest. InUltraDow 30, the most you

could lose is 100 percent ofyourmoney,nomore.

That will never happenwiththeDow.Thecompaniesare not all going to gobankrupt at the same time,and if they ever do you’llhave a lot more to worryabout than the value of yourportfolio. Something willhavegoneseriouslywrongintheworld.

MaximumMidcap

You’ve seen the power ofthe solid companies of theDow, the usefulness of theDow dividend strategies tofindthestocksfromtheDowwith the most potential forshort-termappreciation,andawaytobeatboththeDowandthe dividend strategies byleveraging the entire Dow totwiceitsperformance.Now, let’s apply the same

leveragingapproachyoureadabout in Doubling the Dow

above to a different index.The goal is to do better thanthe Dow, but there’s no rulesaying we need to restrictourselvestoonlyDowstocksto do so. Why not beat theDow using an entirelyseparategroupofstocks?Thatgroupshouldloseless

than the Dow during fallingmarkets,makemore than theDow in rising markets, orboth. I found an index thatdoes both. It’s the S&P

MidCap 400. It tracks 400stocks with a medium-sizedmarketcapitalization.They’renot large caps, such as thoseontheDowandS&P500,norare they small caps, such asthoseontheRussell2000andS&PSmallCap600.They’rejust right, sandwiched in themiddle, the sweet spotof thestock market. You saw thisfor yourself on pages 38 and39.In researching even better

ways to beat the Dow, Icompared long-term andshort-term charts of variousindexes in search of a Dowbeater. They all had theirmoments of outperformancecoupled with moments ofunderperformance, but theMidCap400roseconsistentlynearthetopofthelist.Look at its total returns

compared with the totalreturns of the Dow as ofDecember29,2006:

The MidCap 400 is notimmune to bad times, ofcourse, and no recent yearsays bad times better than2008, when all stockssuffered. That year, theMidCap 400 lost 37 percentand theDow lost 34percent.Thesearetheirtotalreturnsas

ofDecember31,2008:

Asyoucansee,themidcapindex has handilyoutperformed its larger capbrother over time, despitelaggingrecently.It’snothardto seewhymidcaps dowell.Large caps are established in

theirindustries.They’relargebecause they’ve alreadygrown a lot. They could stilldowell,butnotnearlyaswellas they did in their earlyyears.Small caps have a lot of

potential,buta lotofdanger.Foreveryonethatgoesontobecome Starbucks orMicrosoftorPfizer, therearehundreds that becomenothing. Investors lose theirmoney. Employees lose their

jobs.Dreamsgoupinsmoke.That’sthenatureofsmallcapinvesting, andentrepreneurshipingeneral.With midcaps, we get

companies that have clearedtheir first hurdles withoutexhausting their growthpotential. They’ve proventhat they have a good thinggoing,buttheyhaven’tgrownoldandstodgy.Theyprovidea lot of potential for arelatively small amount of

risk.Now, let’s apply

leveraging to themaswedidearliertotheDow.To leverage the Dow, I

suggested using eitherProFunds UltraDow 30(UDPIX) or ProShares UltraDow30 (DDM). To leveragethe MidCap 400 index, IsuggestusingeitherProFundsUltraMid-Cap (UMPIX) orProShares Ultra MidCap400(MVV).

As with the Dow, thebenefit of themutual fund isthat it allows you to investmore each month withoutpaying a commission. Thebenefit of the ETF is that itallows you to buy and sellimmediately as you do withstocks.According to my tracking

inTheKellyLetter, the tablebelow shows howMaximumMidcap via UMPIXcomparedtoDoubletheDow

via UDPIX from December31, 2002, to December 31,2008.Look very carefully and

see if you can find the yearyou’d most like to removefrom the list.Time’sup.Didyou choose 2008? Good.Then you’re qualified tomoveontothenextsection.

TheDownside

If there’s one thing that’s

clear in the abovebackground, it’s that theelephant in thechina shopofthesestrategies isanextremebearmarket.Theenemyofallleverage is the downside. Infact, that’s what caused therecessionof 2008.Banksgotthemselves into big troublewith leverage in the housingmarket, and it changed theworld.Oneconclusioncouldbeto

skip leveraging and just own

theDoworS&P500througha plain vanilla index fund.Many advisors suggest that.By definition, you’ll beguaranteed marketperformance over time andyour research will be done.Youwillnotbeatthemarket,butnorwillyoulosetoit.Our goal, however, is to

beatthemarket,solet’skeepexploringways togetaroundthe downside weakness ofthesestrategies.

Recently, the number ofleveraged investmentproducts has exploded. Theynow cover not just the Dowand S&P MidCap 400 butmany other indexes targetingdomestic stocks of everycompanysize,foreignstocks,sectors such as finance andenergy, commodities such asoil and gold, and currencies.They don’t just doubleperformance anymore, either.They now offer triple

leverage for three times theperformance of the targetindex and even inversedoubleandtripleleverageforsteroid-pumped performancein the opposite direction ofthe target index. There arehundreds of new ways toprofit no matter which waythe market is moving. I’veprovidedacollectionoftheminAppendix2.Most of these leveraged

products are designed to

achievetheirgoaldaytoday.They track the dailymovements of their targetindexes, which is why theiraccuracydegradesasthetimeframe lengthens, especiallywhenvolatilityishighbutthenet performance is flat. It’spossible to get the long- ormedium-term forecast right,choose the right leveragedproduct, and still just matchorevenlosetotheindex.Let’s say you own MVV,

which doubles the dailyreturn of the S&P MidCap400 index. In one randomsample week, Monday toFriday, the midcap indexposts these returns: -5percent, -3 percent, +4percent, +3 percent, +2percent. The index is up 0.7percentfortheweek.Becauseyou’re doubling the index,youshouldbeup1.4percent,right? Right, but you’re notbecauseyou’redoublingeach

daily performance, not theweekly performance. Runthosedailytalliesattwicethenumbers and you get aweekly net performance ofprecisely 0.7 percent—thesame as the plain index butwith twice the volatility andheart rate. If the leveragedadvantage slipped in justoneweek, imagine how farofftrack it can get overmonthsandyears.This doesn’t mean the

leverage is useless, though.The market rises two-thirdsof the time, and addingmoney to a line that’s risingmore steeply than themarketitself works. Look at therecent growth of $10,000 inMaximum Midcap, DoubletheDow, and the Dow itselfthrough the Diamonds Trust,symbolDIA:

In the five years endedDecember31,2007, leveragetook Maximum Midcap 81percenthigher than theDow,and Double the Dow 34

percent higher. Thedevastation of 2008,magnified by leverage, tookMaximum Midcap to anoverall12percentlowerthanthe Dow, and Double theDow 24 percent lower. Seethe degradation over time?Overthesesixyears,theDowgained 4 percent, so wewould expect Double theDow to have gained about 8percent.Duetoslippagefromthe adverse effect of a

magnified downside, itinsteadlost21percent.Now,beforeyoupackyour

bags and leave leverage forgood, consider that table uptotheendof2007.Wouldn’tit have been nice to haveownedMaximumMidcapformost or all of that five-yearperiod?Sureitwould,solet’ssee if we can knowwhen toget out and avoid years like2008.

LimitingtheDownsidewith

Charts

We can boost the long-term performance of thesepermanent portfolios bytrying toavoid thedownside.You’ve now arrived at themost controversial of allmarket topics: timing.“Nobodycandoit,”saysone

group. “Baloney,” saysanother.I’ll present three chart

indicators that have workedfairly well together and letyou decide for yourselfwhether timing is worth theeffort.Inmyview,thosewhoswear off timing and thosewho swear by timing bothmakegoodpoints.Timingis,if not impossible, verydifficult.Wecanallagreeonthat. However, we can also

probably agree that anythingoffering a chance to avoidyears like 2008 is worthexploring.The three indicators we’ll

consider are not perfect, butthey’re better than nothing.They are SMA,MACD, andRSI. We’ll look at each oneindividually, with help fromcharts provided by OnlineTrading Concepts, then pullthem together in an examplethat includes the crash of

2008 on charts provided byStockCharts.com.

SimpleMovingAverage

A simple moving average,or SMA, price line smoothsout an investment’s path toshowitstrendmoreclearly.Ifclosing prices over the lastfive trading days were $32,$36, $34, $35, and $31, thenthe SMA would be $33.60,

arrived at by adding the fivenumbers to get 168 and thendividingthatbyfive.Ifwedothat the next day, and thenext, and the next, we’llcreate a five-day SMA linethatwecanwatch for trends.We can set the intervalwherever we want. TypicalsettingsforSMAare20days,50days,and200days.A price line’s relationship

to its SMA shows you itstrend. If the price is staying

above the SMA at a risingangle,that’sarisingtrend,oruptrend.Ifthepriceisstayingbelow the SMA at a fallingangle,that’safallingtrend,ordowntrend.Theeasiestwaytogetbuy

and sell hints from thismeasureistowatchforwhenthe investment’s price linecrosses above or below itsSMA.Whentheinvestmentismovingup,theSMAactsasasupport line and the price

dipping below the line andmoving back up signals abuy. That’s shown on thefollowing chart of a 20-daySMA of the Dow JonesIndustrial Average ETF,symbolDIA:

Noticehowmuchsmootherthe SMA is than the price.

See how well it shows theupward trend, and then theabrupt change to adowntrend?That’shelpful.When the investment is

moving down, the SMA actsas a resistance line and theprice popping above the lineand moving back downsignalsasell.That’sshowninthechartonthenextpage.Many traders use several

moving averages together,such as a 20-day, a 50-day,

and a 200-day andwatch forthemtocrossovereachotherfor hints on future pricedirection.We’ll keep it easy,

however,bywatchingjustthepriceandthe50-daySMAforcrossover signals in the2008exampleonthenextpage.

MACD

This measurement shows

trends in an investment bylooking at the differencebetween fast and slowexponentialmovingaverages,or EMAs, of its closingprices. An exponentialmoving average is similar tothe simple moving averagewe looked at above, but itplacesmoreweightonrecentprices than on past ones,making it reactmore quicklyto trend changes. Fast andslowrefertothetimeperiods

used, with fast being a shortone and slow being a longone.As these averages cometogetherandmoveapart,theysend hints about futuredirection. That’s why thename of the measurement ismoving average convergencedivergence,orMACD.

The MACD message is

composedofthreeparts:✔ MACD: The12-periodexponentialmovingaverage minus the26-period. This isthe differencebetween fast andslow we justdiscussed above,andperiodcanreferto hours, days,weeks, months, or

any other timesegment. Thedefault isdays, andthat’s what we’lluse.✔ MACD SignalLine: The 9-periodexponentialmovingaverage of theMACD.This is thetrend of thedifference betweenthe 12-period trendand the 26-period

trend.✔ MACDHistogram: TheMACD minus theMACD signal line.A histogram iscommonly knownas a bar chart, andthis one showswhether MACD isabove, the sameas,or below its signalandbyhowmuch.

Seeallthreepartsinactiononthischart:

That’s just thebottompart

of the chart. Next, let’sexpand the scope to includethe full chart with theinvestment’spriceline.The main way to use

MACDisbywatchingforthemoving averages to crossovereachother.Abuysignalhappens when the fast 12-periodEMAcrossesover theslow 26-period EMA, whichcauses MACD to cross overthe zero line. A sell signalhappens when the fast 12-

period EMA crosses belowthe slow 26-period EMA,whichcausesMACDtocrossbelowthezeroline.Another way to use this

curious collection of lines isto watch for the MACD tocross theMACD signal line,which flips the histogram tothe opposite side of the zeroline. Flipping above it is abuy signal; flipping below itisasellsignal.Seeing it is easier than

reading about it, so witnessallpartsatworkon thechartonpage135.I find the bars of the

histogramtobethefriendliestway to followMACD. Lookhow simple they are. Theirdepth or height tells us howstretched the investment isgetting either down or up,theirmovesbacktowardzeroshow that something ischanging, and their crossingover or under the zero line

shows us a new trend hasbegun.Notice that any way you

choosetofollowMACDwillhave you missing the verytopsandbottomsof thepriceline but catching the bulk ofthe next trend. That’s thegoal. If you’re happy onlywhen catching absolutebottoms and absolute tops,you’ll rarely be happy. Giveyourself a break by seekingmostofamove,notallofit.

RSI

Relative strength indexcompares an investment’scurrent price to its pastperformance togaugecurrentstrength. Be careful about afine distinction atwork here.RSI compares aninvestment’scurrentsituationwith its own history. Adifferent measurement thatsounds the same, relativeprice strength, compares a

stock’s price action to theprice action of all otherstocks. We looked at that inChapter 3 and will see itagain in the Investor’sBusiness Daily section ofChapter6.The idea with RSI is that

we can know from aninvestment’s history when ittends to reverse direction,eitherupfromalowordownfrom a high. RSI is easy tounderstand. It fluctuates

between 0 and 100, withreadings over 70 indicatingoverboughtanddueforafall,and readings under 30indicating oversold and duefor a bounce. You’resupposed to wait for thereversal to happen beforeeither selling or buyingbecauseyouneverknowhowfar the move will go beforereversing. So, an RSIcrossing above the oversold30lineisabuysignal,andan

RSI crossing below theoverbought 70 line is a sellsignal. RSI is called anoscillatorbecauseitoscillatesup and down in a wavepatternbetween0and100.Like SMA and MACD,

RSI needs a time frame.Thedefault is a 14-period timeframe, and the periods canagain be hours, days, weeks,or anything else, but areusually days. Shortening theperiod increases the number

of signals, and lengthening itdecreasesthenumber.The following chart shows

RSIsignalsforeBay:

Lookattheveryleftofthe

chart.SeethatwhenRSIfirstcrossed under the oversoldline,eBayhadfurthertofall?That’swhyyouwait forRSIto move back over beforebuying, because it hints thatthe worst is over andimprovement is at hand.Sometimes it gets evenmoreextreme. I’ve seen RSIs getas low as 15 before turningback up and as high as 90beforeturningbackdown.

UsingThemTogether

Now, let’s see how SMA,MACD, and RSI togetherwouldhavehelpedyouavoidthe 2008 downturn in ourMaximum Midcap strategy.Getting the samesignal fromtwo of the threemeasurements is usuallyenough to warrant takingaction. Getting the samesignal from all three is quiteconvincing.

The following chart showsUMPIX from December 29,2006, toDecember31,2008,and includes SMA, MACD,and RSI with the defaultperiodswediscussedabove:

At the end of February2007, both MACD and RSIsaid to sell, even though theprice and SMA showed anuptrend. MACD crossedbelow its signal lineandRSIcrossed below 70. The pricecrossed below the SMA thenbounced around it for acouple of weeks, showingthat a trend change had notoccurred. Within a month,both MACD and RSI

suggested getting back in.Notice that they gaveconflicting signals during the25 percent run higher fromearlyMarchtoearlyJune,butSMA showed the uptrend tobe intact. That’s why usingthreemeasurementsisagoodidea.Early June 2007 was the

best time to sell before thecrash of 2008. UMPIXreached a high of $62.40 onJune 4. RSI hit 70 that day

andbeganbackingoff—asellsignal. Three days later,MACD slipped below itssignal line and the histogramflippedbelowthezeroline—asecondsellsignal.Thepricefell to the SMA, too—acautionflag.

RSI began giving buysignalsat theendof Julybutwasn’t confirmed by anMACD buy signal until thethirdweekofAugust.On October 9, RSI hit 69

and backed off—closeenoughtobeconsideredasellsignal if confirmed byMACD. A week later,MACD slipped below thesignal line and the histogram

flipped under the zero line—thesellsignalwasconfirmed.In earlyNovember, the priceslipped convincingly belowthe SMA to signal adowntrend.Allofthisismoreclear on the chart zoomed tothe fourth quarter of 2007,shownonthepreviouspage.After issuing dual buy

signals at the end ofNovember 2007,MACDandRSIdidnotagreeonatimetosell before the early 2008

tumble.MACDsaidtosellattheendofDecember,butRSIdid not. However, the pricereversing off the overheadSMA in December wasanother sell signal. That wastwo out of three, and wouldhave gotten you out ofUMPIX for most of theDecember-to-January sell-offshown on the two-year chart(page137).Staying on the two-year

chart, both MACD and RSI

said to buy at the January2008 lows; then MACD andSMA said to sell at theFebruary high; then all threemeasurements said to buyagain in March before theimpressive25percentrallytothe May highs. MACD andRSI then sensed thenosebleed level and said tosell before the 16 percentdroptolateJune.At the beginning of July,

RSIsaidtobuy,andthatwas

confirmedbyMACDinmid-July.SMA,however,stronglydisagreed, showing the pricenowhere near anotheruptrend. At the beginning ofSeptember, MACD camearound to SMA’s way ofthinking,andthetwotogethermadeapowerfulcasetosell.Let’s take a closer look byzoominginonthesecondhalfof 2008, shown on the chartonthenextpage.Notice that just when

MACD tagged its signal lineat the end ofAugust and thehistogram played along thezeroline,thepriceofUMPIXpopped above its SMA andthen reversed back down.Meanwhile, we couldunderstand why RSI wasn’tshowingoverbought.UMPIXwas already in a downtrendshown by the downwardslopingSMAline,anditwasabout to get much worse. Itdidn’tgofromaloftyhighto

a lower high; it went from alowtoamuchlowerlow.RSIcan’t catch that because itssignals come fromoverbought and oversoldconditions,andUMPIXneverbecame overbought to issueanRSI sell signal in summer2008.Theother twodid, though,

and two out of three is goodenough for us. The creditmarket panic swept in andtook UMPIX down 77

percent from itsAugust highto its November low. At theOctoberandNovember lows,bothMACDandRSI said tobuy,butSMAdisagreed.As you can see, SMA,

MACD, and RSI togethercaught a lot of good turningpoints in this two-year spanandsparedinvestorsthebruntof 2008’s wrath. Their buysuggestions in October andNovember were hard tofollow amid some of the

worstfinancialheadlineseverprinted but paid off fairlyquickly.

StayPutMostoftheTime

When we time the marketcorrectly, it’s wonderful. It’sthe holy grail of the stockworld:gettingout justbeforea big crash and getting backin just before abig recovery.It’shardtodoevenonetime,though, much lessconsistentlyyearafteryear. Ipromise you that the guy on

TV being praised for callingthe most recent movecorrectly got the last one ortwo wrong and will one daybe wrong again. Why do Iknow? Because I’m one ofthoseguys.Chances are quite good—I

dare say, certain—that youwill experience the samespotty record when trying totimethemarketonyourown.If not, if you get it rightconsistentlyyearafteryear,e-

mail me. I’ll have a fewquestions.Thegoodnewsisthatmost

of the time it’s best to juststay put inMVV orUMPIXbecausethemarketrisesmorethanitfalls.Bigbearmarketsare the exception, not therule. Staying put on a risingline benefits fromcompounding as gains buildupon prior gains, and youwatchprofitsmount.Whilestayingput,keepan

eye on SMA, MACD, andRSI for indications of bigtrouble ahead. Because it’shard to determine whentrouble is big and when it’ssmall,you’llsometimesgetitwrong.Knowthatinadvanceand give yourself a break.With theabove tools inhandyou’ll do a pretty good job.That’smore thanwecan sayfor the billion-dollar bankinggeniuses who ran their firmstoinsolvencyin2008.

WhattoExpect

If you decide to leverageeither the Dow or the S&PMidCap 400, expect a wildride. The price you pay forenjoying higher highs issuffering lower lows.Shooting higher and fallinglowerthanatargetindexisn’tforeverybody.If you can change your

wayof thinking to see lowerlows as opportunities amidcrisis, you’ll love thesedoublingstrategies.Ifinsteadyou see lower lows as abjectfailurewhile theworld ends,you’ll hate these doublingstrategies. Know that thedownside will happen, andexpect it.Do not be shockedbyit.Valueaveragingteachesus

that buying more when thepriceisdowneventuallypays

off—as long as recovery isassured.That lastpart iskey.Iftheinvestmentisonitswaytozero,nomethodofbuyingitmakessense.Youcankeeplowering your average costall the way into the dirt, butyou’ll still end up withnothing. You will havebought oblivion on sale. Ihope that’s obvious. Peoplewho owned certain large,supposedly too-big-to-failfinancial firms rediscovered

thatin2008whenthosefirmswentbankrupt.The beauty of basing a

permanent portfolio on anindex is that recovery isassured. The investmentreliesnotononecompanybuton 400 in the case ofMaximum Midcap. They’renotallgoingtodisappear.Think of the doubling

strategies as crazy discountstores that sell the sameproduct that other stores sell,

but at absurdly low pricesnow and then. The “sameproduct”iseventualrecovery.For example, whenMaximum Midcap andDouble the Dow dropped 40percent from June 2002 toOctober 2002, the Dowdroppedonly20percent.Usually, a person looking

at that would point to theDowasthebetterinvestment.For the long-term investor,however, the doubling

strategies were better. Why?Because they eventuallyrecovered, too, but investorshad a chance to get them attwice thediscountduring thesaleperiod.It didn’t take long to pay

off.WhenMaximumMidcapgained 127 percent fromMarch 2003 to March 2004,the Dow gained only 37percent.From early May 2006 to

mid-July 2006, Maximum

Midcap fell 25 percentwhilethe Dow fell only 6 percent.You see that and think, “Ishouldhaveputallmymoneyin baseball cards.” But bynow you know what camenext, right?Over thenext12months, Maximum Midcapgained 58 percent while theDowgainedonly28percent.What I am pointing out

hereis thatextremevolatilitycoupled with assuredrecovery is a potent

combination. It’s why Icontinue believing in thesestrategies throughgood timesandbad,butespeciallyduringbad.Whenmostofwhatyouheariscomplainingaboutthestock market, get out yourcheckbook. Eventualrecoveryisonsale.Puttingitalltogether,then,

your core portfoliowill havetwoparts:

✔ Valueaveraging

the S&P SmallCap600 via IJR toachieve steady 3percent quarterlygrowth.✔ Leveraging theS&P MidCap 400index via MVV orUMPIX. You’llstayputmostofthetime to compoundstrongperformance,but keep an eye onthe chart to see if

SMA, MACD, andRSI warn of bigtrouble ahead.When they do,you’ll get out andwaitforbuysignalstotakeadvantageofrecoveryonsale.

On top of this coreportfolio, you’ll chooseindividual stocks with thepotential to perform evenbetter. That’s what we’ll

explorenext.To see the current

performance of these andother strategies, visit mywebsite atwww.jasonkelly.com/strategies

5

GetReadytoInvest

This chapter contains theplanning you need to dobefore investing. I discussopeningabrokerageaccount,putting money into it, and

placingtrades.

ChooseaDiscountBroker

Asyou readonpage16, Ilike discount brokers a lot.After reading this book andconductingyourownresearchoncompanies,youdon’tneedthe expensive opinion of a

full-service broker. Savesome money, consolidateyour investments, andcontinue forming your ownopinions.The brokerage business

changes quickly, so thissectionisdeliberatelylightonspecifics. Most brokerscharge commissions between$5 and $30 with variousincentiveplansthatcomeandgo.Most brokers offermajorstockresearchfromfirmslike

Standard & Poor’s for free.Visit each broker’s websiteforcurrentdetails.Ifyouchooseabrokerthat

hasanofficenearyourhome,suchasFidelityorScottrade,you can always walk in andtalk to a live human being.Some people actually preferthat.

E*Trade

E*Trade is a financialbazaar with everything frombankingandbillmanagementto shopping and taxes. Ohyeah, and they can tradestocksandmutualfundstoo.Contact Information:www.etrade.com

Fidelity

Fidelityisagoodchoiceif

you’re looking for a place toassemble a mutual fundportfolio together with yourstocks. The company’sFundsNetwork programgathers leading names intoone place without loads ortransaction fees. AnadvantagethatFundsNetworkhas over other supermarketsis that it includes Fidelity’sown funds, which issignificantbecauseFidelityisthe biggest fund company in

America. Itmaintains officesthroughoutthecountry.Contact Information:www.fidelity.com

Firstrade

Firstrade offers a flat-feesystem. It haswonhonors insurveys for its low prices,simpleinterface,andattentivecustomer service. It’s free to

transferyour account, there’sno minimum deposit, andthere are no inactivity fees.It’safriendlyplace.Contact Information:www.firstrade.com

Schwab

Schwab’s OneSourcemutualfundsupermarketrunsneckandneckwithFidelity’s.

Although Schwab can’t offerFidelity funds, it tends togather higher quality namesfrom other fund familiesincluding its own Schwabfunds. It maintains officesthroughoutthecountry.Contact Information:www.schwab.com

Scottrade

Scottrade is consistentlywellrankedinsurveysfor itslow prices, the convenienceof its branch offices acrossthe country, and its toleranceof low account balances andinactivity. Its website pageload speed is among thefastestinthebusiness.Contact Information:www.scottrade.com

TDAmeritrade

TD Ameritrade receiveshigh praise for its slicktrading interface, extensivemutual fund network,innovativeresearchtools,andcompetitiveprices.Itstradingplatforms show what theportfolio and stocks you’rewatching are worth this verysecond.Contact Information:www.tdameritrade.com

TradeKing

TradeKing ranks high insurveys for its low price,$4.95 per stock trade. That’sthe whole story. In its ownwords, “We don’t have apricing structure, we have aprice.”Contact Information:www.tradeking.com

SuperDiscounters

BuyandHold,ShareBuilder, and Zecco aresuperdiscounters.Theyoffercheap single trades, freetrades under certainconditions, and monthlysubscription tradingpackages. Make sure youunderstand the limitations oftheir various plans. If theprice is cheap and you canstillmanageyourinvestments

thewayyouwant,itcouldbeworthatry.Contact Information:www.buyandhold.com,www.sharebuilder.com, andwww.zecco.com

PlaceOrders

Once you’ve chosen a

discount broker and you’vegot money in your account,you’re ready to invest. Thissection explains the bid, ask,and spread; and discussesdifferent types of ordersavailabletoyou.

Bid,Ask,andSpread

The bid is the highestquoted price that buyers arewillingtopayforasecurityat

any specificmoment. In thatsame specific moment, theaskisthelowestquotedpricethat sellers are willing toaccept for the security. Thebidis thepriceyougetwhenyou sell the stock, the ask isthe price you pay to buy thestock. The spread is thedifference between the twonumbers and is kept by adealerwho’scalleda“marketmaker” on the OTC and a“specialist” on one of the

exchanges. The dealermaintains fair and orderlytrading by keeping aninventory of stock to satisfydemand when buyers andsellers can’t be matched up.He’s a middleman just likethe owner of the bookstorewhere you bought this finetitle.Allmiddlemenpurchaseinventory at a price lowerthantheysellit.Thespreadisbiggest for stocks that arethinly tradedbecause it takes

fewer dealers to satisfydemand.Fewerdealersmeansless competition and, thus,bigger spreads. Now youhave career advice for yourchildren: become dealers inthinlytradedstocks.Let’s take a closer look at

thesethreenumbers.IfMisterMagazine asks $15.50 andbids $15, the spread is 50cents.Placingamarketorderbuys your shares at $15.50.The instant after you buy

your shares, they’re worthonly $15 because that’s thepriceothersellersareasking.In one of my investmentseminars, a gentlemanquestioned whether he couldask for the extra 50 cents torecoup his purchase price.Ahem, well, no. First of all,nobody’s actually askinganybody for anything. It’s afigure of speech. Themarketknows thebidandaskpricesbased only on supply and

demand.Second,even ifyoucould ask for a higher price,nobody would pay it. Ifeverybody but you is sellingat $15.50, why would I pay$16tobuyfromyou?Asyousee, thespreadcan

translate into a seriousinvestment cost if you sellright away. In our MisterMagazine example, 50 centsrepresents a full 3.2 percentofthe$15.50bidprice.Aflatbrokeragecommissionof$18

ona100-sharetradeisonlya1.2 percent cost. The spreadis more than 2½ times theexpense of the commission!Before you get too riled upandembarkonadealerhunt,remember that you don’tactually suffer the burden ofthe spread unless you sellright away. Hopefully, yourstock will appreciate farbeyond thespreadand itwillbecomeirrelevant.Alwaysbeawareofthespreads, though,

because your stock mustmove beyond the combinedspread and commission costsjusttobreakeven.

Orders

Giving an order to yourbroker is a thrillingmoment.It means you’ve done yourresearch, thought about yoursituation, and are ready totake action. There are two

types of orders: market andlimit.

Market

A market order is thesimplest type. It instructsyourbroker tobuyasecurityat the current ask price.That’s it. Your buy price iswhatever the thing is tradingfor when the order reaches

the floor. With today’s fastcommunications, thatprice isgoing to be fairly close towhereitwaswhenyouplacedthe order, if not the exactsame price. For instance, sayMisterMagazineistradingat$15.50 per share and youplace amarket order for 100shares.Ifyoudon’tbuyyourshares for precisely $15.50,you’llprobablypick themupsomewhere between $15.40and$15.60.

Limit

Alimitorderinstructsyourbroker to buy or sell asecurityatapriceyouspecifyor better. That means if yousay to sell a stock at $10,yourbrokerwillselleitherat$10 or at a higher price. Ifyousaytobuyastockat$20,yourbrokerwillbuyeitherat$20oratalowerprice.Limit orders and stop

orders (next section) have atime period associated withthem.Whenyouplacealimitorder, it iseitheradayorderor a good-till-cancelled(GTC) order. A day orderexpires at the end of thecurrenttradingdayregardlessof whether or not itsconditionsweremet.AGTCorder remains open until itsconditions are met, whichmightneverhappen.I love limit orders anduse

them almost exclusively.There’s no better way toremain calm about themarkets than to evaluate acompany, decide on a fairprice to pay for its stock,specify that price to yourbroker in aGTC limit order,and forget about it. If thestockhitsyourbuyprice, thebroker buys and sends you aconfirmation statement. Ifnot, you never hear about it.Itworksthesameonthesell.

If a stock you own isbouncing around what youconsider to be a good sellprice, just call your brokerand specify your sell priceandnumberof shares to sell.Then forget about it. A fewdays later, perhaps, the stockwill spike up for a briefmoment, hit your sell price,andgoaboutonitswayupordown. You’ll receive astatement confirming yoursale.

You shouldn’t literallyforgetaboutyourlimitorders,of course.The last thing youwant is for a stock to hit itsbuy limit when you don’thave any money sitting inyourcoreaccount.You’llgettoknowyourbrokerrealwellifthathappens.WhenIsaytoforgetaboutyourlimitorders,I mean to relax and let themarketdoitssillything.Ninetimes out of ten, my limitorders come through and I

never sweat a drop waitingfor the precise right time tobuy and sell. I specify it inthe limit order. If it happens,great.Ifnot,Iletitgo.Of course, this is pure

hooey to some people. Theywouldsayit’slunacytoplacelimit orders and forget aboutthem.Theyareassumingthatthey can watch a stock andpicktherighttimetobuyandsell. If you bought MisterMagazine at $15.50 and it

rose to $30, would you sell?You could reevaluate and, ifyou thought it might gohigher, place a limit order tosell half your shares at $31.Some would say that’sfoolish because the stockmight rise to $35. Might,could, would have, almostdid, it happened once to afriend of mine, nearly camethrough—anybody cansurmise this way forever. Iwould be happy to have

tacked on an extra $1 tomysell price and to have kepthalf my shares. Then youcould place another limitorder for the remainder at$36. Ah, the critics say, butwhat if it rises to $40?Thenyoumadeamistake.In truth, you shouldn’t be

playing themarkets like that.You should always examinethe worth of the companiesyou own and determinewhether they’re still worth

owning.Who cares what themarket says they’re worth?Think like Warren Buffettand treat your stocks likeyour own companies. Theyare your own companies, acertain percentageof thematleast.Whenyoudodecidetobuy and sell, consider usinglimit orders. They take awaysome of the pressure andusually allow you to save afew bucks on the buy andmakeafewextraonthesell.

Stop

A stop order becomes amarket order when a priceyou specify is reached. Likelimit orders, stop orders areeither good for the day orgood-till-cancelled. If youownastockandinstructyourbroker to sell it at a pricelower than it currently tradesfor, that’s called a stop lossbecauseyou’restoppingyour

potential loss and protectingthe profit you’ve alreadygained. You can use a stoporder in the other direction,too. Technically it would becalledastopgain,butnobodycalls it thatbecauseitsoundssilly. What you’re reallydoing is ratcheting up thepointthatyouwanttosell.Whenthepriceyouspecify

inastoporderisreached,thestop order becomes amarketorder. That means your

broker will then trade thestock at its current price. Ifthe price is moving quickly,thatmightbehigherorlowerthan your stop. This is animportantdistinctionbetweenlimit orders and stop orders.Alimitordertradesthestockat the price you specify orbetter;astoporder tradesthestockatitscurrentpriceafterit touches the price youspecify. Thus, with a stoporder,yourtrademightoccur

atapricebetterorworsethanthestopprice.Togetaroundthisinherent

problemwithstoporders,youcanuseastoplimitorder.Asitsname implies, itcombinesthe features of a stop orderand a limit order. First, youspecifythepriceatwhichyouwantthestopordertokickin.Thenyouspecifythepriceatwhich you want the limitordertotrade.Ifthepriceyouspecifyinthelimitorderisn’t

reached, your order neverexecutes.Thatguaranteesthatyou won’t trade at a priceworsethanyouspecifyinthelimitorder.Let’s run through an

example. Say you’re eyeingMister Magazine at $15.50per share. You want to buy100shares if it startsmovingupward considerably. Youcould place a stop order at$17. That means that ifMister Magazine suddenly

spikes up to $19, your stoporder will become a marketordertobuy100shares.Iftheprice is moving quickly, theorder might not go throughuntil Mister Magazine asks$18. Perhaps that’s finewithyoubecauseyou justwant topickupyourshareswhenthestock breaks out. It’s moreimportant that you actuallybuy the 100 shares than it isto buy them at a specificprice.

Ontheotherhand,itmightannoy you to pay more forMister Magazine than youthink it’s worth. You stillwant to buy 100 shares if itstarts moving up. You couldplace a stop limit order withthe stop at $17 and the limitat $17.50. If the stock hits$17,yourstoporderbecomesa limit order to buy 100shares at $17.50 or better. Ifyourbrokercanonlyget$18,theorderwon’texecute.

Once you buy your 100shares, let’s think positiveandsaytheyriseto$30.Youdon’twant to lose theprofitsyou’vealreadygained,soyouplace a stop loss at $28. IfMister Magazine hits theskids and plummets to $18,yourorderwillkickinat$28and sell at the nextopportunity, which might belower than $28. That reallybugs you, so on furtherconsideration you decide to

cancel the stop order andreplace it with a stop limitorderwithastopat$28andalimit at $28 as well. Now ifMisterMagazineplummetsto$18, you might go with it.Why? Because your limitorder to sell at $28 or betterwon’tkickinifthepricehits$28 and immediately fallslower without ever comingback up. Know what youwanttodoandplacetherightkindoforder.

TrailingStop

Thisisanothertypeofstoporder,butIputitinaseparatesection because it deservesdistinction. The trailing stopis a tool I’ve come to loveovertheyears,asitoffersoneof the least stressful ways tomaximizeprofits.If the price of a stock you

own is rising but you thinkit’sgettingalittletoppedout,

what should you do? If yousell now and it keeps rising,you’ll be upset. If you don’tsell now and it reversesdirectionanddrops,you’llbeupset.Ohdear.Youwanttoownthestock

as long as its uptrendcontinues, and that’s thespecialty of trailing stops.They “trail” behind the priceas it rises upward but lockinto place when the pricebeginstofall.Youspecifyin

your order the price, orpercentagedistance,atwhichthestopordertosellkicksin.As with all stop orders, thisone can be a market, to sellimmediately,oralimit,tosellataspecifiedprice.When you set the price,

youdosowitheitheradollaramount or a percentagedistance. I prefer the latter.Thebigger thedollaramountor the wider the percentage,the less likely the order is to

trigger but the more lossyou’re willing to acceptbefore you sell. A typicalorder might be a 10 percenttrailingstop.Here’s how that would

work. You buy 2,000 sharesofMisterMagazineat$15.50foratotalof$31,000.Itrisesover six months to $26 pershare. Fantastic! However,you know that a 68 percentgain in six months isvulnerable to a pullback.

Earnings are coming up,though,andyou think they’llbe good and might give onelastpop to thepricebefore itsettles. You decide on a 10percent trailing stop lossmarket order and place it atyourbroker.Mister Magazine does

indeed beat earningsestimates—blowsthemaway,as the headline reads—andthe stock rockets up to $31.Youweresmarttostayinbut

also smart to know that norising trend stays steepforever. When you firstplaced the10percent trailingstop, its trigger price was$23.40, which was just 10percentbelowthe$26tradingprice. Now, after the post-earnings pop to $31, thetrailing stop’s new triggerprice is $27.90. You think,though,thatthestockismorevulnerable than ever becauseof the quick shot higher on

earnings,soyou“tightenup”the stop to 5 percent. Afterthat, the new trigger price is$29.45.The stock rises to $32 the

next day, which moves yourtrigger up to $30.40, thenfallsbackto$29,thento$26,and then to $20 beforeflatteningout.Wheredidyousell? At $30.40, right wherethe 5 percent trailing stoplockedinplace.See why I love trailing

stops?By theway,youcanusea

trailing stop at any time, notjustwhenyou’re sitting on aprofit. Sometimes a stockdrops immediately after youbuy it, andyouwant to limitthe loss but are willing togive it a little more playbefore cutting it off. Youmight be down 10 percentand set a trailing stop at 5percent to limit your loss to15 percent. That’s a trader’s

mindset, though,and inmostcases you’ll be better servedby an investor’s mindset. Ifyou did thorough researchandbelieveinthecompany,itshouldbebetter tobuymoreshares at the cheaper price,nottodumpthefirstones.Notalways,though,andin

caseswhereyouwanttostopthe loss but leave room forrecovery, a trailing stop willbeyourfriend.

6

ResearchtoRiches

It’stimeforyoutolearnhowand where to conductresearch,themostcriticalpartof investing. Every masterinvestor swears by it. Your

returns will be directlyproportional to the quality ofthe companies youbuy.Thatquality depends on yourresearch.Have no fear! There is

moreinformationavailabletoyou than you can use. PeterLynch wrote in One Up onWall Street, “I can’t imagineanything that’s useful toknow that the amateurinvestor can’t find out. Allthe pertinent facts are just

waiting to be picked up.”After reading this chapter,you’ll laugh at people whosay theycan’t investbecausetheydon’tknowwheretogetinformation.Isubmitthatitisnow more difficult to avoidinvestment information thanto get what you need. It’severywhere: from yourChristmas list to your libraryto themagazine rack at yourlocal grocery store,investment research is there

for you to snatch up, fileaway,andturnintoprofit.This chapter shows where

to get the information. Thenext chapter shows what todowithit.

PersonalExperience

Followyourmoneytofindgreatcompanies.Itworksfor

Peter Lynch and it canworkforyoutoo.Ifyouneedtojogyourmemory, take a look atyour last few credit cardstatementsoryourcheckbookregister. Where do yourepeatedly spend money?Life’snecessitiescan turnupgreat companies. Take food,for example. You might notwant to invest in your localgrocerychain,butwhataboutthatrestaurantchainyoukeepvisiting?Allyourfriendslike

it,thepapergaveitafour-starrating, it’s always packed,andthefoodiswonderfulandreasonably priced. It’s worthchecking into.That’showaninvestorfriendofminefoundStarbucksCoffeewhenitsoldsplit-adjusted at 75 cents inAugust 1992. In November2006, it reached $40. His$10,000 investment became$533,000.Hemighthavebeenhappy

to read the previous section

on trailing stops. Like moststocks, Starbucks wasdevastated by the crash of2008. It closed that year at$9.46,down76percent fromitshighinNovember2006.Awide trailing stop to givelong-term winner Starbucksroomtofluctuate,perhaps20percent, would have sold at$32.Evenifhehadsetthe20percent trailingstoponeyearearlier, inNovember2005, itstill would have sold at

$31.90 inAugust 2006, afterStarbucksspikedupto$39.88in May 2006, locking in thetrailing stop at $31.90. Hewould have felt bad asStarbucks recovered back upto $40 in the next threemonths but pretty goodduringthetwo-yearslidethatfollowed and took Starbucksto a low of $7.06 inNovember2008.How about clothing? Like

me, you might enjoy

watching people in publicplaces such as a shoppingmall.Whataretheywearing?One year, I noticed kidswearing Tommy Hilfigerclothes more and morefrequently. It didn’t take agenius to know the clothingwasfromHilfigerbecausethenamewasemblazonedacrossthefrontofeveryT-shirtandsweatshirt. I went into thedepartment stores and lookedforracksofHilfigerclothing.

Muchtomyintrigue,Ifoundentire sections of the storesdevotedtoHilfiger.InalocalMacy’s, “Hilfiger” hung inhuge gold letters against thewoodpanelingandthrongsofkids stood under the signholding shirts up to eachother for first looks. That’sdarned interesting to aninvestor,wouldn’tyousay?Ichecked out the company’snumbers and recommendedHilfiger to friends in spring

1993. A buddy picked upshares at $10.50 in July. Attheendof1996,hesoldthemfor$48.I have a more recent

clothing story for you.We’llcall it rags-to-riches-to-rags.Mymother and sister visitedmeinJapaninMay2006.Mymother wore a pair of Crocssandals that she raved aboutthe entire visit aswewalkedaround Tokyo and flowerparks near my home in the

countryside.She toldme thatCrocs were invented inColorado,wherewe’re from,and that everybody backhome had a pair. When myfriends in Japan saw thesandals, they asked aboutthem, tried them on, andwondered if I would buysome for them on my nexttrip back to the States. Anactionable tip? You bet.Shares of Crocs were lessthan a split-adjusted $12 that

May. In October 2007, theybroke$75foragainofmorethan 525percent in less thantwo years. I have a feelingPeter Lynch would love thisstory . . . up to this point.Along came 2008. If thecrash did what it did toStarbucks, imagine what itdid to the much smallerCrocs.AtitsNovember2008low,Crocs traded for just 79cents.Centsmindyou. In 11months, the stock fell 99

percent.Note to self: trailingstops.Food, clothing, and other

necessitiesaregoodplacestostart looking for companies.Onceyou’veexhaustedthem,think aboutwhereyou spendyour discretionary dollars,that is, for things you don’tabsolutely need. Perhaps youlovehomemoviesandnoticethat some companies justwon’tgoaway.Onemightbethe place you rent videos,

maybe Netflix. You couldhave bought it split-adjustedfor less than $5 in fall 2003and sold it for almost $40 inJanuary2004.Anothermightbe the movie companyDisney. If you decided backinOctober 1990 to getmoreout of Disney than a mousecartoon and a fewrollercoasters,youcouldhavepurchaseditsstockfor$8andsold it in January 2007 for$35. That’s a 700 percent

gain ina littlemore thanoneyear with Netflix and a 338percent gain in a little morethan 16 years with Disney,both of which you wouldhave found by just veggingout on home movies. Whosayscouchpotatoescan’tgetahead?Ifyourcompanyismaking

an officewide computerupgrade, somebody is goingto research which computersto buy. Ask that personwhy

he or she chose Apple, Dell,HP, IBM, or Sun. Maybeyour friends use the samebrand.Ifyourfamilyneedsapersonal computer, conductresearch yourself and payattentiontothethingsthatareimportant to you. Whatmatters to you and yourfamily probably matters tomillions of others. If onecompany meets your everyneed,checkitout.Youmightfind a kaleidoscope of big

name players and decide toresearchallofthem.Onewillprobably surface as a clearleader. If not, considerinvestinginmorethanone.Getting investment ideas

from your personalexperience is an easyway tostartyourstockstowatchlist,whichwe’llcoverinthenextchapter. Keep buying whatyou buy, but observe whatyou buy and who else isbuying it with you. Your

tendencieswilloftenprovetobe the tendencies of a lot ofpeople.Ifyouloveaproduct,sowillothers.Ofcourse,youneed tokeepyourwitsaboutyou and always conductfurther research beforeinvesting.Don’tbuystock inevery company you everpatronize. Even companiesyoulovecanlosemoney,likewe just saw with Crocs, andnot every successful productwill produce a soaring stock.

AsPeter Lynch points out, aproductthatisatinypartofacompany’s business can’tmove the stock very much.Sonomatterhowmuchyourkids love the lunar ball youbought for them, if it’s onlyone of 800 toys made byWhacky Whimsicals, youdon’t have much reason toinvest.Maybe thecompany’sMars mittens are causinghives to break out on littlehands everywhere and little

lawyers are filing littlepapers. Always look beyondyourfirstimpressions.

TheInvestmentGrapevine

Just past your personalexperienceliestheinvestmentgrapevine. After I noticedeverybody packed into the

Hilfiger clothing section, Iconducted further researchand decided Hilfiger was astock worth buying. Noticethat I didn’t actually buy itmyself,butIdidtellafriend.He bought it and made akilling.Where did he learn about

Hilfiger? From my personalexperience. He harvested theinvestment grapevine to findagreatcompany.Be careful of stories that

are too good. It’s humannature to talk about ourtriumphsandusuallytobuildthem up bigger than theyreally are. Remember thosefishing stories your grandpaused to tell every Christmaswhile your grandma rolledhereyes?Theywereprobablya lot closer to the truth thanhis investment stories.Always remember that anycompany you hear about isonly a lead. That is,

something to look intofurther. You probablywouldn’t hire a babysitter atthe advice of a friend whoheard about her from hismanager who talked to hisbrotherwhosawanadtackedto a telephone pole. Don’tinvest on that kind ofreferenceeither.Best friends,colleagues, and especiallyrelatives are notorious fortheirhot tips that freezeoverthemomentafteryoubuy.Be

warned and conduct yourownduediligence.Instead of tuning in to

somebody else’s success,listenforpeoplelamentinganinvestment gone bad. Ifsomebody conductedthorough research on acompany, decided it was agreat investment, andhappenedtobuyatthewrongtime,youcan takeadvantageof the situation to buy thatgreat company at a discount.

Unfortunately, most peopleprefer telling others abouttheirwinners.Toobadforthelistener because knowingsomebody’s runaway, high-flying stock isn’t nearly asuseful as knowing which oftheir holdings are down.Myfriends and I have made apointofdisclosingeverythingin our portfolios to eachother.Thatway,whenoneofus gets in at thewrong time,others can use that

information to buy a goodstockatabargainprice.And,ofcourse,thepersonwhogotin at the wrong time canalways buy additional sharestoprofitonthewaybackup.It pays to listen to tales of

woe.Thenexttimesomebodycomes up to you and startsbragging about their latesttriumph,askabouttheirmostdisappointing stock. Ask ifthey’re planning to buyadditionalsharesat thelower

price. Let other peoplemakemistakes with their moneywhileyoushowupintimeforthe recovery. If you keepinvesting long enough, Iguarantee you’ll have anopportunity to return thefavor.

Publications

Even though it’s anelectronic world these days,printed publications still playapart ininvestmentresearch.It’snice tocurlupwithyourfavoriteinvestmentmagazine,perusethepaperoveracupofcoffee,orreceiveanewslettertargeted to your situation.This section covers all formsofprintedpublications.

Magazines

Thefirstmoneyyouspendon investment researchshouldgotowardamagazinesubscription. They’re cheapand they’re packed withhelpful how-to articles andsome pretty darned goodinvestment advice. Nobodyconsidersitcooltogetagoodstock lead from a $5magazine purchased alongwith a carton of yogurt, butI’ve found some goodinvestments thatway.Oneof

my favorite techniques is tomonitor the model portfoliosshown for different moneymanagers or a list of stockschosen by the magazineeditors for one reason oranother. The magazinesmonitor the performance oftheirpicks,making it easy towait for some of them todeclineinprice.These aremy two favorite

investment magazines, andmyfavoritenewsmagazine:

SmartMoney

This is “The Wall StreetJournal Magazine,” and it’sexcellent. Flipping throughthe magazine gives you animpressionofquality.There’snotabloidfeeltoitlikeyou’llfind in many investmentmagazines. SmartMoney runsarticles on every aspect ofinvesting, but does aparticularly good job with

mutualfundsandstocks.Theeditors hold themselvesaccountable for their stockpicksandarealways strivingtoimprovetheirmethods.Byfollowingtheirprogress,yourownskillswillimprovealongwiththeirs.Contact Information: 800-444-4204,www.smartmoney.com.Annual subscriptions cost

$24.

Kiplinger’s

This magazine has abroader scope thanSmartMoney. Instead oftalking just about investing,Kiplinger’s moves into otherissues of personal businesssuch as credit card spending,loans, college tuition, and

vacation planning. Themagazine’s real claim tofame, however, is its mutualfund surveys. With cleargraphics and easily digestedtables, they lead the industryyear after year. Its columnsare nothing to sneeze at,either.Contact Information: 800-544-0155,www.kiplinger.com. Annual

subscriptionscost$20.

TheWeek

A big part of investing iskeepingyourfingerontrends.Forthat,youneedanefficientway to stay informed. Myfavorite news magazine isThe Week. It condenses thebest-written stories from theU.S. and international media

intoa tidymagazinethatyoucan read in a single sitting.Rather than churn out long,in-depth coverage, it printsonly the highlights fromseveralangles.Contact Information: 877-245-8151,www.theweekmagazine.com.Annual subscriptions cost$50.

Newspapers

Justabouteverynewspaperincludes stock tables, butthere are times when youneed more than a quote orvolume information. Duringthose times, it’s a good ideato check out one of the fourpapersinthissection.

TheWallStreet

Journal

This is certainly the BigKahuna among investmentnewspapers. Everybodywho’sanybodyglancesattheWSJfromtimetotime.It’sagood idea for you to do thesame.Thefrontpagecontainstop

news summaries in a sectioncalled “What’s News.” Aquick skim of the summaries

will alert you to items ofinterest. You can follow apage number to read thecompletearticle.The heart of the paper is

section C, “Money &Investing.”That’swhere youcan see how the Dow isperforming, what interestrates are doing, whether thedollar is falling or risingagainst foreign currencies,where commodities areheaded, and a slew of other

information. Read the topinvestmentstories,getquotesonevery stockyouown, andtracktheperformanceofyourmutualfunds.Contact Information: 800-975-8609, www.wsj.com.Annual subscriptionsofficially cost $215, but arefrequentlyofferedat$99.

Investor’sBusinessDaily

Investor’s Business Dailyis the result of WilliamO’Neil’sfrustrationinfindingwhat he considered the mostimportant information aboutstocks. Because he couldn’tfind it anywhere, he decidedtopublishithimselfandthuswas born Investor’s BusinessDaily.Youcanreadallabout

O’Neil’sinvestmentapproachonpage67.IBD covers news in an

executive news summary ontheleftsideofthefrontpage.It contains key national andinternational news in singleparagraphs. The right side ofthe front page coversimportant news stories indepth.Insidethefrontpageisa feature called “To ThePoint,” and it gets therequickly.You’llfinddozensof

newsitemsthatyoucancoverin a glance. The streamlinedfrontpagecombinedwith to-the-point summaries givesyou “twice as many newsitems inapageandahalf asyou’ll find in 60 pages ofother publications,” in IBD’sownwords. The paper printsa ton of features toonumerous to outline here. Ihave never purchased anissue of IBD that wasworthless. There’s always

somethinggood.IBD’s stock tables are

O’Neil’s main reason forstarting a new paper. Theycontain five SmartSelectmeasurementsyouwon’tfindanywhere else: earnings pershare rank for the past fiveyears, relative price strengthrank for the past 12 months,industry group relativestrength, an overallevaluationof salesandprofitmargin and return on equity,

andaccumulation/distributionforthepastthreemonths.Thefive measurements arecombined into a compositerating that gives the mostweight to earnings per shareand relative price strength.Thepaperalsoshowsadailypercentagechangeinvolume.Here’s a snapshot of themeasurements from IBD’sGooglelistingonFebruary1,2007:

Let’shaveacloser lookatthemeasuresfromIBD.

SmartSelectCompositeRating

This is a stock’s overall

score from 1 to 99, with 99beingthebest.ThecompositetalliesIBD’sfiveSmartSelectmeasurements, with extraweight given to earnings pershare and relative strength.Googlescoreda99.

EarningsperShareRating

This measurementcomparestheearningsgrowthof all companies and thenranksthemfrom1to99,with99being the strongest.Thus,by lookingat thisonesimplenumber, you know howGoogle’s earnings growthstacks up against IBM’s,Hewlett Packard’s, Pfizer’s,andHomeDepot’s.The paper takes each

company’searningspersharefor the two most recent

quarters and computes theirpercentage change from thesametwoquartersayearago.That result is combined andaveraged with eachcompany’sthree-tofive-yearearnings growth record andthe final figures for everycompany are compared witheach other. Thus, a companywith an EPS rank of 95 hasearnings figures in the top 5percent of all companies inthetables.

Google had a 98, placingitsearningsgrowthinthetop2percent.

RelativePriceStrengthRating

Thismeasurement looksata stock’s price performancein the latest 12 months.That’s it. It doesn’t look at

stories, earnings, or priceratios. It simply reports thehard numbers and answersthe question, how did thisstockperformcomparedtoallothers?IBD updates the numbers

daily, compares all stocks toeach other, and ranks themfrom 1 to 99, with 99 beingthe best. That means acompanywitharelativepricestrength of 90 outperformed90percentofallotherstocks

inthepastyear.Google had an 80. It

outperformed 80 percent ofallstocks.

IndustryGroupRelativePriceStrengthRating

This measurementcompares a stock’s industry

price performance in thelatest six months with theperformance of all otherindustries. The industry thenreceives a letter grade fromA+ to E, with A+ being thebest.You know by glancing at

this gradewhether a stock isoperating in a dominant orstruggling industry. IBD saysthat roughlyhalfofa stock’sperformance is traced to thestrength of its industry, the

theorybeingthatarisingtidelifts all boats and vice versa.Who’sdoingbetter,computerhardwaremanufacturers,foodprocessors, homeimprovement retailers, ortobacco companies? Thismeasurementwilltellyou.To see all the industries

ranked over the past sixmonths, find the IndustryGroup Rankings table in thenewspaper. The top tenperformers from yesterday

are printed in bold and thebottomtenareunderlined.Google’s industry,

Internet-Content, had a lettergrade of A and was ranked25. On that same day,Transportation-Airline wasranked 1, Leisure-Gaming/Equipwas ranked 5,Telecom-Wireless Svcs wasranked 10, Retail-Clothing/Shoewasranked45,Tobaccowasranked105,andBeverages-Alcoholic was

ranked120.

Sales+Profit+ROERating

This measurementcombines a stock’s recentsales growth, profit margins,and return on equity toprovide a quick snapshot ofcompany health. The stock

gets a grade from A to E,withAbeingthebest.GooglehadanA,placingit

among the healthiestcompaniesonthemarket.

Accumulation/DistributionRating

Thismeasurement looksatwhether a stock is being

heavily bought or sold bycomparing itsdailypriceandvolume over the past 13weeks. The stock receives agrade from A to E, with Abeing the best. An A grademeans the stock is underheavyaccumulation,orbeingbought frequently. An Egrade means the stock isunder heavy distribution, orbeingsoldfrequently.IBDistryingtoconveythe

direction that the price is

likely to head as a result oftrading trends. In otherwords, is the trend one ofaccumulationwhere thepriceshouldriseasaresultofhighdemand,oristhetrendoneofdistribution where the priceshould fall as a result of lowdemand?Google was graded B+.

That’sgoodaccumulation.

VolumePercentChange

IBD calculates the averagedaily trading volume of eachcompany’s stock during thelast 50 trading days. Then itcompares each day’s tradingvolumetothe50-dayaverageandprints thedifferenceasapercentage.Google’sdailyvolumewas

71percenthigherthanusual.

Contact Information: 800-831-2525,www.investors.com. Annualsubscriptionscost$295.FinancialTimesIf you’re craving a global

perspective, consider theFinancial Times of London.The so-called pink pages,named after the distinctivecolor of the paper, bring younews, editorial, and global

market prices withcommentary.Oneofmyfavoritefeatures

is the single-topic specialreports. Each one covers acountry, an investment trend,a new business strategy, anindustry breakthrough, orsomething similarly focused.Ifyouhappentogetthepaperwhen it’s focused onsomething of interest to you,the briefing will be veryuseful. Other times, you

mightjustdiscoversomethingyouhadn’tconsideredbefore.Another nice feature for

those too busy to read everyday is the SaturdayWeekendFT that summarizes theweek’skeyevents.Contact Information: 800-628-8088, www.ft.com.Annual subscriptions in theU.S.cost$198.Barron’s

IfTheWall Street Journallost your business, Barron’smight catch your fancy.Either way, you’re dealingwithDowJones&Company.Itownsbothpapers.I like Barron’s a lot. It’s

published every Mondayinstead of every morning.Weekly information is oftenall you need. Also,Barron’sis published in a convenientmagazinestylethat’seasiertoread on restaurant tables and

airplanes. I hate bending andfolding thepagesof standardsize papers to keep readingthe current story. WithBarron’s, you just turn thepageslikeamagazine.So,onthe publishing side ofcustomer satisfaction thispaperwinstwothumbsup.Itsfrequency is just right, andit’seasytouse.The center of each paper

contains “MarketWeek,” themeat and potatoes data. It

shows vital signs of theeconomy, theweek’s biggestwinnersandlosersfromeachexchange, and superblydesigned stock and fundtables. Unlike the typicalpaper’s crunched,overlapping columns,Barron’s prints tables thathave white space betweendifferent pieces ofinformation. Though thetables don’t contain data asvaluable as that in IBD, they

do display the most recentearningsandcomparethemtoearningsfromayearago.Themutual fund tables showperformance for the lastweek, year-to-date, and threeyears. Finally, “MarketLaboratory” will give youplenty to think about for thenextweekasyouponderhowevery relevant indexperformed, how muchvolume the markets moved,every economic indicator,

andsoon.Contact Information: 800-975-8620,www.barrons.com.Annual subscriptions cost$149.

Newsletters

A newsletter should be atrusty friend whoaccompanies you throughgood times and bad. It’s

important that you like therelationship that a newslettereditorbuildswithyou.Heorshe should be honest, admitmistakes, and work hard tohelp you get ahead. Nobodyis perfect in the stockbusiness, but somebody whocanprovideyouwithasteadystream of good ideas in anunderstandable manner willprove worth the subscriptionprice.This section shows six

goodstocknewsletters.

DickDavisDigest

The Dick Davis Digestpioneered the newsletterdigestapproachonthetheorythat no single investmentadvisorhasallthebestideas.The Digest is chock full ofinformation. Companiescovered in each issue are

listed alphabetically on thebackpage,makingiteasyforyou to monitor the latest onstocks you own or arewatching. The storiesassemble expert informationfrom other newsletters intothis one convenient source.For casting a wide net, it’shard to beat the Dick DavisDigest.Contact Information: 800-

654-1514,www.dickdavis.com. 24issues per year, 12 pages,$145.

Grant’sInterestRateObserver

If you’re looking to readwhattheprosreadandtousethe information better than

they do, consider Grant’s. Itpublishes some of the mostinsightful marketcommentary I’ve found. In awrytone,theeditorsdeliveracarefullookatbalancesheets,CEO comments, analystrecommendations, and thedisposition of the market. Intheir own words, “Notknowing exactly what thefuture may bring, we try toidentifychangewhereitmostfrequently occurs: at the

margin.”Contact Information: 212-809-7994,www.grantspub.com. 24issues per year, 12 pages,$850.

TheKellyLetter

On my website, I publish

articles and track theperformance of myinvestment ideas—includingthe ones in this book. Putyourselfonmyfreeemaillisttoreceivenotesonthecurrentmarket. Subscribing takeslessthantensecondsbecauseIaskforonlyyournameandemail address. If you’rewilling to part with $5 permonth, upgrade to TheKellyLetter and receive exclusivemaster investor profiles like

thoseinChapter2,followtheprogress of my permanentportfoliosfeaturedinChapter4, see exactly what stocks Iown, what stocks I’mwatching to buy, what I’mselling, and my marketanalysis.Ifyoulikethisbook,you’lllovetheletter.Contact Information:www.jasonkelly.com. Morethan48issuesperyear,email

delivery,$5.48permonth.

MorningstarStockInvestor

Morningstar is an industryheavyweight, firstmaking itsname in mutual funds andthenmovingon tostocks. ItsStockInvestor newslettercontains aggressive and

conservative portfolios,analyst commentary, and alist of stocks to sell. Thepublication focuses onstrategies used by successfulinvestors and tries to putthose strategies into a usableform.The smart table designand astute writing make thisone of the most enjoyablereadsonthemarketplace,andprofitabletoo.

Contact Information: 800-735-0700,www.morningstar.com. 12issues per year, 24 pages,$119.

TheOutlookOnline

Published by Standard &Poor’s,TheOutlookisoneofthe most widely readinvestment newsletters. S&P

analystsprovideclearmarketcommentary, stock updates,stockscreensbasedonS&P’sSTARS rankings and FairValue rankings, andinvestment recommendations.Youcan findTheOutlook ina three-ring binder at mostpubliclibraries.Justaskforitat the reference desk. Mostindividualinvestorssubscribeto themoreaffordableonlineedition. To read more aboutSTARS and Fair Value, see

“S&PSTARS/FairValue”onpage222.Contact Information: 800-523-4534,www.spoutlook.com. 48issues per year, onlinedelivery,$200.

OutstandingInvestorDigest

Of Outstanding InvestorDigest,WarrenBuffettwrote,“I’dadviseyoutosubscribe.Iread each issue religiously.Anyone interested ininvesting who doesn’tsubscribe is making a bigmistake.” That’s about asmuch endorsement as anypublicationshouldeverneed.Outstanding Investor Digestis a collection of the bestideas from the brightestinvestment minds around. It

prints exclusive interviews,excerpts from letters toshareholders, conference calltranscripts,andother“inside”scoops. The front table ofcontents shows the names ofinvestors featured in thatissueandanalphabetized listof companies covered inside.Next to the table of contentsare the beginning paragraphsfrom several key articles.Outstanding Investor Digestisaneclecticpublication that

varies in length and isdelivered on a sporadicschedule. It’s an investmentgoldmine.Contact Information: 212-925-3885, www.oid.com. 10issues, 32 pages, $295 forrecurring annual subscriptionplan.

ValueLine

Value Line publishes thepremier stock research tool,The Value Line InvestmentSurvey. It covers around1,700 companies. Almosteverythingyoucouldwanttoknowabouteachcompany iscondensed to a single page.When you get to this book’sstrategy and begin filling outthestockstowatchworksheetin theback,you’ll useValueLineexhaustively.BegunbyArnoldBernhard

during the Great Depression,Value Line boasts more than100,000 subscribers today. Ifyou count the number ofpeople who look at reportsfrom libraries or photocopiesfrom brokers, Value Line’susersnumber in themillions.Thecompany’sanalystshavelearned a thing or two aboutstock research over the pastseven decades. Let’s take acloserlookatTheValueLineInvestment Survey. First,

we’ll look at IBM’s profilebackin1997,thenwe’lllookat its profile in 2009. Seeinghowacompanyevolvesovertimeishelpful.

ThePartsofaValueLinePage

Let’s say that back inJanuary 1997 you got a hot

tip from your neighbor thatIBM had fully recoveredfrom its dark days in 1993and was poised for greatthings.Youdecided tocheckit out by looking up IBM inValueLine.What youwouldhave found is on pages 168and169.Doesn’tthatlooklikelight

reading? Actually, it is onceyou familiarize yourselfwiththe most important parts—which I’ve conveniently

numberedandhighlightedforyou. Now I’ll take you on atour of IBM’s Value Linepage.

1.TheRankings

Value Line ranks everystock from 1 to 5 fortimeliness and safety, with 1beingthebest.Timelinessisagaugeofthestock’sprojectedperformanceoverthenext12

months as compared to allother stocks followed byValue Line. The measureexamines a company’searnings momentum and thestock’s relative strength. Therankingsaredistributedalongabell curve.Stocks ranked1or5eachaccountforabout5percent of all stocks, thoseranked 2 or 4 each accountfor about 17 percent of allstocks,and theremaindergettheaverage3rank.

The safety measure looksat a stock’s volatility andfinancial stability, thenassigns a rank of 1 to 5 justlike the timeliness rank.Stocksranked1forsafetyarethe least volatile and moststable, thoseranked5arethemostvolatileandleaststable.Are the rankings

foolproof? No. If they were,stock research would consistof simply choosing stocksfrom those ranked 1. Worth

ran a story on Value Line’sranking system in February1997. Value Line’s researchchairman,SamuelEisenstadt,remarkedontheusefulnessoftheranks:“Justgetridof thefours and fives from yourportfolio and you’ll do well.The system almost doesbetter at signaling the poorstocksthanatpickingoutthewinners.”You can see on the sheet

that IBM was ranked 2 for

timeliness and 3 for safety.Evidently,Value Line agreedwith your neighbor aboutIBM’sbrightfuture.

2.PriceProjectionsandInsiderDecisions

HereyoureadValueLine’sprojectionsforthestockpriceover the next three to fiveyears, and the annualpercentage return that it

translates to. You’ll recordthe projected price high andlowonyourworksheet.Below the projections is a

box for insider decisions. Itlists the buy and sell activityofcompany insiders foreachof the past nine months.You’llwritethebuysonyourworksheet.IBMwasprojected togain

asmuch as 80percent in thenext three to five years. Theworst case expectationwas a

20 percent gain. In the lastnine months, three insiderschosetobuystock.

3.P/ERatioandDividendYield

Because P/E and dividendyield are so commonly used,Value Line prints the currentmeasurements boldly at thetop of the page. You see onyour sheet that IBM was

currently trading with a P/Eof14andadividendyieldof.8 percent. To give you abarometer reading of IBM’stypicalP/E,ValueLineprintsthemedianP/Efromthepast10years.IBM’swas15,thusthe stock was just slightlycheaperthanusual.

4.PriceHistoryChart

Thechartplots stockpriceover the past decade or so.The overall trend line iscomprised of little verticallinesforeachmonth.Thetopofeachvertical lineindicatesthe month’s price high, thebottom indicates themonth’sprice low. The price highsand lows for each year are

printed at the top of thegraph.In addition to the price

history, there are two otherlines on the graph. The solidblacklineiscashflow,averyimportant measure of acompany’s financialstrength.It shows how much moneywas actually coming into thecompanyover theyears.Thedotted line is relative pricestrength.Thatlineshowsyouhow the stock was

performing compared to allother stocks. It usuallyfollows roughly the samepattern as the stock priceitself.Thatis,whenthestockis falling it is performingpoorly compared to otherstocks.Makessense,right?Looking at IBM’s chart,

yousawthatyour friendwasrightaboutanotherthing.Thestock had definitely roaredbackfromitsdismal1993.

5.HistoricalFinancialMeasurements

Here’s the data dump.Value Line prints acompany’s financialmeasurementsforthepast16years or so. There’ssomething for everybodysuch as earnings per share,dividends per share, averageannualdividendyield,andnetprofitmargin.I’veputarrowsnexttothemeasurementsthat

show up on your stocks towatchworksheet.Thissectionisexcellentfor

spotting trends. For instance,if the company’s net profitmargin is slipping from yearto year, that’s a bad sign. Ifworking capital is decreasingand debt is increasing, that’sanother bad sign. If earningsare growing steadily fromyear to year, that’s a greatsign.As for IBM, it looked

prettygood.Its1996earningsper share were just 2 centsbelow 1995, which was thebest year on the chart. Bothyears were a far cry from1993’s loss and 1994’smeasly 4.92. The net profitmargin was 8.1 percent in1996, a gain from the yearbefore and one of the bestover the previous five years.It’s always nice to see animproving profit margin.Also, 1996 debt was $8500

million, down from $9000millionin1995andthelatestin a steady debt decreasefrom 1993’s $15245million.Hmm,perhapsyourneighborwasontosomething.

6.CapitalStructure

Thisiswhereyouseehowmuch debt the companycarriesandhowmuchstockisoutstanding.Debtiscriticalin

evaluatingacompany,asyoushould know by now. EveryoneofthemasterinvestorsinChapter 2 says to avoidcompanies with excessivedebt. You’ll write thecompany’stotaldebtonyourworksheet.IBM’s long-term debt was

$9669million.

7.CurrentPosition

A company’s currentposition shows its short-termhealth. It looks at assets thatcan be quickly turned intocash and liabilities that areduewithinayear.You’lluseinformation from this sectionto compute the current ratioand quick ratio on yourworksheet. Both are simpleevaluations of a company’sshort-termhealth.IBM had current cash of

$7002 million, current assets

of $39379 million, andcurrent liabilities of $31071million. Those numberstranslated into a current ratioof1.27(currentassetsdividedby current liabilities) and aquick ratio of .23 (currentcash divided by currentliabilities). Those numberswereadequate,Isuppose,butnothing to sound trumpetsabout. I like to see currentratios of at least 2 and quickratiosofatleast.5.Whatwas

most disturbing to me aboutIBM’s 1996 numbers is thatthey were worse than 1994and1995.Inbothprioryears,cash and current assets werehigher, and current liabilitieswerelower.Overalldebtwascoming down, however, somaybe some of those currentassets were going to goodstuff. Still, thiswas a tarnishon IBM’s otherwise sterlingreport.

8.AnnualRates

In this handy box, ValueLine computes rates ofchange for importantmeasures like revenues, cashflow, and earnings. Includedare the rates of change overthe past ten years, past fiveyears, andprojected rates forthe next five years. You’llwrite projected revenue andearningsonyourworksheet.IBM had definitely turned

itself around, judging fromthe annual rates. Its earningshad fallen over the past tenandfiveyears.However,theywereprojectedtoincreaseby23.5 percent over the nextthree to five years. That’sexcellent.

9.QuarterlyFinancials

For the last five years,Value Line prints quarterly

figures for sales, earnings,and dividends.You can lookover these tables to see if acompany’s business isseasonal or steady all yearlong. IBM’s numbers wereconsistent from quarter toquarter. I guess people buytechnology and relatedservicesallyearlong.

10.Business

This humble little box inthe center of the pagesummarizes the basics abouta company. You read aboutits main business, sidelinebusinesses, howmuch of thecompany is owned by itsdirectors, and where tocontactthecompany.From reading this

information, youwould havelearned that IBM was theworld’s largest supplier ofbig-time computer

equipment. It also made 18percent of its money fromsoftwareand10percentfromservices.Afull48percentofits business came fromoverseas. That’s great toknowifyou’reworriedaboutthe U.S. economy. Finally,directors owned less than 1percent of the stock. That’snot good to hear. You wantdirectors to own a lot of thestockbecausethentheyactinits best interest. If your

investment ship sinks, youwant the people in charge ofthecompanytogetwet,too.

11.Analysis

One of Value Line’ssecurities analysts followsevery stock. In this section,the analyst gives his or heropinion on the company’scurrent status and futureprospects.

IBM’sValue Line analyst,George Niemond, said thecompany was doing betterthan he expected. He saidIBM would post solidearnings in 1997 and shouldcontinuedoingsothroughtheendof thedecade.One thinghedidn’tmentiondirectlybutyou could infer from the lastparagraphwas that IBMwaswellpositioned toexploit thegrowing popularity of theInternet. Mr. Niemond

pointedout that IBMalreadyhad a powerful globalbusinessnetworkinplace,heacknowledged thecompany’sexpertise in networking, andhehighlightedIBM’s interestin electronic commerce. Allthree of those strengthsweregoingtohelpIBMownsomeoftheInternet.Ifyouthoughtthe Internet had a future,perhaps IBM would havemade a good investment foryou.

Attheveryleast,yourtimespentwithValue Line wouldhave given you some realmeat to chew with yourneighbor. Your opinionswould be based on hardevidence, not just tipswhispered over your fencewhilethelawnmoweridles.Let’ssaythatafterreading

the Value Line information,you decided to buy 100sharesofIBMonFebruary3,1997, at $155. On May 28,

1997, the stock split 2-for-1and you had 200 shares. OnMay27,1999, thestocksplit2-for-1 again and you had400 shares. By February 3,2009, with IBM at $93 pershare, your initial $15,500was worth $37,200. That’s a12-year gain of 140 percent.During that same time, theS&P 500 gained just 6.6percent, so you’re prettyhappy.You wonder, though, if

you should hold on longer.Whereshouldyoulooktoseehow IBM’s doing now?ValueLine,ofcourse.

TheJanuary2009ValueLineProfile

Whatyou find is thatyourold pal George Niemond isstill following IBM. His

January 9, 2009, installmentisonpages174and175.The format should look

familiar.Inourever-changingworld, isn’t it nice to knowthat some things remain thesame?As it was back in 1997,

IBM was still ranked 2 fortimeliness,but itssafetyrankimproved to 1. Move youreyesdownandnoticeasmallchange in the profile, theadditionofthetechnicalrank

below the safety rank. Itlooks at the stock’s relativeprice performance over thepast52weeksandthenranksthe stock based on howwellit should perform against themarket in the near term.Stocks ranked 1 or 2 shouldoutperform themarket in thenext quarter or two, stocksranked 3 should follow themarket, and stocks ranked 4or5shouldunderperformthemarket.

The technical rankprobably seemsa lot like thetimeliness rank to you. Theway they’re different is thattimeliness considers thecompany’s earnings whenprojecting near-termperformance; the technicalrank does not. It considersonlystockpriceperformance.Whichshouldtakeprecedent?Timeliness. Straight fromValue Line’s glossary comesthis handy tip: “Under no

circumstances should thetechnical rank replace thetimelinessrankastheprimarytool inmakingan investmentdecision. Over the years, thetimeliness rank has had asuperior record.” Of course,seeing both ranked 1 or 2wouldbebestofall.

IBM’s technical rank was3. That’s neutral, but itstimeliness was positive. Alltold, the ranking box gaveIBMagreenlight.Thestockwasprojectedto

gain asmuch as 170 percentin thenext twotofouryears.The worst-case projectionwasa120percentgain.IBM’s P/E ratio was 9.1,

much cheaper than it was in

1997.Notice the trend.From1997, it increased to almost29 in1999,stayed in the20suntil 2003, then begandeclining.Atthebeginningof2009, IBM was the bestbargain it had been in years.Anothergreenlight.Glancing at IBM’s price

chart,youseethatthebulkofyourgainshappenedbetweenwhenyouboughtin1997andwhen the stock toppedout inJuly1999.Ifyou’dhavesold

then, you would havepocketed gains of some 280percent, but don’t beatyourself up too much. Fewpeople timed the end of thedot.com bubble correctly.What you see after the crashisthatIBMtrendedupalittlethen down a little, rose 80percent from its 2006 low toits2008highbeforecrashingwith therestof themarketatthe end of 2008, then lookedin January2009 tobebasing

forarecovery.Anothergreenlightforholdingon.The earnings trend looked

solid.Fromwhenyouboughtin 1997, earnings per sharerosesteadily to4.44 in2000,slid down to 3.95 in 2002when all of technology washurting in the post-crasheconomy,butturnedupagainin the recovery. In yearsfollowing 2002, IBM’s EPScame in at 4.34, 5.05, 5.22,6.06, 7.18, 8.75, and were

expected to be 9.25 in 2009.That trend line is a beauty.Anothergreenlight.IBM looked good by the

numbers, and Mr. Niemondagreed in words. He wrotethatIBMprobablyhadagood2008 with strong System zmainframe and softwaredemand, and growingservices signings. He notedthe tough economicconditions but said the needforcompaniestosavemoney

couldworkinIBM’sfavorascustomers turn to it asawayto consolidate theircomputing needs. He alsoliked IBM’s focus onemerging economies aroundthe world. He thought thesefactors plus IBM’s ongoingstock-buybackprogramcouldboost the share price by 5percent in the next year. Heconcluded,“IBMshareshavesome appeal . . . shareearningsshouldagainstart to

expand at a double-digitannualpace.”Howabouta real-life test?

Decide now whether youwould have held yourposition or sold it. Then,check IBM’s current price tosee how you would havedone. To help with yourcalculations, write down thatIBM was $93 and the S&P500 was 839 on February 3,2009. Since then, whichperformedbetter?

WheretoFindValueLine

YoucouldfindValueLinereportsinyourmailboxeveryweek.Anannualsubscriptioncosts $598. With that, youreceive a large bindercontainingall1,700reportsin13 sections. Each week, anewsectionarrivestoreplaceoneoftheexisting13.Asyoucan see, the entire binder is

updatedevery13weeks,or4timesayear.If you want to give it a

whirlbutaren’t ready topartwith $598, consider a trialsubscription.Foramere$75,yougettheinitialbinderwithall 1,700 reports and you getthenext13weeksofupdates.After the trial runs out, youcan assess whether you usethereportsenoughtojustifyafull subscription. You canbuy a trial subscription once

everythreeyears.Perhapsyoudon’twantall

1,700reportstakingupspaceon your bookshelf. Instead,you just want reports for thecompaniesthatinterestyouatany given time. Then turn toyour local library. NearlyeverydecentlibraryI’vebeento has a copy of Value Lineavailable. You can stop bywith a list of companies thatinterest you, look them up,photocopy eachpage, andbe

onyourway.Finally, youcandowhat I

doandsubscribetotheonlineedition. It provides the entiresystem in both HTML andPDF formats, enables you tosearchforprofilesbyenteringcompany ticker symbols, andoffers a stock screener withwhich you can create andsave your own searches. Athirteen-weektrial is$65anda one-year subscription is$538.

Contact Information: 800-833-0046,www.valueline.com. Annualsubscriptions cost $598 forprintand$538foronline.

LimitedCoverageinValueLine

One drawback to TheValueLineInvestmentSurvey

is that it covers only 1,700stocks.They’rethebig,well-establishedcompanies.ValueLine does publish anexpanded volume called theSmall&Mid-capSurvey thatreports on 1,800 additionalcompanies. The expandedreports lack analystcommentary and projections.Combined, the Value Linestandard and expandededitionsstillcoveronly3,500stocks. That leaves about

17,000 companies withoutValueLinereports.Thus, for small companies

thatyoutrulydiscover,you’llneed to turn elsewhere forcritical information. Suchalternate sources includeeverything in this chapter,most notably informationfrom the companiesthemselves. Financialstatements tell you a lot ofcritical information about acompany. Also, custom

softwarepackagesandonlinescreeners such as Yahoo!FinanceStockScreener(page185)providemuchofwhat’scontained in Value Line’spublications.Standard & Poor’s StockGuideAnother professional

publicationsimilarinspirittoValue Line is Standard &Poor’s Stock Guide. It listsvital information about eachstock in a single row

spanning two pages. You’llfind a description of thecompany’sbusiness,itsstockprice range in several timeperiods, its dividend yield,P/Eratio,5-yearearningspersharegrowth,annualizedtotalreturns, current position,long-term debt, and earningsforthepast5yearsandpast6months.The guide is considerably

smaller than Value Line. Itcontains everything in a

single softboundvolume. It’supdatedmonthly.You can find Standard &

Poor’s Stock Guide at mostlibraries,oryoucansubscribetoreceivemonthlyupdatesinyourmailbox.Contact Information: 800-523-4534. Annualsubscriptionscost$145.

CompaniesThemselves

Before investing in anycompany, some people insiston seeing an investor packetfrom headquarters. In there,you’ll find an annual reportcontainingahappylookatthecompany’s future andfinancial statements thatmaynotbeashappy,a recent10-

K and a recent 10-Q, pressreleases, analyst reports, andgeneralinformation.Formanysmallcompanies

thatinterestyou,thecompanyinvestment packet will formthe bulk of your research.Value Line and Standard &Poor’s don’t cover mostsmall companies. The wholeidea of discovering smallcompanies is, well,discovering them. If ValueLine and Standard & Poor’s

and everybody else alreadyknows about them, they’vebeendiscovered.This section showshow to

request an investor packetandhowtouseit.

RequestanInvestorPacket

Get the company’s phonenumber somewhere. Youmightget itfromValueLine,a magazine article, the

Internet, a custom softwarepackage, or directoryassistance. On the WorldWide Web, try typingwww.NAME.com to find thecompany’s site. For instance,you’ll find Microsoft atwww.microsoft.com, IBM atwww.ibm.com, FederalExpress at www.fedex.com,and Ford at www.ford.com.The company site shouldcontain investor informationandmightincludeabuttonto

requestacompletepacket.Atthe very least, you shouldfindthephonenumber.Ifthecompany name isn’t itsWebaddress, search on thecompany name at a site likeGoogle or Yahoo! They willprobably return lots of sitelinks for you to explore forthephonenumber.Onceyouhavethenumber,

call it and ask to speakwiththe Investor RelationsDepartment. The receptionist

might ask if you need aninvestor packet and just takeyour address on the spot.Otherwise, you’ll betransferred to InvestorRelations. Tell the friendlyvoicethatyouwantakitthatincludes:

✔ The annualreport✔ The 10-K and10-Q✔ Analystreports

✔ Recent pressreleases✔ Any freeproductsamples

While thefreesamplesarea long shot—especially ifyou’re investing in Ford orBoeing—the rest is prettystandard.Aweek to tendayslater, your veryown investorpacket will arrive free ofcharge. What a joy,capitalism!

If you can’t find thecompany’s phone number,contact the Public Register’sAnnual Report Service toobtain a free current annualreport for any publiccompany. The website iswww.prars.com and thephone number is 800-4-ANNUAL.Youcanorderupto eight annual reports at atime.Youwon’tgetapacketas complete as the one frominvestor relations, but the

annual report is better thannothing.Tearopentheenvelopeand

...

ReadtheInvestorPacket

Clear a space on yourkitchen table or desk andspread the contents of theinvestor packet in front ofyou.

AnnualReport

Start with the annualreport. It’s probably veryattractive because it’s asmuchmarketing collateral asit is informative. Sometimes,if you’re researching veryyoung companies, the annualreport will be little fancierthan a student term paper. Ipersonally like that. Themoney can be put toward

something that will earn aprofit. That’s what we’re allinthisfor,darnit!Opening the report, you’ll

probably be greeted with aletter from the ChiefExecutive Officer. Next,you’llpagethroughphotosofcompanyheadquarters,happycustomers, select employees,and lots of product displays.Followingthephotogalleryisusually an article about thecompany’s roots, its recent

accomplishments, its missionstatement, and how wellequipped it is for the future.Theeasygoingstuffgenerallyconcludes with a reprintedadvertisementoronethatwascreated specifically for theannualreport.They’re all a bit different,

but that’s the general idea.Read over the fun stuff, thenmove along to the financialstatements. They’re almostalways contained in the back

half of the annual report, butoccasionallythey’reseparate.Let’s learn about the

financial statements bylooking at real-life numbersfrom IBM’s 2006 annualreport. We also examinedIBMontheValueLinereportearlier.

BalanceSheet

Abalance sheet is a quicklookatwhatacompanyownsandwhatitowes,alsoknownas assets and liabilities. Thedifferencebetweenthetwoiscalled stockholders’ equityand is what causes thebalance sheet to balance.RatherthandragyouthroughAccounting101,I’mgoingtohighlight just the importantparts of the sheet. Here’sIBM’s:IBM2006BalanceSheet

Liabilities

Assets

Assets are divided intocurrent and long-term.Current assets are things like

money in the bank anduncollected invoices. Long-term assets are things likebuildings. I spared you thetedious divisions on myexcerpt and just showed acouple important items alongwiththetotal.Cash is exactly what you

thinkitis.Attheendof2006,IBM had $8 billion in itsbank account—nearly twicewhat I had at the time. Youwant a company to have

plentyofcashsoitcanpayitsdebts and take advantage ofopportunities, suchasbuyingsmallercompanies.Notes and accounts

receivableismoneythatIBMwas owed by customers forcomputerhardware,software,and services. Whereas yourdrinking buddy might oweyouatenspotforlastFriday,IBM’s buddies owed thecompany $10.8 billion at theend of 2006. On the one

hand,it’sgoodtoseealotofmoneycomingtoIBMinthefuture.Ontheotherhand,youdon’t want receivables togrowfasterthansales.You’llfind sales on the incomestatement.Therestoftheassetsection

shows things likemarketablesecurities, inventory, plantandproperty,andotherthingsthat IBM owned. I’ve addedit all together as “a bunchofotherstuffIwon’tlist.”

Liabilities

Liabilities are also dividedinto current and long term.Current liabilities are duewithinayearwhilelong-termliabilities are due further inthefuture.The liabilities section is

pretty straightforward. Taxesare what the company owesto the IRS just likeyouneedtopayeveryyear.

Debt is bad. You wouldliketoseeaslittledebtonthebalance sheet as possible,both current and long term.You’d love to invest incompanies that don’t haveany debt. As Peter Lynchpoints out, a company can’tgobankrupt if itdoesn’toweany money. IBM owed astaggering$22.7billionattheendof2006.The last item is accounts

payable. That’s the money

IBM needed to pay itssuppliers for itemspurchasedoncredit.

Stockholders’Equity

Stockholders’ equity is thedifferencebetweenassetsandliabilities. It consists ofoutstanding shares of stockandother things likeretainedearnings and unrealized

gains. Added to liabilities,stockholders’ equity causesthebalancesheettobalance.

IncomeStatement

An income statementshows the company’searnings and expenses. It’swhereyoucan figure theall-importantgrossprofitmargin,thedifferencebetweenwhata

company earns and what itspends.Here’sanabbreviatedversion of IBM’s incomestatement:IBM 2006 IncomeStatement

Cost

There’s not a lot to it,really. Revenue shows youwhat IBM sold in eachdivision of its business. Costshows you what it cost IBMtoachievethosesalesineachdivision. Then the statement

breaksthenumbersdownintoinvestor-centric stuff likegross profit and earnings pershare.You can see that IBM

increased its revenue whilereducingitscostfrom2005to2006,therebyaddinganextra$1.8 billion of gross profit.That’sagoodsign.Youwantgrossprofittogrowfromyeartoyear.Grossprofitgrewalot,and

so did earnings per share.

Each share of stock earnedonly$4.96in2005butearned$6.20 in 2006. That’s a 25percent increase! Currentshareholders love to see that.The bottom of the incomestatement provides anadditionalexplanationfor thejump in earnings per share:There were 70million fewershares in 2006 than in 2005.IBMbought back a lot of itsstock,anotherplusforcurrentinvestors.

Want to check IBM’smath? On your calculator,divide the 2006 net earningsapplicable to commonshareholders (9,492,000,000)by the number of sharesoutstanding in 2006(1,530,806,987) and see ifyougetthesamenetearningspersharefigurethattheygot.If you don’t, call theSecurities & ExchangeCommission . . . or yourcalculatormanufacturer.

10-Kand10-Q

If you want hard numberswithout all the fancymarketingcopy in theannualreport, you’re going to lovethe10-Kand10-Q.Eachisameatier version of thefinancialinformationfoundinthe annual report. 10-Kscomeoutyearlywhile10-Qscome out quarterly. 10-Qsinclude management

discussion of current issuesfacing the company. 10-Ksareaudited,10-Qsarenot.Asfor the numbers on thesesheets, you’ll find revenues,costs, expenses, operatingprofits, net income or loss,andotheritems.

StockScreeners

Sincetheearliereditionsofthis book, it’s become easierand cheaper to find goodstocks. As recently as a fewyears ago, stock databasescame on CDs. You had toinstall theprograms, thengetdata updates by downloadingfiles from websites orreceiving new CDs everymonth. The programs wereexpensive, too. Some costmorethan$500peryear.Freeonlinestockscreeners

have changed the rules. Prosused to scoff at pared-downtoolsfromplaceslikeYahoo!Finance, and some still do.Thethingis,freetoolsarenolonger pared down. They doeverything an individualinvestor needs them to do.Much as I’ve looked—andI’velookedalot—Ican’tseeanycompellingreasontopayforstocksoftwareanymore.All youwant froma stock

screener is quick, easy

research that allows you tomake your own bestdecisions.With thatdirectivein mind, let’s look at threescreeners.

Yahoo!FinanceStockScreener

This is what I use everyday. It provides fast resultsthat you can sort by anycriterion.Ifyougettoomany

companies, just add morecriteria to whittle the listdown, or make yourparametersstricter.For instance, in February

2009 I was interested incompanies that had a price-to-salesratio(P/S)below5,aprice-to-earnings ratio (P/E)below 10, and projectedearnings-per-share (EPS)growthinthefiveyearsaheadof more than 50 percent. Ityped those criteria into the

screener, and received 163results.That was too many, so I

dropped the P/E to 5. Thatstill left 67 companies.Next,I slapped on a minimumprofit margin requirement of30percent andgot a tidy listof16companies.Iclickedthe“5 yr Growth” criterionheader in the results tabletwice to resort the list indescending order fromhighestgrowthratetolowest.

The whole process took lessthantwominutes.The fastest growers

included DryShips (DRYS$5),GulfmarkOffshore(GLF$24), and Transocean (RIG$55). All three were cheapfrom the global economicslowdown in 2008 thatdropped oil pricesdramatically and reducedshippingvolume.Whether or not they did

well (see for yourself by

typing their symbols intoYahoo!Financeandcheckingtheircurrentprices)isnotourconcern here. What I wantyou to appreciate is howquickly I was able to findthese potentially profitablerecoverystoriesusingYahoo!Finance Stock Screener, andhow easy it was for me toconduct additional researchwithjustafewmouseclicks.The basic HTML screener

is usually fine for me, but

Yahoo! also offers a Javascreener that’s fancier. It hasa regular desktop software-like interface instead of awebpageinterface,andoffersmore screening criteria. It,too,isfree.Contact Information:screener.finance.yahoo.com/newscreener.html

MorningstarStock

Screener

Morningstar’s screener isanother good alternative. Ittaps into the firm’s helpfulanalysis tools like its stocktypes, equity style box, andgradingsystem.In February 2009, I

screened for aggressivegrowth companies with “A”grades for growth,profitability, and financialhealth. Whereas that same

request turned up 51companies twoyearsprior, itfound only four after thecrash of 2008. I could haveclicked the “Score TheseResults”buttonandgonetoascore card to specify theimportance of each criterionby clicking radio buttonsbetween1and10beneathit.The list of the top ten

scoring stocks would haveappeared to the right of thecriteriaandwouldbeupdated

on the fly as I clicked away.With only four winners,though, that step wasn’tnecessary. The four wereCognizant TechnologySolutions (CTSH $20),HansenNatural(HANS$34),LifePartnersHoldings(LPHI$18),andNeustar(NSR$16).Contact Information:screen.morningstar.com/StockSelector.html

MSNMoneyScreenerandStockScouter

MSN Money’s screenertakesadifferentapproach.Itsinterface is simple withdropdown menus that keepsearches focused on basicnotions rather than specificdata.For example, the choices

for P/E are just “Any,” “Ashigh as possible,” and “Aslow as possible.”The idea is

that you probably don’t carespecifically if the P/E is 9.7,butjustthatit’slow.Thedataset returned is usually small,but unfortunately it can’t besorted. I find myself feelingthat something is beingmissedwiththisscreener.It’sjust a little too basic, butcould be handy for quickideas.Amoreusefultooltomeis

MSNMoney’sStockScouter.It’s a rating system that

assigns some 5,000 stocks anumberfrom1to10onabellcurve,with10being thebestpotential for beating themarket. In February 2009,therewere178stocksrated1,591rated5,and127rated10.Iclickedon thegroupof10-rated stocks, wondering as Ididsowhyanybodywouldgoanywhereelse.The group came up in a

table with sortable columnheads, and I could add

columns to the table bychecking boxes next toadditionalcriteria.Isortedthetable in descending orderfrom highest to lowestexpected six-month return.The top 16 stocks wereprojected to gain 15.17percent in six months, andincluded AkamaiTechnologies (AKAM $18),Double-Take Software(DBTK $7), and DeckersOutdoor(DECK$55).

Finally, MSN Moneyoffers a deluxe screener viadownload. Personally, Iprefer keeping everythingonline.Contact Information:moneycentral.msn.com/investor

TheInternet

Whatstartedasagatheringof investors under abuttonwood tree in lowerManhattan turned into theNew York Stock Exchange.Totrade,youhadtobethere.Then the telephone camearound and people could calltheir orders in. Now, asuccessfulinvestorcangohisorherentirelifewithouteverseeing Wall Street. Nothingrepresents everyman’sworldwide access to the

markets better than theInternet.For a list of links to each

resource below, visitmy siteatwww.jasonkelly.com/investonline

InvestmentSites

This section containssummaries of the bestinvestmentsitesIknow.

Barron’sOnline

I’ve liked Barron’s foryears, and the newspaper’swebsitebringsallthebenefitsof its print publication to theInternet,withextrafeaturestoboot. The quality of writingleads the industry, with thewit of editor Alan Abelsonbringing a smile to many aworn trader on the weekend.He’srarelyrightaboutwhere

themarket’sheading,becausehealwaysthinksit’sgoingtocrash even though historyshowsthatitusuallyrises,butyou won’t care because he’ssoentertaining.Hehadafieldday in 2008, though!Elsewhere on the site you’llfind plenty of data in thefamous Market Lab,commentary, interviews withexperts, highlighted charts,researchtidbitsfromanalysts,forecasts from publications

bothmainstreamandeclectic,and even a portfolio trackingservice.Contact Information:www.barrons.com

Bigcharts

Bigcharts, a division ofMarketWatch, which is a

division of Dow Jones &Company, provides freeinvestment charts. They’recustomizable by time frame,offer benchmarks forcomparison, come in variousstyles, and are available in aprinter-friendlyformat.Contact Information:www.bigcharts.com

Briefing.com

You’ll find a refreshinglyhype-free collection of news,commentary, and analysis atBriefing.com. It’s clear fromthe writing that the staffspecializes in finance, notEnglish,andsometimesthat’sjust fine. They make theirpoints with little regard forstyle. The free section of thesite contains 30-minute

market updates, breakingnews, a look at story stocks,an active portfolio that hasperformed well, an after-hours report, and updates ontheeconomy.Contact Information:www.briefing.com

BusinessWeek

The popular magazinekeeps a well-organizedwebsite. You’ll find everyimportantbusinessstory,plusan excellent investor sectionaccessible quickly from ahorizontal tab menu. Thewebsite’s partner is Standard&Poor’s,sothere’splentyofreliable data in articles,charts, and a glimpse ofcontent from S&P’snewsletter, The Outlook.Expect this partnership to

last. Both BusinessWeek andStandard&Poor’sarepartofThe McGraw-HillCompanies.Contact Information:www.businessweek.com

ClearStation

ClearStation, an E*Trade

subsidiary, calls itself “TheIntelligent InvestmentCommunity.” Membersprovide their own picks andpansfromthemarketandthesite tracks their performance.Youcanseewho’sdonewell,what their current portfoliolooks like, and follow alongfor whatever profit or lossthey achieve. It’s free toregister,afterwhichyou’llbean official “clearhead.” Youcanalsoelecttoreceivedaily

stockideasfromtheA-listofamateur analysts.ClearStation is away to findpotential investments, butalways conduct your ownresearchbeforefollowinganyadvice.Be keenly aware thatthesitefocusesonshort-termtrading and E*Trade hopesyou’ll use its brokerageservices to place such trades.Still, with your wits aboutyou at all times, take a peekat the lively discussions to

findsomeprofitableleads.Contact Information:clearstation.etrade.com

GoogleFinance

As with most offeringsfrom Google, the onlinegiant’s finance site is simpleand fast. Its stock profiles

provide the usual statistics, anice interactive chart, andwindows into commentaryfrom both Google discussionboardsandexternalblogs.Itscompany managementsection is particularly welldone with thumbnail photosof most officers along withlinks to theirbiographiesandrecent trading activity. Thesite offers free portfoliotracking.

Contact Information:finance.google.com

JasonKelly

I use my website to trackevery investment strategyI’ve written about. You’llfind updates to informationcontained in my books,

articlesoncurrentinvestmentissues, and other financialpointers. If nothing else, getyourselfonmyfreeemaillistto get periodic commentaryand investment ideas. Ipromise not to send you anycreditcardads.Contact Information:www.jasonkelly.com

MarketWatch

MarketWatch, brought toyou by Dow Jones &Company, collects the latestnews headlines but alsobrings columnists who offertheir take on developments.The roster is a revolving listthat changes with eachedition of this book. Thelatest includes Mark Hulbertof Hulbert Financial Digest

fame.Contact Information:www.marketwatch.com

Morningstar

Morningstar has been thedefinitive source of mutualfund information for yearsand has diversified its

coverage to include stocks.That dual focus combinedwith thecompany’s expertisein presenting research hasproducedasuperbinvestmentwebsite.Theusualdiscussionboards and portfolio trackingare in place along withfeatures you won’t findelsewhere such as Instant X-Ray, where you input yourportfolio holdings and get areport showing where yourmoney is allocated by asset

class,marketcap,interestratesensitivity, industry sector,and region of the world.You’ll be surprised at howmuch of Morningstar’spremiumresearchisavailableonthewebsiteforfree.Contact Information:www.morningstar.com

MotleyFool

The Motley Fool is apopular stock forum. NamedforalineinShakespeare’sAsYouLikeIt,thesiteisnotforfools at all but rather foreverybody who stands apartfrom Wall Street’s so-calledwise men: full commissionbrokers, marketprognosticators, and gurus.Shakespeare wrote, “I met a

fool i’ the forest, a motleyfool.” At this site, WallStreet’swisemenare foolishand the Motley Fools arewise, hence they’re labeledFools with a capital F. Thesite’s claim to fame is itsextensive message boardsystemcoveringalmosteverypubliccompany.Thelevelofthought that goes into manyof the posts is enlightening,above what I’ve run intoelsewhere online. If you’re

wondering about a stock,swing by The Motley Fooland see what its communitythinks. Typing the symbolwill take you straight to adiscussion about your stock,or you can view the top 25boards for new investmentideas.Contact Information:www.fool.com

RGEMonitor

RGE Monitor is theeconomic firm founded byNouriel Roubini, a professorat NYU’s Stern School ofBusinessanda former senioradvisor to theU.S.Treasury.RGE stands for RoubiniGlobal Economics. The sitecoversnearlyeveryaspectofthe global economy in click-down sections with succinct

summaries, data points, andlinks to expanded articles. Inthe site’s own words, itprovides,“Theeconomicandfinancial intelligence thatmatters.” Complete accessrequires a subscription, butsome good material isavailableforfree.Contact Information:www.rgemonitor.com

SeekingAlpha

ThisisoneoftheInternet’sdeepest collections ofinvestment content. Lest thenameconfuseyou,here’s thesite’sexplanation:“Alphaisafinance term referring to astock’s performance relativeto themarket; it’s usedmoreloosely by fund managers todescribe beating their index,so every stock picker is

seeking alpha.” The siteshows articles from blogs,investmentfirms,newsletters,and its own writers. You’llevenfindanalysisfromyourstruly.Contact Information:www.seekingalpha.com

SmartMoney

SmartMoney maintains adynamiteinvestmentsitewithunique Java tools like amapof the market and a tear-offportfoliowatchlist.The sametop-flight journalists thatwrite for the magazinecontribute articles to the site.All are archived for easyretrieval.Amongmy favoritefeaturesarethepunditwatch,which tracks the calls of topWall Street analysts, and theupdatesonhowSmartMoney

recommendations areperforming. If a goodcompany dips, you’ll see ithereandcanconsiderbuyingonsale.Contact Information:www.smartmoney.com

StockCharts.com

Youmay be able to guessfrom the namewhat this sitefocuseson.Itschartsareeasyto create, a joy to look at,packed with features, andpowerfullycustomizable.Thesite’sChartSchoolishelpful.In addition to free chartingcapabilities, it offerssubscription plans, includingMarketMessage,anewsletterbytechnicianJohnMurphy.

Contact Information:www.stockcharts.com

TheStreet.com

TheStreet.com founderJames J. Cramer once calledhis site “The Motley Foolwith a brain.” That’s a harshwaytoputit,butIwilltipmyhat to TheStreet.com. Itprovides dozens of daily

articles from pros. There aretech articles and health carearticles, tips on charting andtips on reading a company’sfundamentals.Most of the site requires a

subscription and some of thearticles within the subscriberarea come from specialtyonline publications thatrequire an additionalsubscription. Everythingcomeswithafreetrialperiodoftwoweeksoramonthand

youarenot chargeduntil thetrial period is over. That’splentyoftimetoseeifanyofthe site’s features fit yourinvestmentapproach.Contact Information:www.thestreet.com

Yahoo!Finance

Yahoo! Finance is thechampion investmentresearch site. I use it everyday. It aggregates most ofwhatyouneedtoknowabouta stock or mutual fund intoone free location. Companyand fund profiles arecomplete with managementinformation,contactnumbers,price history, split history,recentannouncements, recentand archived news stories,blogpostings,andeverything

else you’d expect. Profitmargin? It’s there.Returnoninvestment? It’s there. Aninteractive chart withadjustable time frameparameters and the ability toadd other stocks and indexesfor comparison? It’s there.From how a stock did in thelastfiveyearstohowitdidinthelasthour,Yahoo!Financehas you covered. You cancreateasmanyportfoliosandwatch lists as you want.

Everythingisfastandfree.Contact Information:finance.yahoo.com

OtherSites

Other investment sites thatmight appeal to you includeBloomberg atwww.bloomberg.com, CNNMoney at money .cnn.com,the Financial Times at

www.ft.com, Minyanville atwww.minyanville.com, andMSNMoneyatmoneycentral.msn.com.Worthy financial blogs

include Bespoke InvestmentGroup atbespokeinvest.typepad.com,The Big Picture atwww.ritholtz.com/blog,Calculated Risk atwww.calculatedriskblog.com,Footnoted.org atwww.footnoted.org,

Infectious Greed at paul.kedrosky.com,andTheKirkReport atwww.kirkreport.com.For links to breaking

investment articles, stop byAbnormal Returns atwww.abnormalreturns.comand RealClearMarkets atwww.realclearmarkets.com.You’ll find plenty aboutexchange traded funds liketheonesavailableforDoublethe Dow and Maximum

Midcap atwww.etfconnect.com. Youcan buy and sell entirepredetermined portfolios atwww.foliofn.com. If youwant more charts andtechnical analysis tools, trywww.decision-point.com andwww.prophet.net.The Securities and

Exchange Commissionmaintains a site atwww.sec.gov. Search for acompany’s EDGAR filings

and other documents atwww.secinfo.com. Geteconomic data atwww.economicindicators.gov.Monitor insider investmentactivityatwww.j3sg.com.The New York Stock

Exchange is atwww.nyse.com and theNASDAQ is atwww.nasdaq.com.Want more information

about investing? Stop by theAmerican Association of

Individual Investors atwww.aaii.com and theNational Association ofInvestors Corporation atwww.betterinvesting.org.

7

ThisBook’sStrategy

You’vecomealongway,myfriend. You speak thelanguage of stocks, you’vestudied master investors andthe lessons of history, you

know how to use permanentportfolios, you’re all set upwith your discount broker,and you know both how andwhere to conduct research.Afterall thatpreparation, it’stimetoassembleastrategyofyourown.That’sthefocusofthischapter.The strategy has three

parts.Firstyou’llbuildacoreportfolio with the methodsyou learned in Chapter 4,next you’ll assemble and

track a list of potentialinvestments, then you’llmanage a portfolio ofindividual stocks from yourlist to enhance the returns ofyourcoreportfolio.I’m trembling as I write.

Profits are near. Years fromnow you’ll look back andscribble in your personaljournal the words of JohnKeats:“MuchhaveI travel’dintherealmsofgold...”

BuildaCorePortfolio

Before you travel therealms of gold in search ofriches, you need a strongfortress from which to baseyour searches. You canretreat to the fortress whenyour search party turns upnothing or is attacked bymarauding bears. Your

fortress will probably startsmall,butwillgrowinsizeasyoursearchpartyreturnswithriches.You’re going to combine

growth and value in yourfortress and your searchparty. Some of the bestinvestors combine these twoapproachesandhistoryshowsthat they coexistwell.Often,when growth investing isstruggling in the market,valueinvestingissoaringand

viceversa.Bycombining thetwo, you should come closertosteadysuperiorreturns.You’re going to rely on a

proven team to build yourfortress: permanentportfolios.UseDoubletheDowtoput

all 30 Dow companies toworkonyourfortressattwicetheir normal strength. Iprovide background for alltheDowstrategiesinChapter4 and explain Double the

Dow specifically on page122.Foranapproachwithaneven better record, useMaximumMidcaptoput400medium-sized companies towork at twice their normalstrength. I explain thatapproachonpage126.No matter which

permanent portfolio strategyyou choose, you’ll addconsiderable strength to yourfortress. When the Hunattacks with his army of

bears, you’ll be glad to haveDow or midcap companiesready to scramble and repairthecurtainwalls.

MaintainYourStockstoWatchWorksheet

Once you’ve built a core

portfolio,you’vegotastrongfortress from which to baseyoursearchesforwealth.Thefortress should stand throughgood times and bad,strengthened by provenpermanent portfolios. Nowit’s time to enter the wildworld of individual stockpicking. You’ll rely on theadviceyoureceivedfromthesix master investors inChapter 2 and history’slessonsinChapter3.

Toshieldyourselffromtheinfluence of rumors, greatstories from your neighbors,catchy headlines, and cool-sounding company names,you’re going to keep apersonalized list of 20companies to watch. That’sright, just 20 companies. Inorder for a new company togetaspaceonthelist,itmustbe better than one of thecurrent 20. By structuringyour list in this fashion, you

forceittoimproveovertime.Continuing the realm of

riches metaphor, this list isyour roster of henchmen thatyou use to assemble searchparties. When you actuallyinvest in one or more of thestocks, you send themout ofyour fortress to find riches.Whenyousell,theyreturntothe fortress, where you storethe money either in yourpermanent portfolio or cashcoffers. The realm is a nasty

place outside the fortress.Someofyourhenchmenmaynever return. In other words,somestocksmightgotozeroand you’ll strike them fromyour list. Sometimes you’llsell a stock but still keep aneyeonit.Itstaysonyourlistuntil something better comesalongtobumpitoff.I love this system.When I

first started looking for goodinvestments on my own, mylife piled highwith company

reports, Value Line pages,Standard & Poor’s profiles,magazine articles, and so on.Itbecamesoridiculousthatatone point I thought myportfoliowascomingtogetherbased on which papers beattheirwaytothetopofthepilethat day. That’s not a goodwaytoinvest.So I stole a blank sheet of

paper from my laser printerand scribbled across the top,“Stocks ILike.”Then Iwent

througheverystackofpaper,writing down the name ofeach company and a fewmeasurements that wereeasily obtained from thepaperwork. When the lastpieceofpaperhit the floor, Ihad a list of 58 companyprofiles in front of me.Picture me looking at thesheet of paper as fairy dustsprinkled the air. What arevelation! Putting everycompany in the same place

with the same measurementsallowed me to instantly seewhich companies were mostattractive. I scratchedout theduds and gleefully whittledmy list to a tidy groupof 20stocks. I’ve never lookedbacksince.Now,whenever Iencounter a stock tip in anarticle,aconversation,oronabathroomwall, I simply findits worksheet measurements,compare it to the 20 stocksI’m watching, and see if it

beats out any of the current20.Ifnot,Iforgetaboutit.Ifso,Istriketheweakestofthe20andreplaceitwiththenewstock. In the course of thissimple process, I either savemyselfthehassleofreadingalot of material on a newcompany or I strengthen mylistofpotentialinvestments.Constant scrutiny of your

list is healthy. Call itinvestment Darwinism ornatural stock selection. I’ve

evolved alongside my listsince that first glorious daywiththefairydust.Inowcallthe process Stockwatch andlist my companies on theStocks to Watch Worksheet.There’sacopyforyouintheback of this book. Let’sexplorehowtouseit.

Gatherthe

WorksheetCriteria

You should be burstingwith investment ideas afterspending time with theresources explained in theprevious chapter. If you’relike me, there will be toomany great investments andnot enoughmoney.The tricknowistopareyoursatchelofstocksdowntothebest20for

placement on your stocks towatchworksheet.That’swhatthis section is all about. It’sthe heart of our strategy.We’ve reached the point ofyour investment journeywhere it’s time to discoverspecific measurements thatcapture the advice of our sixmaster investors, reflect thelessons of history, and areeasy enough for you toactuallyuse.Toomanybookslist hundreds of ideal

measurementsforyourstocksto possess, but fail to notethatittakeshoursjusttofindthem all—if you ever do. Idon’t have the patience forsuch approaches and assumethatyoudon’teither.For convenience, I group

all measurements on thestocks to watch worksheet.TopackinalltheinformationI like to know about acompany, I needed to breaktheworksheetintotwosetsof

columnheadingsandputonly10 companies on a page.Thus, to track 20 companies,you’ll have two stocks towatch worksheets. Your 20stocks might contain 5 largecap value companies, 5medium cap growthcompanies, and 10 small capgrowth companies in oneplace. The combination willbeuniquetoyourinterests,ofcourse,butyoudon’tneedtojuggle multiple criteria for

different types of companies.I designed the worksheet tobe flexible enough to followanystockyoulike.If you’re scouring stocks

forthefirsttime,yourgoalisto build your initial list withthe 20 best stocks you canfind. Thereafter, you willscrutinize every stock youencounter against the 20alreadyonyourlist.Your worksheet is in the

back of the book. Follow

along as I explain eachmeasurement and where tofind it. The worksheet lookslikethis:

For each measurement, Iexplain what it is, the

requirementtomakeyourlist,the ideal direction of themeasurement, and where tofind it. Insomecases,notallof theitemsapply,soI leavesome out. Also, rather thanreprint sample pages frominformation sources such asValueLine,Ipointyoutotheresources section where Ireprint a sample page onetime and identify eachpertinentpieceofinformationonit.You’lleventuallyknow

byheartwheretolookfortheinformationyouneed.CompanyBasicsThese are the essential

measurements of a company.They tell you who thecompany is, its stock price,andhowbigthecompanyis.Company Name, Symbol,andPhone

We’ll start out easilyenough. Simply fill in thenameofcompaniesthatmakeyourlist,theirtickersymbols,and their phone numbers.Makesureyougetthemright.Thatsoundssilly,butafriendofmineboughtatonofMFSCommunications (NASDAQ:

MFST) back in June 1996thinking he was buyingMicrosoft (NASDAQ:MSFT). Switching the F andS leads to a world ofdifference. Microsoft rosefromasplit-adjusted$7.50inJune 1996 to $20 in January2009. MFS Communicationswas acquired by WorldCom,whichdeclaredbankruptcyinJuly2002.Luckily,myfriendcaught his error on his nextmonthlystatement.

Where to Find It: If youencounter a stock in anarticle, its symbol is usuallyprovided in parenthesis afterthe first appearance of thecompany name. You’ll findabbreviated company namesand ticker symbols in almostevery newspaper’s stocktables.You can also look upnames and symbols on theInternet or buy a copy of

Standard&Poor’sTheTickerSymbol Book. It’s updatedevery year and arrangescompanies alphabetically bysymbolinthefirsthalfofthebookandbyname in the lasthalf. It also shows whichexchange each stock tradeson. The book costs less than$10 and is great to havesitting in your briefcase ornexttoyourcomputer.For company phone

numbers, consultValue Line.

It prints the address andphone number in the middleof each company’s profilepage.CurrentStockPriceand52-WeekHigh/Low

This is simply the stock’s

recent trading price alongwithitshighandlowoverthepast 52 weeks. It’s alwaysgood to know the currentprice because that’s whatyou’ll be paying if you buynow. The high and low aregoodtoknowbecausethey’llgiveyouanideaifthecurrentpriceisnearthetoporbottomof the range. Lots of growthinvestors prefer to buy nearthe top of the range, hopingthat the stock will continue

pushing the upper limit.Many value investors prefertobuynearthebottomoftherange, hoping that the stockrecoverstoitsprevioushighs.There is no such thing as anidealstockprice.Where to Find It: Anynewspaper’s stock table listsyesterday’s trading price andthe 52-week high and low.The Internet is also a

convenientplacetofindstockprice information. Stockquotes are one of the mostcommon reasons people goonline. Well, at least peoplelikeme.MarketCapitalization

This shows you how bigthe company is. To refreshyour memory, determinemarket capitalization bymultiplying the number ofoutstanding shares of stockby the current stock price.The number you get willreveal whether the companyyou’re considering is large,medium, or small. Know thesize of companies you’reconsidering so you have anideawhetheryourportfoliois

weighted too heavily towardonesizeoranother.You may already be

investing in larger,established companiesthrough theDow.Rememberthat the 30 Dow stockscontain names like Boeing,Coca-Cola, Disney, IBM,Intel, 3M, McDonald’s,Microsoft, Merck, and Wal-Mart. They’re the hugest ofthehuge.If you’re already in larger

companies through the Dowor other large cap index,consider focusing yourindividual stock pickingeffortsonsmallercompanies.They’ll add some spice toyour portfolio and allow youto capture a truer picture ofthe marketplace. I’m notsuggesting you ignorehouseholdnamesjustbecausethey’re big, I’m suggestingyou make a concerted effortto find undiscovered

companies that will betomorrow’shouseholdnames.Referring back to theMorningstar capitalizationtable on page 39, you’ll seethat small companies had amedian market cap of $940millioninearly2009.

LookforSmallerCompaniesI can’t list an idealmarket

cap for a company becausethere is no such thing. Iquadrupled my money in

IBM while friends lost 60percent in DiamondMultimedia, a smallcompany. Opportunity anddangerlurkeverywhere.Where to Find It: You canfind the total number ofshares outstanding listed inseveral places. The easiest isprobably on the Value Linepageyou’llbeusingforgobsof other stock information.

Thereyoucanseethenumberof shares over the past 15years in addition to thecurrent number. Anothergood source is Standard &Poor’s Stock Guide. Sharesoutstanding is also printedwith quarterly earnings infinancial newspapers such asInvestor’s Business Daily.Finally, several Internet sitessuch as Yahoo! Finance listmarket cap itself, saving youthetimeofcalculatingit.

DailyDollarVolume

Whilemarketcaptellsyoua company’s size, dollarvolume tells you how muchmoney trades in the stockonagivenday.Thatinformationdetermines how liquid the

stock is, that is how easily itis bought and sold. It’s easytofiguredailydollarvolume:Multiply a stock’s averagedaily trading volume by itsshare price. For example, onFebruary 23, 2009, ExxonMobil’sdaily tradingvolumewas 40,719,343 and its pricewas $69.30. Multiplying thetwo,yousee thaton thatdaythe stock traded a dollarvolumeof$2,821,850,740.Most mutual funds won’t

touch stocks with low dollarvolumes because it might bedifficult for them to sell thestock in the future. Ifnobody’s buying, the pricewill drop and the spreadwillbe big. If you try sellingshares of Mister Magazine,peoplewon’tevenknowwhatthe company doesmuch lessbeinterestedin

SmallCapsShouldHaveLowVolumebuyingit.Ifyoutryselling

shares of Exxon Mobil,there’s abuyer at every turn.MisterMagazineisanilliquidstock, Exxon Mobil is very

liquid.Like market cap, there is

no ideal number for dailydollar volume. The measureis of most interest to smallcap investors. If you’re asmall cap investor, you’lllook for low daily volume,say less than $3 millionbecause that means mutualfundswillstayawayuntilthevolume starts increasing.When it does, funds mightbuy in and drive the volume

and price even higher. Youwillhavebeeninvestedsincethe early dayswhenyou andtenotherpeoplefollowedthestock. Handsome profitsshouldcomeyourway.Largecapinvestorsdon’tpaymuchattention to daily volumebecause it’s always big andeverybody already knowsabout the company. You’renot going to sneakupon theworld with shares of ExxonMobil.

By the way, don’t get tooilliquid no matter what yourmarket cap preference is. Awidely accepted bareminimum trading volume is$50,000 a day. Much belowthat and you’re going to beselling your stock on thestreetcorneralongwithcheappencils and windshieldcleanings.Where to Find It: The best

place to locate volumeinformation is Investor’sBusinessDaily.Everyday, itprints the number of sharestraded in a stock and thepercentage that the numberdiffersfromthestock’susualvolume. In IBD listings,you’ll find (along with otherstuff)thisinformation:

The number 852 is theprevious day’s tradingvolume shown in thousands.In this case, Exxon traded852,000 shares. -42 showsyouthepercentagedifferencethat852,000 is fromExxon’susualvolume.Toarriveattheaverage daily volume, just

divide 852,000 by .58 (thedifference between 1, whichrepresents 100 percentvolume, and Exxon’s dip of42 percent. 1 minus .42equals .58) to get an averagedaily share volume of1,468,966. Multiply that bythe share price of $87.25 toget, ta-da, an average dailydollar volume of$128,167,241. Every day$128million of Exxon stockchangeshands.

You’ll also find volumeinformationontheInternet.Sales

It’s helpful to know howmuch business yourcompanies are doing. Salesreveals that number to you.Market cap, daily dollar

volume, and sales usuallyfollow the same trend. Thatis, small companies tend totrade in low dollar volumesandhavemodestsales.Largecompanies tend to trade inlargedollarvolumesandhavea lot of sales. In early 2009,oil and gas explorerQuicksilver Resources hadprevious one-year sales of$741 million while Coca-Colahad$32billion.Onceagain,Ican’ttellyou

an ideal figure for thismeasure. Common sensescreams“Bigger,ofcourse!”However, that isn’t alwaysso. A lot of small capinvestors prefer sales to belittle because it indicates thatthe company is stillundiscovered.Littlesalescangrow faster than big sales.Cokecan’teasilyturnits$32billion annual sales into $64billion, but Mister Magazinecanturnits$5millionannual

sales to $10 million just byrunning a TV commercial.When sales and earningsgrow quickly, share pricetendstofollow.You won’t pay too much

attention to this figure foryour large cap stocks. In theprice-to-sales ratio discussedlater,salespersharebecomesimportant. But there are fewtimesthatIlookattheoverallsales of my large companyinvestments for anything

other than curiosity: “$32billion?Wow, that’s a lot ofCoke.”Where to Find It: TheeasiestplacetogetsalesisonyourhandyValueLine sheet.It’s right there along withnearly everything else youcould ever want to knowabout a stock. By the timeyou’re finished with thisbook, you’ll want an “I ♥

Value Line” bumper stickeronyourcar.Financial websites also

showsales for the trailing12months. Be aware that salesaresometimescalledrevenue.CompanyHealthNow you know the basic

information about yourcompany.It’stimetoseehowhealthy it is. This sectiondiscusses measurements thatwilltellyou.NetProfitMargin

AsyoureadinChapter2,ahigh net profitmargin is oneof Warren Buffett’srequirements for investing ina company.Onpage28,youlearned that a company’s netprofit margin is determinedby dividing the money leftover after paying all its

expenses by the amount ofmoney it had before payingexpenses. So, if a companymakes $1 million and pays$900,000 in expenses, its netprofit margin is 10 percent($100,000 divided by$1,000,000).Net profit margin is the

first measurement on yoursheet that looks beyond acompany’s size to theeffectivenessof itsoperation.Amanagement teamthatcan

maintain a high net profitmargin in the midst ofincreasing competition isevery investor’s dream. Thisone number answers thequestionthatgetstotheheartof a company’s capabilities:How much of its earningsdoesitkeep?Onyourworksheet, record

the net profit margin andcircle the up or down arrowbased on the trend over thepast five years. If the

numbers aren’t consistentlyincreasingordecreasing,lookat thechangefromfiveyearsagoand theprojected figuresforthisyearandnext.Required: Any companymaking your sheet shouldhave a net profit margin inthe top 20 percent of itsindustry. These are theleaders in their fields andwhereyouwantyourmoney.

The reason I go with arelative value instead of anabsolute value is that typicalnet profit margins changefrom industry to industry.Airlines generally havenegative profitmargins—I’mnotkidding—andput in theirbusiness plans guidelines fordeclaring bankruptcy. Mostcommodity retailers such assupermarkets, auto partsstores, cheap clothing stores,and consumer electronics

storeshavenetprofitmarginsbelow 5 percent. I’ve seensome around 1 percent. Forevery dollar they sell, theykeepapenny.Companies with the

highestnetprofitmarginsarethosewithexclusiverightstosomething, such as a brandnew laser printingtechnology. If nobody elsemakes it, the company cancharge whatever they want.Less competition, or no

competition at all, allowsprices to rise and profitmargins to expand. As aconsumer,youlovelowprofitmargins because they meanless money out of yourpocket. As an investor, youlove high profit marginsbecause they mean moremoney out of customerpocketsintocompanycoffers.Sometimes it doesn’t meanmoremoney out of customerpockets. If the company is

truly clever, the high netprofitmarginwillcomefromcutting costs everywherepossible. That leads to a lowprice for the customer butmore money kept by thecompany. Yes, you cynic,win-win situations arepossible even in thebusinessworld.I’ve met investors who

insist on absolute minimumnet profit margins, say 15percent. That immediately

keeps themfrominvesting inWal-Mart (3.3percent),Nike(9.4percent),andevenApple(14.7percent).ButMicrosoftpasses with a net profitmargin of 27.8 percent.Usually, people insisting onabsolute profit margins aresmall cap investors, and themostcommonminimumis10percent.Ifyoudecideinthecourse

ofyourinvestmentcareerthatan absolute net profitmargin

makes sense amongcompanies you consider,pencil it above the columnheading on your worksheet.There’s nothing wrong withthat. I’ve personally foundthat my portfolio holdscompaniesofallstripesandIhaven’t been able to find aminimum net profit marginthatfits themall.That’sfine,too.Therearelotsofwaystomakemoneyinstocks.

Ideal:Withnetprofitmargin,biggerisalwaysbetter.Ifyouhave a company on yoursheet and encounter anotherin the same industryequal inall regards but net profitmargin, strike the oldcompany and add the newone.Sure,you’llwanttolookat how big the difference isand if the new companyconsistently boasts a higher

margin, but you get thepicture.Biggerisbetter,andabig net profit margin gettingbiggereveryyearisheaven.

LookforaHighNetProfitMarginWhere to Find It: Yahoo!FinanceStockScreener(page185) allows you to groupcompetitorsby industry.Youcan then rank them by theirnet profit margins, seeing inseconds who’s on top andwho’snot.Youcanalsogetnetprofit

margins in other placesonline.CashandTotal

Debt

These two figures showyou a company’s health.ThemasterinvestorsinChapter3teach that good companieshave strong financialstatements: high net profit

margins, lots of cash, andlittle or no debt. You justfinished reading about netprofit margin. Now it’s timetodiscusscashanddebt.A company with a lot of

cash can respond to businessneeds better than one withlittlecash.Allabusinessdoesis buy things and sell themfor more than they cost. Ittakes cash to buy thingswhether they’re qualifiedemployees, new equipment,

supplies, marketing material,or even other companies. Abusiness cannot have toomuchcash.Debt, on the other hand,

sucks a company dry. It eatsup money that couldotherwise go toward thoseemployees, equipment, andsupplies. If a business isforced to spend its moneysatisfying debt, then it can’tspend as much strengtheningitsoperation.

Ideal: We’ve alreadydiscussed cash and debtextensively, so I won’tbelabor thepointshere.Yourcompanies should have a lotofcash,and littleornodebt.We’ll use ratios later in theworksheet to make sure thelevels of cash and debt areacceptable.Where toFind It:Cash and

debt are reported on acompany’s balance sheet. Aswith net profit margin,however, you can get whatyouneedfromValueLine aswell. It lists cash assets andtotaldebt.

LookforLotsofCashandLittleorNoDebtYou can also find the

figuresinstockdatabasesandontheInternet.StockHealthYou’ve got a pretty good

picture of the company’shealthatthispoint.Let’stakea closer look at the stock’shealth specifically. This

section looks at seven greatvitalsignsforeverystock.SalesperShare

You already know theimportance of a company’ssales. Now it’s time to seethat figure per share tounderstand howmuch you’re

paying for a piece of thosesales.In the sales discussion on

page 203, I said there is noideal sales figure. Becausesalespershareissimplysalesdivided by sharesoutstanding, there is still noideal figure for sales pershare. Small cap investorsoften prefer it small whilelarge cap investors usuallydon’tcareexceptas it relatesto price. We’ll discuss that

later in the price-to-salesratio. For comparison’s sake,let’s break down the salesfiguresforthetwocompaniesin the sales discussion onpage203.In 2008, Quicksilver

Resources had sales of $741million,whileCoca-Colahadsales of $32 billion. Eachcompany had sharesoutstanding of 167 millionand 2.3 billion respectively.Dividing the sales by the

numberofsharesoutstandinggives us a sales per share of$4.66 for Quicksilver and$13.80forCoca-Cola.On your worksheet, fill in

the sales per share numberand circle either the up ordown arrow based on thetrendoverthepastfiveyears.If some years are up andothers are down, you’ll needto exercise judgment todecide whether it’s an up ordown trend. Compare the

current number to five yearsago. Is it bigger or smaller?Finally,lookatprojections.Isthe company expected toreport higher sales per sharenextyear?Required: For growthcompanies, list only thosethat have increased sales pershare ineachof thepast fiveyears and are projected toincrease themagain thisyear

andnext.

LookforIncreasingSalesperShareIdeal: While you will insist

on five years of increasingsalespershareinyourgrowthcompanies, you want thisnumber to have increased ineachofthepastfiveyearsforall companies. Even stocksthat have been hammered inprice will occasionally showa history of increasing sales.Thosearegreatbargains.Where to Find It: ValueLineprintssalespersharefor

thepast15yearsandprojectsthe figure for this year andnext.Ifyouenjoyusingyourcalculator, you could figurethe number yourself bydividing sales by the numberofsharesoutstanding.Sales per share is also

available on the Internet andinstockdatabases.CashFlowperShare

As itsnamesuggests, cashflow is the stream of moneythrough a company. Youwant it to be positive andyou’d love it to be big. Apositive cash flowmeans thecompany is receiving in atimelyfashiontheprofitsthatit’s owed. It may come as asurprisetoyouthatnotevery

profitablecompanycanboasta positive cash flow. Why?Becausesomecompaniesselltheir goods on credit. Let’ssay Mister Magazine, mystalwart subscription-sellingcompany, came up with apromothatallowedpeopletotry their new magazinesubscriptions for six monthsbefore paying. That’s greatfor business. Thousands ofpeople would pile onto theMister Magazine bandwagon

and the company’saccountants could put thosepromised subscriptiondollarsonthebooksunder“accountsreceivable.” At first glance,Mister Magazine appears tobeflushwithnewprofits.Anditwillbe—eventually.

During the six-month lagtime,lotsofexpensesneedtobe paid. There are the prizestobuyforthecompany’sbestsalesreps,flierstobeprinted,electricity bills, energy bars

for the bicycle-based salesforce,andsoon.Where’sthemoney going to come from?Not from the newly signedthousands of subscribers.They don’t owe a dime forsix months. If times get tootight, Mr. Mag might beswaggering its way to thelocal bank for a short-termloan. Iwon’t evenwaste inkonhowmuchyouand Ihatedebtbynow.ThesituationatMister Magazine would be

grim.That’s why you want to

invest in companies withpositive cash flow. They getpaid as they sell. When theelectricbillcomesin,theycuta check from their profits.They don’t need no darnedbankbecausetheirbusinessesgeneratecash.I like to see cash flowper

shareasopposedtocashflowfor the whole company.Breaking this and other

measures into their per sharefigures makes for easycomparisons and easilycomputedratios. In thiscase,we’ll eventually record theprice-to-cash-flowratio.Let’s look at some real-

world figures for companiesyou know.In 1993, GeneralMotor’s cash flow per sharewas $12.06, Microsoft’s was$0.12,andNike’swas$1.40.In2008,GM’scashflowpersharewas-$7.05,downfrom

ahighof$32.32in1997and$31.49 in 2004. Thecompany’s well-advertisedbusiness trouble in therecessionwas reflected in itscash flow per share, and itdeclared bankruptcy in June2009.ValueLine’s projected2009 cash flowper share forGM was -$9.10. Littlewonderthecompanysoughtagovernment bailout tosurvive.Meanwhile, in 2008,

Microsoft’s cash flow persharewas$2.16butprojectedto be $2.05 in 2009 as itsufferedlowerdemandforitsproductsduringtherecession.Nike,too,hithardtimesasitscash flow per share declinedfrom $6.39 in 2006 to $4.53in2008.On your worksheet, fill in

the cash flow per share andcircle the up or down arrowbased on the trend over thepastfiveyears.Aswithsales

per share, use your ownjudgment to determinewhether a company whosecashflowpersharefluctuatesupanddownovertheyearsisinanuptrendoradowntrend.Don’t forget to look atprojectedcashflowpersharewhendecidingonanarrowtocircle.Required:Tomakeyourlist,a company must have a

positive cash flow per share.For growth companies, listonlythosethathaveincreasedcashflowpershareineachofthe past five years and areprojected to increase it againthisyearandnext.Ideal: For all companies,biggerisbetterandyoupreferittohaveincreasedovereachofthepastfiveyears.WheretoFindIt:Cashflow

is reported on, surprise ofsurprises, a company’sstatement of cash flows. It’sone of the financial formssent to you along with thebalance sheet and incomestatement.

LookforIncreasingCashFlowperShareWhat we’re searching for

iscashflowpershare.Whileyou could figure it yourself

by dividing the company’scash flow by the number ofsharesoutstanding, it’seasiertojustgetitfromValueLine.Just below sales per shareyou’ll find cash flow pershare for the past 15 yearsalongwithprojectionsforthisyearandnext.You’ll also find the

information in stockdatabasesandontheInternet.EarningsperShare

Thisisthemostcommonlycited per sharemeasurement.It’s the “E” part of the P/Eratio, the first yardstickalmost every value investorexamines to determinewhether a stock is expensiveor cheap. Before you canknowtheP/Eratio,youneedtosee theearningsper share.

Also, you want to knowwhether earnings per sharehave been increasing ordecreasingovertime.Growthinvestors insist on anincreasingearningspershare.On your worksheet, fill in

the earnings per share andcircle the up or down arrowbased on the past five years.For growth stocks, circle theup arrow only if earningshave increased ineachof thepast five years and are

projectedtoincreasethisyearand next. For value stocks, asuper discount is oftenaccompanied by a dip inearnings. Occasionally,however, something elsehammers a stock’s price andearnings remain constant orincrease. In that case, you’rereallygettingabargain.Withvalue stocks, use yourjudgment to decide on an upor down arrow based onwhetherthecurrentnumberis

an overall increase from fiveyears ago, whether theincreaseislargeorsmall,andby theprojectedearningspershareforthisyearandnext.Required: For growthcompanies, list only thosethat have increased earningsper share in each of the pastfiveyearsandareprojectedtoincrease themagain thisyearandnext.This requirement isby definition. A growthcompany is a company that

has been increasing earningsandshouldcontinuedoingso.Just to be safe, though, Iwanted to spell it out. If youare a growth investor, you’llinvestonlyincompaniesthathave the up arrow circled onyour worksheet. In fact, theonly companies that evermakeittoyourworksheetareones with up arrows. It’s abasic requirement for growthinvestors.

Ideal: While earningsincreases are required forgrowth stocks, they’re stillniceamongvaluestocks.Foreverystock,youprefertoseefive years of earningsincreaseswithprojectionsforfurtherincreasesthisyearandnext.Where to Find It: Belowcashflowpershareandsales

per share, Value Line printsearningspershareforthepast15 years along withprojections for this year andnext.Intwoseconds,youcanget all three of thesemeasurements from oneplace. That’s the kind ofresearchIlike.Once again, you can find

this information in stockdatabasesandontheInternet.

LookforIncreasingEarningsperShareDividendYield

You read a lot about thismeasureinChapters3and4.A high dividend yield is thedeciding factor used in theDow dividend strategies andwas proven to work amonglarge companies in JamesO’Shaughnessy’s study ofstock market history. It’s averyimportantfiguretolarge

companyinvestors.Small company investors

ignoredividendyieldbecausesmall companies don’tusuallydeclaredividendsandthereforehaveyieldsofzero.The measure is neither athumbs up nor thumbs downon a company that declaresno dividend. It’s a solidthumbs sideways, totallymeaningless. Thus, if you’rea small company investor,you’ll leave this column

blankonyourworksheet.Onyourworksheet, record

the dividend yield. You’llnotice there are two sets ofarrows in thiscolumn.Circletheupor downarrowon theleft based on the past fiveyears. As with the othermeasures in this section, useyour judgment to decide onan arrow. If the currentdividendyieldissubstantiallylarger than it was five yearsago and is larger than itwas

last year, that’s an uptrend.Dips along the way arecommon. Circle the up ordown arrow on the rightbased only on whether thecurrent dividend yield islarger or smaller than lastyear.Ideal:Ingeneral,youwanttobuy large companies withhighdividendyields.Tosplithairsoverthis,you

prefer to invest when theoverall dividend yield hasbeen decreasing but thechangefromlastyear tonowhas shown a remarkableincrease.On yourworksheet,thistranslatestotheleftdownarrowcircledandtherightuparrow circled. Such asituation could indicate astock that has been growingin price over the past fewyears, but took a quick fallrecently. Notice that this is

ideal, not required. I haven’ttested this or confirmed itwith anybody else. I merelyread James O’Shaughnessy’sfindings in Chapter 3 andlooked at how the Dowdividend strategies work.Judging from those twosources, this treatment ofdividend yield among largecompanies makes sense.Keepitinmind,butdon’tletit cloud the tried-and-truetechnique of choosing large

companieswithhighdividendyields.

LargeCompaniesShouldHaveHigh

DividendYieldsRemember, ignore

dividend yield among smallcompanies.Where to Find It: ValueLineprintstheaverageannualdividendyieldforthepast16years along with projectionsfor this year and next. Themeasure is of suchimportance to investors thatValue Line prints the current

dividend yield at the top ofthepage.You will also find current

dividend yield listed in thestock tables of mostnewspapers, in stockdatabases, and on theInternet.ReturnonEquity

As you read on page 32,return on equity shows youwhat a company has earnedwith the money people haveinvested in it. You simplydivide net income by totalshareholders’ equity to comeup with a percentage. Forexample, if a companyreports net income of $8million and totalshareholders’ equity of $40million,itsreturnonequityis20percent.Forthosewhoare

very tired right now, 8divided by 40 equals .20, or20 percent. Warren Buffettlikes this measurementbecause it gives a clearpicture of what a companydoes with its profits. If acompany gets bigger everyyear, it will probably earnmore money. But investorsshould ask, does it earnenough additional money tosupportitslargersize?Returnon equity answers that. If a

companycanmaintainahighreturn on equity as it grows,youknowthatmanagementisdirectingprofitswisely.Although there is no

requirement for ROE, I liketo see ROEs of at least 20percent maintained orimproved over the years.Occasionally, value investorswill accept low or negativeROEs in companies theythink are about to make achangeforthebetter.

Ideal: 20 percent is a solidreturn on equity. Of course,bigger is better. If you’rebargain hunting, you mightacceptaloworevennegativeROEfromtimetotime.Thatshould be quite rare,however. For the most part,you want a company thatcontinues returningsubstantial profits toinvestors.AsteadyROEwill

revealthat.

LookforaHighReturnonEquityWhere to Find It: Net

income is reported on acompany’sincomestatement;total shareholders’ equity isreported on a company’sbalance sheet. You’ll receiveboth of these financialstatements in the investor kitmailed to you from thecompany. You would neverinvest in a company withoutseeing these statements first.Remember, you’re aprofessionalnow.Also,ROEisinmoststock

databasesandontheInternet.InsiderBuys/Ownership

Remember that ourmasterinvestors like to see insiderownership of a company. Ifthepeoplewho run theplacehaveamaterial interest in its

success, they’re more likelytodoabetterjob.Tothatend,you want to own companiesthatareownedbyinsiders.It’s worth repeating that

youshouldn’tpayattentiontoinsider sells. People raisemoney all the time for needsranging from housing downpaymentstoexoticvacations.Sale of stock is notnecessarilyacommentontheseller’s belief in the stock’sfuture.Itmightjustbeaneed

forcash.A key insider buy is what

lead me to watch SunMicrosystems for a goodopportunityin2002.BillJoy,oneofSun’scofounders,soldmore thanonemillion sharesofSunatpricesbetween$74and$87intheyear2000.Thetechnology bubble poppedandSun plummeted to earth.Hewaitedacoupleyearsandthen bought one millionshares on July 29, 2002 at

prices between $3.93 and$4.01 per share. The onlyreasonheboughtsharesofhiscompany’s stock is that hethought it was undervaluedand would eventually go up.WhenBillJoyboughtagain,Iresearched Sun andconcluded that it facedserious challenges, mainlyfrom Microsoft, but that itwas a survivor andwouldbeabletoparlayits$3billionincash to a good recovery. I

monitored the stock. Itdropped below Joy’s buyprice, eventually reaching$2.34 in October 2002. Ibought one lot at $2.56,another at $2.96, and a thirdat $3.23. The stock rose 168percent to its 2007 highbefore crashing witheverythingelsein2008.Here’sanotherexample.In

February2006, Inoticed that61 percent of FirstMarblehead’s stock was

owned by insiders. Thestudent loan company wasembarkingonarecoveryafterfallingonanalystdowngradesandabriberyscandalthatleditsCEOtoresign.Theinsiderownership combined withothersignsofbusinesshealthled me to buy shares at$36.75. The stock rosesteadily, split 3-2 onDecember 5, and kept rising.By the time I wrote thisupdate in January 2007, the

stocktradedat$57,some133percent higher thanmy split-adjusted $24.50 buy price.Then came 2008 and thecompany’s neardisappearance.Fromtheir2007highs,Sun

and FirstMarblehead fell 89percent and 99 percent totheir respective 2008 lows,showing yet again theimportance of trailing stops,whichyoureadaboutonpage151.

On your worksheet, writethe number of insider buysover the past year and thepercentage of insiderownership.Ideal: The more insiderownership, the better. Youcan’t have toomany insidersbuying shares of their owncompany. For small capinvestors, insider ownershipis of particular importance

because a lot of smallcompanies are just startingout and management is acrucialfactorintheirsuccess.The founder and presidentprobably knows how to runthe machines, answer thephones, and respond tocustomer complaints. Youwant that person to own astake in the company. I likesmall companies to have atleast 20 percent insiderownership.

Where to Find It: ValueLine prints a chart of insiderdecisions to buy and sell. Itlists the numbers for eachmonth over the past year.Simply add up the buydecisions and write thenumberonyourworksheet.Ina business overview box inthemiddleofeachcompany’spage,ValueLine often printsthe percentage of the

company that officers anddirectorsown.Insider ownership is also

reported in The Wall StreetJournal, Investor’s BusinessDaily, and Barron’s.However, it’s rare for one ofthe publications to becovering a company you justhappentobeinterestedin.Tofind insider ownership for acompany you’re researching,the quickest path is a call tothecompany itself.You’llbe

calling to request an investorpacket anyway and can askthe representative aboutinsiderownership.Finally, websites such as

J3SG focus on insideractivity, andYahoo! Financekeeps an insider page forevery public company. Itshows who’s buying andselling, how many shares,when, and at what price.That’s where I discoveredthat Bill Joy was buying

sharesofSunMicrosystems.StockBuyback

It’sgreattoseeacompanybuying its stock back. Therewill be fewer sharesoutstanding, which improvesthe supply-demand ratio andshould increase the share

price eventually. Also, asPeter Lynch wrote, “If acompany buys back half itssharesanditsoverallearningsstay the same, the earningsper share have just doubled.Fewcompaniescouldgetthatkindofresultbycuttingcostsorsellingmorewidgets.”Youwant to see your companiesbuying back shares of theirstock.Simply write the word

YESorNOinthiscolumnof

yourworksheet.Makesureifyou write yes that it’s asignificant enough buybackprogram to earn a yes. If thecompany bought back a fewtoken shares one time, thathardly qualifies as a stockbuyback program. Use yourjudgment.Ideal: You want a YES inthiscolumn.

Where to Find It: The bestplacetofindoutaboutastockbuybackprogram is from thecompany itself. Contact thecompany by calling investorrelations or browsing thecompanywebsite.PastPerformanceAfter seeing the current

healthofthestock,it’sagoodideatotakeapeekathowit’sfaredinthepast.Thissection

shows four measurementsthattellyou.EPSRank

A company’s earnings pershare drives just abouteverything related to thestock.Bynowyouknowthat.EPS rank looks at a

company’s earnings recordand compares it to theearnings record of all othercompanies to see how thecompany stacks up. It’s aquick way to see whichcompanies are earningsmachines and which areearningsaccidents.EPS rank is printed every

day in Investor’s BusinessDaily. The paper takes eachcompany’searningspersharefor the two most recent

quarters and computes theirpercentage change from thesametwoquartersayearago.That result is combined andaveraged with eachcompany’s five-yearearningsgrowth record. The finalfiguresforeverycompanyarecompared with each other,giving each company a rankfrom 1 to 99, with 99 beingthe best. Thus, a companywith an EPS rank of 95 hasearnings figures in the top 5

percent of all companies inthetables.This measure is of most

interest to growth investorsbecause they look forconsistently strong earningsand for the company toexceed expectations. Valueinvestors like earnings, too,but they’ll often buy acompany with strugglingearningsifitmeansthestockisenoughofabargain.

Required: Growth investorsshould insist on companiesthat have an EPS rank of 85or better. Value investorshave no requirement for thismeasure because they’llaccept lower earnings if itmeansabargainstockwithachanceofrecovery.Ideal: For growth investors,biggerisbetter.

WheretoFindIt: Investor’sBusiness Daily prints everystock’s EPS rank each day.How’s that for convenient?Simply locate your stock inthe tables and see its rankfrom 1 to 99 in the columntitled EPS. A stock with arank of 85 has earningsresults in the top 15 percentofallcompanies.

GrowthInvestors:LookforHighEPSRelativePriceStrengthRank

This measure looks at thestock’s price performance inthe latest 12 months. That’sit. It doesn’t look at stories,earnings, or price ratios. Itsimply reports the hardnumbers and answers thequestion, how did this stockperform compared to allothers?

Investor’s Business Dailyupdates the numbers daily,compares all stocks to eachother,andranksthemfrom1to99,with99beingthebest.Thatmeansacompanywitharelative price strength of 90outperformed 90 percent ofall other stocks in the pastyear.AswithEPS rank, relative

pricestrengthrankisofmostinterest to growth investors.Momentuminvesting,astrict

growth discipline, requiresinvestment in companies thathave done well and shouldcontinue that momentum todo well in the future. So, ahighEPSrankcombinedwitha high relative strength rankcould indicate a stock on aroll.Maybeevenanaceinthehole.Required: Growth investorsshould restrict themselves tostockswitharelativestrengthrank of at least 80. Value

investorshavenorequirementfor relative price strengthbecause it would precludebargaincompanies.Ideal: For growth investors,biggerisbetter.

GrowthInvestors:LookforHighRPSWheretoFindIt: Investor’sBusiness Daily prints everystock’s relativepricestrengtheachday.Justfindyourstock

in the tables and record itsrank from 1 to 99 on yourworksheet. The column istitled“RelStr.”Astockwitharelative strength rank of 80has outperformed 80 percentofallotherstocks in thepastyear.Five-YearSalesandEarningsGain

You’ve already found thecompany’s sales per share inthe Stock Health section ofyour worksheet. Now you’regoing to find its averageannual gain for sales andearnings over the past fiveyears. Our requirement forgrowth companies is to have

increased sales and earningsineachofthepastfiveyears.Here we find out by howmuch.With small companies

especially, strong sales andearnings are essential. Thetypical requirement is forthem to have grown at least25percentoverthepastyear.We are looking at five-yearhistory here. I like smallcompanies to have five-yearaverage annual sales and

earnings increases of at least15 percent. For largercompanies, I accept nothinglowerthan10percent.Want some real-world

perspective?In1999,GeneralMotor’s earnings per sharewere $9.18, Nike’s were$0.79, and Microsoft’s were$0.71. In 2004, GM’s were$4.95,Nike’swere$1.76,andMicrosoft’s were $0.75. In2008,GM’swere-$38.74andhadbeennegativesince2005,

Nike’s were $3.74, andMicrosoft’swere$1.87.About GM, Value Line

analystJasonA.Smithwrotein February 2009, “Amidlanguishing sales and recordlosses, the auto maker isburning through cash at analarming and clearlyunsustainablepace....Theseshares are too risky aninvestmentatthisjuncture.”

Required: Look forcompanies that have grownboth sales and earnings anaverageofatleast10percenta year over the past fiveyears. For small companies,require15percent.Ideal: For those who like tosee a strong history of salesandearnings,biggerisbetter.Countmeanda lotofothersinthatcamp.Therearesome

who look forweak sales andearnings records in hopes offindingaturnaround,butthatapproachmakesmequeasy.Itforces you to buy into anindustry’s worst competitorsinsteadofthebest.Isaystickwithstrongsalesandearningseven if you’re a valueinvestor.Where to Find It: ValueLine prints both sales and

earningsgrowthpershareforthe past 5 and 10 years in asmall box titled “AnnualRates”ontheleftsideofeachprofilepage.

LookforIncreasingSalesandEarningsYou can also find the

measure on the Internet andinstockdatabases.Five-YearPriceAppreciation

This one’s simple enough.

You just want to see howmuch the stock price haschanged over the past fiveyears. I take the high pricefrom five years ago andcompare with the currentprice. To compute thepercentage change, you canuse the % CHG button onyour handy businesscalculator or just do itmanually. For you manualtypes,dividethecurrentpriceby the high price from five

years ago. Subtract one fromthe difference to get thepercentage change. Forexample, say MisterMagazine tradedat ahighof$22 five years ago and istrading at $95 today. Divide95by22toget4.32.Subtract1toget3.32,ora332percentincrease.There’s no rule for this

number. A lot of valueinvestors prefer to see adecreasefromfiveyearsago.

Growthinvestorswon’ttouchastockthathaslostmoneyinthe past five years.Regardless of yourpreference, it’sgoodtoknowwhat happened to a stock inthepastfiveyears.Where to Find It: ValueLine prints the high and lowstock price for the pastsixteen years at the top ofeach profile page. You can

alsogetarecenttradingpriceat the top of the Value Linepage. For a stock’s currenttradingprice,checkthestocktablesinanewspaperorgetaquote from the Internet. Forhistorical quotes, use a stockdatabase.ProjectedPerformanceAfter seeing the stock’s

currenthealthandhowithasfared in the past, take a look

at projected performance.This section uses twomeasurements from ValueLine: projected sales andearnings, and projected stockhigh/lowprice.SalesandEarnings

It’s our old friends again.

Sales and earnings comprisethe lifeblood of a companyandhavemoreinfluenceonastock’s price than any othermeasures. It makes sense tosee how they’re projected togrowinthenextfiveyears.I look for companies that

are expected to grow bydoubledigits.Igetstricterascompany size gets smallerbecause small companiesshouldbegrowingfasterthanlargeones.

Required: Large companiesshouldbeexpectedtogrowatleast 10 percent a year,medium companies at least15 percent, and smallcompaniesatleast20percent.

LookforHighProjectedSalesIdeal:Biggerisbetter.Where to Find It: ValueLine prints the five-year

projected rates of change forbothsalesandearningsinthesameplaceyou found resultsfor the past five years. It’s abox titled“AnnualRates”ontheleftsideofthepage.There are lots of other

places to find earningsprojections includingpublications from StandardandPoor’s, information fromcompanies themselves,subscription newsletters, andthe Internet. Because you’re

already usingValue Line forso much of your otherinformation, it’s convenienttorelyonitsprojections.ProjectedStockHigh/Low

Wanttoseejusthowmuchmoney you stand to gain?

This is themeasure. It reliesonprojections,ofcourse,andthose are never guaranteed.Butanalystsspendtheir livestrying to be accurate and itnever hurts to see what theyexpect to happen. Thismeasure simply records theprojected high and low stockpriceforthenextthreetofiveyears.Required:Boththehighand

lowpriceprojectionsmustbebigger than the current price.Neverinvest inastockthat’sexpectedtofallinprice.Also,make sure the lowprojectionrepresentsaworthwhilegain.If the stock is currentlytradingat$50andthethreetofive year projected low priceis$55,whybother?Ideal: Bigger is better forboththehighandlow.

Where to Find It: I’m sureit’llcomeasashock to learnthat Value Line prints acompany’sthree-tofive-yearprojectedhighand lowprice.The numbers are in a boxtitled “(Years) Projections”ontheupperleftcornerofthepage, where “years” is thethree to five range. Forinstance, in 2010 the titlereads“2013-15Projections.”

You’llalsofindprojectionsontheInternet.

LookforHighProjectedPrices

RankingsProfessional rankingsarea

quickway toseewhatothersthink of a company you’reconsidering. The two GrandPubahs of stock rankings areValueLineandStandardandPoor’s. You’ll recordrankingsfromeachofthetwoonyourworksheet.ValueLineTimeliness/Safety

ThefolksatValueLinearenice enough to provide tworankings for every stock.Eachisonascalefrom1to5,with 1 being the best.Timeliness is a prediction ofhow well the stock shouldperform relative to all otherstocksinthenext12months.Safety is a measure of a

stock’svolatilityascomparedto its own long-term record.If a stock continually tradesin a tiny range, it isconsidered safe and receivesabetterrating,saya1or2.Ifthe stock fluctuates widelyfrom its historic average, itreceivesaratingof4or5.Required: I pay a lot moreattention to the timelinessrankthanthesafety.Inmany

cases, I actually prefer awider tradinghistorybecauseit means there’s a betterchance the stock will rise.That translates into a poorsafety rating, perhaps a 4 or5. Ifacompany ispoisedfortremendous things, I want itto break from its historicaverage. So take the safetyrating with a grain of salt,unless you’re looking forsteady dividend payers anddon’t want much fluctuation

inthestockvalue.As for timeliness, limit

yourself to stockswith ranksof 1 or 2. Nobody evercomplains about a stock thatrisesinprice.Ideal: For timeliness, lookfor stocks ranked 1. There’sno ideal for safety becausesomeinvestorswantvolatilitywhileothersdonot.

LookforaTimelinessof1or2Where to Find It: ValueLine prints timeliness andsafety in a box at the upperleft corner of each profile

page.Youcan’tmissthem.S&PSTARS/FairValue

The Standard & Poor’sSTARS and fair valuerankings are used to selectstocks for the S&P platinumportfolio, which consists of

S&P’s favorite stocks. Nowyou’ll gather bothmeasurements for individualstocksyouselect.Standard&Poor’suses its

STARS system to predict astock’spotentialoverthenext12months.STARSstandsforStock Appreciation RankingSystem, and classifies stocksfrom1 to 5with 5 being thebest. I know, it’s a bummerthatValue Line makes 1 thebest and S&P makes 5 the

best.Trythis:Starsareinthesky and 5 is the highestnumber. Both are upward.That’s a quick association torememberwhatS&PSTARSstrivesfor.Fair value is a rank of the

stock’s recent trading pricecompared to what S&Pconsidersitsfairvalue.We’dall prefer to buy stocks at aprice way below their fairvalue. Therefore, S&P ranksallstocksonthehandy1to5

scale with 5 again being thebest. Thatmeans stockswitha fairvalue rankof5are themost undervalued—bargains—andstockswithafairvaluerank of 1 are overvalued—ripoffs.Well, theymight notberipoffsbuttheyaresellingatapriceconsiderablyhigherthan S&P thinks they’reworth. In politically correctterms, they’re valuechallenged.

Required: Limit yourself tostocks that are ranked 4 or 5in each S&P ranking. Thatkeepsyou in stocksexpectedto be among the bestperformers and reduces yourriskbecauseyou’rebuyinginat a price below theirestimated value. That’sGraham’s old margin ofsafety again. If the stock’salready below its value, then

it probably won’t go muchlower. That’s the idea, atleast.Ideal: Best of all is a stockranked 5 STARS and with afair value rank of 5. Thatcombination, by the way, iswhat the platinum portfoliorequires for a stock to enter.So, for a quick list of stocksthat are ranked high in bothcategories, take a look at the

S&Pplatinumportfoliolist.Where to Find It: Theeasiest place to find periodiclists of companies that areranked high in both STARSandfairvalueisTheOutlook,a weekly newsletter fromStandard & Poor’s. You canfinditinmostlibraries.StockRatiosOnlynowarewegettingto

the stuff you’ll hear mostoftenonapublicbus,oratalunch meeting, or in thebleachers at little league.Herearesevenstockratiostogive you all the ammunitionyouneedtodefendyourstockportfolio.

LookforS&PRankingsof4or5CurrentPrice-to-Earnings

Here it is at last—thegranddaddy of valuationmeasures. Your reading inChapter 3 should haveconvincedyouthatP/Eisnotthe end all, be all of stockmeasures. In fact, P/S hasprovenitselfmoretellingofacompany’s prospects.Nonetheless,P/Eissowidely

followed that you shouldknow it for each of yourstocks. It’s the easiestmeasure in theworld to find,secondonlytothestockpriceitself.Torecapfrompage30,P/E

is simply the stock pricedivided by the earnings pershare. It shows you howmuch you’re paying for eachdollar of the company’searnings. Value investorswant to pay as little as they

can for each dollar ofearnings, growth investorsdon’t care very much.WilliamO’Neil doesn’t evenlook at P/E in his portfolio.Peter Lynch does, however.InOneUponWallStreet hewrites:

The P/E ratioof anycompanythat’s fairlypriced will

equal itsgrowth rate.I’m talkingabout growthrate ofearnings here.. . . If the P/Eof Coca-Colais 15, you’dexpect thecompany tobegrowing atabout 15percentayear,

etc. But if theP/E ratio isless than thegrowth rate,you may havefound yourselfa bargain. Acompany, say,with a growthrate of 12percent a yearandaP/Eratioof 6 is a veryattractive

prospect. Ontheotherhand,a companywith a growthrate of 6percent a yearandaP/Eratioof 12 is anunattractiveprospect andheaded for acomedown.Ingeneral,a

P/Eratiothat’s

half thegrowth rate isvery positive,and one that’stwice thegrowth rate isvery negative.We use thismeasureallthetime inanalyzingstocks for themutualfunds.

I’d like to toss in anotherpopular filter for valuecompanies. The current P/Eshould be at or below thefive-year average P/E. Thatkeepsyoufrombuyinginjustafterthecompanyhasbrokeninto higher trading territory.Sometimes a company willsteadily improve its position,however,anditsP/Ewillrisealong with its growth rate.That’s apositive sign for thecompany and you wouldn’t

want to overlook it simplybecause its current P/E ishigher than its average.Therefore,we’llmakethisanidealP/Econditioninsteadofarequiredone.For your value companies,

keepa close eyeonP/E.Foryourgrowthcompanies,writethe P/E on your worksheetbut don’t let it affect yourdecision very much. Therearemore importantmeasuresforgrowthinvesting.

Required: For valuecompanies, P/E must equaltheearningsgrowthrate.Ideal: For value companies,the lower the P/E the better.As Lynch points out, a P/Ethat’s half the earningsgrowthisaverypositivesign.A P/E that’s below the five-year average P/E is anotherpositivesign.

Where to Find It: P/E islisted in the stock tables ofmost newspapers. That’s ahandy place to find it ifyou’reinahurry.ValueLineconsiders P/E importantenoughtoprintitatthetopofeachcompanypage.Youcanalso find P/E ratios all overthe Internet and in stockdatabases.Both the numbers you’ll

compare to P/E are on yourworksheet.Projectedearningsis listed in the ProjectedPerformancesection.AverageP/Eislistednext.

ValueInvestors:LookforaLowP/EAveragePrice-to-Earnings

Justafteryoupencil in thecurrentP/E,takeamomenttocompute the average P/E forthe past five years. Simply

add up the five averageannual P/E ratios and divideby five. Write the figure onyourworksheet.Knowing this number will

let you see how the currentP/E measures up to thestock’s recent trading levels.As I just mentioned in thediscussiononP/E,it’snicetohaveacurrentP/E that’s lessthan the average for the pastfiveyears.Ideal:You’dliketheaverage

P/E to be higher than thecurrentP/E.Where to Find It: ValueLine lists the average annualP/E ratio for the past 16years. You’ll also find it inmoststockdatabases.Price-to-Sales

The price-to-sales ratio iscatching on as investorsrecognize its superiority overP/E for valuing stocks. Themost compelling evidenceI’ve encountered is JamesO’Shaughnessy’s study ofstock market history, whichyou read about inChapter 3.O’Shaughnessy found thatP/S is a more accuratemeasure of a company’svalue because sales can’t bemanipulated as easily as

earnings. Also, the measurehelps even growth investorsidentify companies that areselling below their potential.Even growth companies arebestpurchasedcheap.Atthispoint,youhavethe

information you need tocompute P/S from yourworksheet.Simplydivide thecurrent stock price by thesales per share. That’s it.Write the figure on yourworksheet. If one of your

stocks is selling for $72 pershare and is expected toreport sales per share of$47.65 thisyear, itsP/Sratiois 1.51 ($72 divided by$47.65).Ideal: For all companiesexcept utilities, smaller isbetter. You want to pay aslittleaspossible for the salesthe company generates.O’Shaughnessy looked for

companies with P/S ratiosbelow 1.5, which happens tobe the figure for mostcompanies.Iliketostaywitha ratiobelow2but this is anideal, not a requirement.Sometimes, companies thatare growing quickly showhighP/Sratiosbuttheirshareprices keep rising. Historysuggests,however,thatalowP/Sisagoodsign.

Where to Find It: Becauseyou have share price andsales per share on yourworksheet,youcanfigureP/Syourself with a calculator.Simply divide share price bysalespershare.The Internet is another

source of share price andsales per share. Some siteseven list a company’s P/Sratioforyou.You’llalsofindP/Sinmoststockdatabases.

LookforLowPrice-to-SalesPopularmagazines,suchas

SmartMoneyandKiplinger’s,sometimes list P/S in tablessummarizingpotentialstocks.

Price-to-Book

As you read on page 29,price-to-book compares astock’spricetohowmuchthestock is worth right now ifsomebody liquidated thecompany. It’s the secondmost common valuation

measure following price-to-earnings. It tells how muchyou’re paying for the actualassetsofthecompany.In truth, P/B isn’t worth

muchtome.Icarealotmoreabout a company’s use of itsequipment to earn moneythan I do about the auctionvalue of that equipment. If Ireallywanted toget themostequipmentformymoney,I’dgo to the auction myself. Iwant the skill of human

beings to turn the output ofequipment into profit. That’sthepointofinvesting.However, it is nice to see

thatifeverythingcrumblesatthe company you’ll still getyour money back. Growthinvestors don’t care at allaboutP/B,butvalueinvestorsliketoseeitlessthan1.Thatmeansthey’repayinglessforthe company than it wouldfetchatauction.

Ideal: Smaller is better. AP/Bof1meansyou’repayingthe auction price for acompany. A P/B less than 1means you’re paying lessthan auction price. BenjaminGraham recommendedinvestingincompanieswithaP/B less than .66.Theywerealmost impossible to findduring thebullmarketof the1990sbutbecameplentifulin

the2008crash.Ifound3,099ofthemwithastockscanruninFebruary2009.Where to Find It: Bookvalue per share is computedfrom numbers on acompany’s balance sheet.Simply divide commonstockholders’ equity by thenumberofoutstandingshares.Then, divide the stock’scurrent price by its book

value.Ifyou’dratherpluckoutall

your eyelashes than computeP/Bon your own, you’re notalone. Luckily Value Lineprints book value per shareforthepast16years.Youcanalso find P/B in stockdatabasesandontheInternet.

LookforLowPrice-to-BookCurrentRatio

As you read on page 25,the current ratio is the mostpopular gauge of acompany’s short-termliquidity. It’s the currentassets divided by the currentliabilities. That’s it. It’susually expressed in thenumber of “times,” as in the

current ratio is three times.That would mean thecompany has three times asmany assets as liabilities,which is goodnews.Perhapsthecompanyhas$300,000inassets and only $100,000 inliabilities. The more assets acompanyhasinrelationtoitsliabilities, the better it’s ableto handle ugly surprises.Why? Simply because itowns more than it owes—asituation everybody prefers.

Run the numbers, then writethe current ratio on yourworksheet.Required: Every companyon your sheet should have acurrentratioofatleast2(twotimes and 2-to-1 are otherways of saying the samemeasure).Ideal:Biggerisbetter.

LookforHighCurrentRatiosWheretoFindIt:Assetsandliabilitiesareonacompany’sbalance sheet. However,because we love Value Line

so much by now, we’ll justusethenumbersprintedthere.Halfway down each profileontheleftsideofthepageisa box called “currentposition.”Inthereyou’llfindcurrent assets and currentliabilities. As usual, thecurrentratioisontheInternetandinmoststockdatabases.QuickRatio

As you read on page 32,the quick ratio divides cashand cash assets by currentliabilities.It’sstricterthanthecurrent ratiowhenevaluatinghowpreparedacompanyistodealwithshort-termcrisesoropportunities. The currentratio compares current assetstoliabilities,butweallknow

that it’s difficult to convert a$5millioninventoryintocoldhardcash.Coldhardcash,onthe other hand, is alwaysready for spending. Noconversions required, noconvincing people of itsworth. That’s why the quickratio compares a company’scashassetstoitsliabilities.Asolidquickratiotellsyouthatthecompanyisverypreparedfor short-term obligations.Run the numbers, then write

the quick ratio on yourworksheet.Required: Every companyon your sheet should have aquickratioofatleast.5.Thatis, the company should havehalf as much in cash as theliabilitiesonitsbalancesheet.Ideal:Biggerisbetter.Where to Find It: Cash

assets and current liabilitiesare on a company’s balancesheet.But,aswiththecurrentratio’s necessary numbers,Value Line prints cash assetsand current liabilities in the“current position” box oneveryprofile.You’llalsofinditontheInternetandinstockdatabases.

LookforHighCurrentRatiosSMA,MACD,andRSI

These three technicalmeasures are explained onpages 131 to 136. There, welookedathowtousethemtolimitoravoidthedownsideofourpermanentportfolios,buttheyareavailableonchartsofany stock you’re consideringandwillhelpyouunderstand

itspricetrend.You’ll need to look at a

chartwith all threemeasuresand decide for yourself whattheir combinedmessage tellsyou. This is subjective, ofcourse. For my worksheet, Iuse five labels to describe aclear trend: “Strong Up,”“Up,” “Sideways,” “Down,”and “Strong Down.”Sometimes, there’s a trendchangeunderway.Ifthechartshows the stock turning

down, I write “Breakdown.”If it shows the stock turningup, I write “Breakout.” Usewhateverwordsworkforyou.The point of the column onthe worksheet is tocharacterize the technicalpicture of the stock so youcan see how it stacks up toothersonyoursheet.Required: Buy stocks in astronguptrendorabreakout.

Ideal: The stronger theuptrend or the clearer thebreakout,thebetter.Where to Find It: Mostfinancial websites providecharts that can add SMA,MACD, and RSI. I like theones at Yahoo! Finance andStockCharts.com.

TrackYourList

Nowyouknowhowtousethe stocks to watchworksheet. It’s your built-infilter that keeps your moneyaway from hot tips and coldlosses. Quite simply,whenever you encounter aninvestmentidea,compareittothecompaniesonyourlist.Ifthe new idea is better, strikeoneoftheexistingcompaniesand add the new one. This

process keeps your list ofideas streamlined and readyfor action when opportunitypresentsitself.Now let’s look at three

techniquesyou shoulduse totrack your list. Alwayscompare competitors, askwhy, and keep theinformationcurrent.

CompareCompetitors

There’s no better way tojudge a company than bylooking at its closestcompetitors.Whenafriendofmine decided to buy Dell in1994, shedid sobecause shethought it was competingwell against IBM, Compaq,andGateway.Later, she soldataheftyprofit,thenwatchedthe industrychange.She sawHewlett-Packard buyCompaq, IBM sell its PCbusiness toLenovo,and then

Dell lose ground to Hewlett-Packard.Dell’sshareshit$42in December 2004, then felldramatically to less than $20byJuly2006,whenmyfriendbegan buying for the 50percentriseto$30inOctober2007, before the stock fellmore than 70 percent byFebruary 2009. Notice thatthrough this longhistory,shedidn’t compare Dell to FordorMCIandshedidn’tchooseitinavacuum.It’scriticalto

knowwhereyourinvestmentsstackupintheirindustries.When you invest in a

company, you want it to beeitherthebestofbreedorthebestpoisedforrecovery.Youdon’twantjustanycomputercompany, you want IBM inthe 1970s and Microsoft inthe 1990s. You don’t wantjustanymilkshakestand,youwant McDonald’s in the1960s. You don’t want justany retail shop,youwant the

beaten down RadioShack inJune 2006 when its shareswere less than $15 and itbegan a brilliant turnaroundplanthatdoubledthestockinayear.Thewayyoufind thebest of breed or the bestrecovery story is by lookingamongcompetitors.If you’re interested in

McDonald’s, conductresearch on theWendy’s/Arby’s Group andYum! Brands, owner of

A&W, KFC, Long JohnSilver’s,PizzaHut,andTacoBell. In the five years endedearly 2009, McDonald’sgained 100 percent, Yum!gained 50 percent, butWendy’s/Arby’s lost 50percent. If you want Wal-Mart, don’t forget to look atCostco, Kohl’s, and Target.Yourfavoritebreakfastcerealmight be from Kellogg, butdon’t invest in the companyuntil you’ve read up on

GeneralMills.Ifeverybody’sravingaboutBarnes&Noble,takeapeekatBordersGroup.Compareprofitmargins.Whokeeps more of every dollarthey sell? If the winner hasbeenconsistent,that’sagoodsign. If one company keepsits head above the rest yearafter year, that’s the one youwant to buy. If one has beendominatedbyrivalsforalongtime but looks poised for acomeback, make sure it has

whatittakestosucceed.How do the ratios

compare? You might pay alot more for each dollar ofsales at one company than atanother. Youmight find thatone company’s managementowns half of all the stockwhile another company’smanagement doesn’t invest adime in their own company.Maybeonecompany’s returnon equity is twice that of itsnearest competitor. Perhaps

everycompanyinanindustrycarries a lot of debt, exceptfor one little gem. Does thatlittlegemshineinotherareasaswell?Ifso,youmighthavefound a new entry for yourworksheet.Sometimes you’ll find a

better option than thecompany first grabbing yourattention.Occasionally, you’ll reach

astalemateanddecidetosplityour money between two

companies. Owning morethan one company from thesameindustryisanespeciallygood technique if it meansyou own the entire industry.Forinstance,investorsbuyingshares of both AdvancedMicroDevices and Intelwillbenefit no matter whichcomputerchipisintheirnextPC.In2008and2009,sharesin both companies becamecheap.If you don’t already know

a company’s primecompetitors,you’ll find themquickly as you conductresearch. Articles willmention them. Sometimesyou’ll find competitorsmentioned in annual reportsor quarterly statements. Ifworse comes to worst, youcan always call a company’sinvestor relations departmentand ask who the competitorsare.Iftheyhesitate,tellthemyou’re organizing a boycott

against all industry playersexcept them and that youneed a list of targets. Thatshouldgetyousomeinfo.

AskWhy

As an investor, alwaysquestion why a company’snumbersarethewaytheyare.Whyiscashflowsolowrightnow when it’s been high in

prior years? Perhaps you’llfind in reading further intothe annual report that thecompany is expandingoverseas and has decided tocreate very flexible paymentterms to attract newcustomers. If there’s enoughcash on hand to stay afloatwhile the new customersdiscover the company, thelow cash flow is fine for awhile.Asking why is central to

every investment decision.Growth investors want toknow why a company isgrowingsoquickly.Theyusethat information to decide ifthe reason will maintain thatgrowth in the future. Valueinvestors always want toknowwhyacompany’spriceis depressed. If it’s for areason that won’t go awayanytimesoon,nobodyshouldinvest.Ifit’sforareasonthatisdisappearing,nowmightbe

the time to get in before theprice rebounds to its formerglory.Beyond a general

understanding of yourcompanies—which youshould always possess—youneed to exercise a lot ofpersonal judgment wheninvesting. If a companyappearsgood inevery regardonyourworksheetexceptforone, say five-year earningsgain, you need to knowwhy

that earningsgainhas laggedand whether it’s anacceptable explanation. Onlyyou can answer suchquestions for your portfolio.These measurements aren’tfoolproof. There aremillionsof children with poor gradeswho achieve spectacularsuccess in life. There isprobably a better chance offinding successful peopleamongthehighgradeearners,but that doesn’t mean we

should brush off the lowgrade earners. It works thesame with stocks. For themost part, you should stickwith those thatshineonyourworksheet.However,insomecases your better judgmentwill lead you to overrule theworksheet’s verdict. Everyinvestment rule gets brokenfromtimetotime.Havingwrittenthat,Imust

underscore the need to beprudent. Remember

O’Shaughnessy’sconclusionsafter studying the history ofthe stock market. Certainstories play out again andagain and again. Yourworksheet uses proven stockmeasurements. If you aregoing to overrule what theysay about a company, you’dbetter have a darned goodreason for doing so and beable to explain it in aheartbeat. That’s why thissection instructs you to ask

why. In asking why, you’llfind the answersyouneed tomakewisedecisions.There’sa story behind all thosenumbers. Make sure you’vereadit.

StoreCompanyInformationinFolders

Once you’ve decided toadd a company to yourworksheet, start a folder forit. Place in the folder all theresearchmaterialyouusedtoconvince yourself that thecompanyisworthwhile.Yourfolders will contain annualreports, financial statements,photocopied pages fromValue Line and Standard &Poor’s, printouts from theInternet, notes to yourself,clippedmagazinearticlesand

newspaperstories,andmaybeeven a photo of you in frontof corporate headquarters orusingthecompanyproduct.Whenever you run across

additional information aboutyour companies, add it totheirfolders.Overtimeyou’llbuild your own investmentresearch center. By openingyour filecabinetandflippingthrough the alphabetizedfolders, you can remindyourself of why you like the

companiesonyourlist.

KeeptheInformationCurrent

Always keep yourworksheetcurrent.Updatetheinformation on it at leastevery quarter. It doesn’t takelong to do so and the smalleffort will reveal valuable

trends.There’s a tendency toresearchacompanyone timeandthenrelyontheresultsofthatresearchformonths,evenyears.Bad idea.Someof thebest investments come aboutby finding good companiesand then watching them forthe right opportunity. If acompany is perfect in allregard but stock price andthatpricedropsby50percentjustwhensalesarebeginningto increase, you better start

buying.Similarly, good companies

can go bad. Just because acompanywasgoodenoughtomake your list a year agodoesn’tautomaticallymeanitgetstostaythere.Thisisn’tatenured membership. Yourcompanies need to undergoconstant scrutiny andcomparison to eagerwannabes. You can’t makefair comparisons unless youhave current information.

Remember my friend whoinvested in Dell. She neededtowatch it carefullyover theyears to understand that thecompany in 1995 wascompletelydifferent fromthecompany in 2005.Understanding that wascrucial to her knowingwhentosellaftertheamazinggainsof the 1990s, when to buyagain at bargain prices in2006, and when to sell inOctober 2007, ahead of the

crashof2008.You found the information

once and should have a filefolder for every company onyour worksheet. To refreshtheinfo,makeaquarterlytripbacktoyourlibraryorlogonto the Internetandgather theinformationagain.Refreshingyour worksheet goes fasterthan finding the informationthefirsttime.

UseYourReasonsandLimitsWorksheet

Once you’ve got a list ofsolidcompaniestoworkwith,it’s time to begin homing inon the select few you’llactually invest in. Here’swhere you need to makevalueandgrowthdistinctions.Chances are good that you’ll

have some companies onyourlistthatarebeatendownin price, others that arepushingnewhighsandrecordearnings. My list alwaysbreaks down that way. Myexperience has neverproduced a list of growthcompanies only or a list ofvalue companies only. IsupposeifIinsistedonapurelist, I could set out to findcompaniesofone typeor theother, but the natural

tendencyproducesamix.Bynowyouknowthat it’s

important to treat valueinvestments differently thanhow you treat growthinvestments.Oneof themostcommon differences is thewayyoushouldviewtheP/Eratio. Inahigh-flyinggrowthstock, you’ll pay lessattention to P/E and moreattention to earnings andrelative strength. In arecoveringvaluestock,you’ll

pay a lot of attention to P/Eand price-to-book whileaccepting poor earnings and—by definition—a weakrelative strength because thestockpricewillbedepressed.The stocks to watch

worksheet doesn’t cater toone side over the other. Itisn’t a puregrowthplayor apure value play and no strictinvestorfromeitherdisciplinewould find the sheet useful.It’sa30,000footviewofthe

land, allowing you to seedifferent colored fields butfew of the plants growingthere.It’srelativelysimpletolook at a company’s majorcharacteristics and decidewhetherit’sagrowthorvaluebet. Once we’ve determinedthat, it’s another simple taskto focus on key measuresappropriate to that type ofcompany.That’s what you’re about

to do with the reasons and

limits worksheet, which Iaffectionately dub the R&L.Itforcesyoutodefinereasonsyou’re interested in acompany and what wouldcause you to lose interest.The R&L worksheet isinvaluable when emotionsstartkickinginand—surprisesurprise—the market reallydoes begin fluctuating justlikeeverybodysaid itwould.Itdoesn’tjusthappentootherpeople,ithappenstoyou,too.

So the stocks to watchworksheet is yourconsistency. It records thesamemeasurementsforeverycompany.You’llalwayslookat those measurements toidentifyacompanyaseitheragrowth or value investment.Once that’s complete, you’llfocus on certainmeasurements to select thebest growth companies andthe best value companiesfromyourlist.

In this section, I’ll give aquick recap of discerninggrowth from value, thenexplainhowtouseyourR&Lworksheet.

DiscerningGrowthfromValue

You should be familiarwith these characterizationsby now. Growth companiesare those that are growing

salesandearningseveryyear.Their stock prices are rising,their profit margins are big,and their expectations arehigh. Value companies aretradingatlowprices.Thelowpricesareusuallytheresultoftough times at the companybut occasionally just becausethe market’s a weird place.Preferably, you buy a valuestock just when it has fixedits troubles and begins toprofitagain,orjustbeforethe

market discovers its discountprice.Often, the best growth

investments are smallercompanies. Of particularimportance in evaluatinggrowth companies are highearnings record,high relativestrength, and low price-to-sales ratios. Remember thatO’Shaughnessy found price-to-sales a great measure tomix with traditional growthyardsticks because it keeps

growthinvestorsfromgettingtoo carried away withemotionandpayingtoomuchfor a stock. Other growthinvestors, such as O’Neil,insistonignoringmeasuresofvaluationcompletely.The best value plays are

usually large companies.Notalways,butmostof the time.Large companies don’tchangemuch and thatmakesthem prime candidates forbargain pricing. They’re not

going anywhere, after all, sothey have no choice but torecover from whatevertrouble they’re in. These aretheChryslersandIBMsofthemarket. For such companies,traditional value measureswillbeyourfocus.Thosearedividend yield, P/E, price-to-book,andprice-to-sales.It’s simple to look at your

stocks to watch worksheetandsay,“Hmm,IseeClorox,Goodyear Tire & Rubber,

Panera Bread, and ResearchIn Motion on here. I’d callClorox and Goodyear valueinvestments because they’reboth down in price but seemto be working towardrecovery.PaneraandRIMareboth growing like crazy, Iguess they’re growthinvestments.” Yep, that’sabout as sophisticated as itgets.Here’s a cheat sheet of

what measurements you

should pay particularattention to for the differenttypesofstocks:

HowtoUsetheReasonsandLimitsWorksheet

It’s time tospecifyexactlywhy you like the companyyou’re about to invest in andwhatwouldcauseyoutostoplikingit.Igottheideaforthisworksheet fromPeterLynch,who uses what he calls thetwo-minute drill to identifycompany strengths andweaknesses. You can reviewthedrillonpage64.Theworksheet isasnapto

use. Photocopy it dozens oftimes because you’ll need a

copy for each stock in yourportfolio. I recommendstarting a separate folder foryourportfolioinformation.Inityou’llkeepstatementsfromyour broker and R&Lworksheets for eachcompany. Your worksheet isin the back of the book. Iexplain each section of itbelow.

GrowthorValue

Simply circle which typeof investment this is, growthor value. You’d be surprisedat the number of people youjustsurpassed.Differentiatingbetween growth and valueinvestmentsisamajorstepinkeeping your expectationsreasonable.Italsohelpsmakedecisions later when thingsstartgettinghairy.

CompanyStrengths

Here you write in whatattracts you to this company.Does it own a patent thatnobody else can touch? Is itopening 500 new stores inJapan? Perhaps it just signedservice contracts with everyDowcompany.

CompanyChallenges

Writeinwhatyouperceiveas the major challengesfacing this company. By theway, I’m not trying to bepolitically correct by callingthem company challengesinstead of companyweaknesses. Most of whatfaces a good company areoutside pressures, things likefierce competitors, rising

supply prices, and changingdemographics. These are notweaknesses of the company,they’re challenges for thecompany tomeet.Hopefully,you won’t be investing incompanies that haveexcessive internalweaknesses. Your list issupposed to contain theindustry-leading, best-of-breed profit machines, andcompanies with strengthenough to recover from

temporary setbacks.Thus, allnamby-pamby politicalcorrectness aside,you shouldbe dealing with companiesthat have challenges insteadofweaknesses.Even the best companies

facehurdlesintheirpaths.Asan investor, you want to bewellapprisedofsuchhurdlesso you can see if they getbigger or if the companyclearsthemwithease.

WhytoBuy

Summarize why you’rebuyingthisstock.Presumablyit’s because you think thestrengths are powerfulenough to meet thechallenges. To help jog yourthoughts, I’ve included somecommonbuyreasonsforyouto circle. Also write in anyspecial developments in theworld that you think will

favorthecompany’sindustry,or move the company’sproduct, or otherwise helpmatters.Occasionally,I’llwriteina

measurement target in thissection of the R&Lworksheet. For instance, if Ireallylikeeverythingaboutacompany but I think it’sselling a bit too high at themoment, I’ll pencil in all thethingsIlikeandconcludethissectionwith aprice target. If

the stock hits that price, Ibuy. You can do this withratios, too,which can triggerabuyifeitherofthenumbersinvolved moves in the rightdirection. If you want toinvest in a company when itreaches a price-to-sales ratioof 1.5 instead of its current2.0, a falling price or risingsaleswillbringyoucloser toyourtarget.

WhytoSell

Certainly just as importantas why you buy a stock iswhatwillcauseyoutosellit.I’ve included some commonsell reasons foryou tocircle.The most common reason tosellisthatthestockreachesaprice target. If you boughtMister Magazine at $8.50,youmight decide in advancethatithaspotentialtodouble.

Soyouwriteinasellpointat$17. When it reaches $17,you might reevaluate.Perhaps it’s an even bettercompany than when youbought it or maybe it reallyhasrunitscourse.Ifindoubt,you could sell half yourpositionandwait toseewhathappens.Be careful of getting too

price-centric in this section.Remember that all stockmeasurements, not just price,

changeconstantly.Ifthepricedoubles but the earningstriple, why in the worldwould you sell? I like to setsellpointswithratios, justasIdiscussedinthewhytobuysection. Instead of sayingyou’llsellMisterMagazineat$17, say you’ll sell it whenthe price-to-sales reachestwice its current measure orits P/E exceeds its growthrate. Combining factorsprovides you with a more

complete picture.Remember,it’s your company. Youshould know everythingthat’s going on, not just thepriceofthestock.Sometimes you’ll want to

write in reasons to sell thataren’t measured on yourworksheet. For example, thefailure ofmedical upstarts toget approval for a new drugor piece of equipment, thedeparture of keymanagement, and a sudden

spate of lawsuits.Youwon’talways know about thesepossibilities, but sometimesyou’ll read about them inyourresearch.Pencilthemin.It’sgoodtobeawareofsuchpotholesinthepath.

BuyYourStocks

The big moment has

arrived. First you learned towalk, then drink from a cupwithnosafetytop,thenspeakin complete sentences, thendriveacar,thenditchclasses,andnowyou’reabout tobuyyour first shares of stock.Darwinwouldbesoproudofyou. In our Realm of Richesmetaphor, you’re about tohire your first henchman tosend out of the fortress withmoney from your coffers tofind fabulouswealth.You’ve

researchedhiscredentialsandare convinced of his merits.All that remains is fundinghim and sending him on hisway.

ChooseaMarketorLimitOrder

You read about differenttypesofstockordersonpage147. Amarket order buys atthe current price and a limit

order buys at a price youspecify. I almost always uselimit orders because stocksbouncearoundsomuchthatIcan take advantage of thatvolatilitytosaveafewbucks.Inmanycases,youcanfigureout the exact price at whichyouwanttobuy,placeagoodtill canceled limit order, andforget about it. If and whenthe stock hits your target,your broker will buy it andsend you a statement. This

technique has workedwondersforme.Limitordersareagreatwaytocircumventyouremotions.Rather than get taken by

the market’s gyrations, yousimplydecide inacalmstateof mind the price at whichyouwanttoinvest.Thenyouinstruct your discount brokerto buy a certain number ofshares at that price. If thestockneverreachestheprice,you don’t buy. There are

plenty of opportunities outthere.Ifonegetsaway,moveon to the next one. A rathertersewoman I knowhas thisto say about life: “Neverchase a man, a bus, or astock. There will be anotherone along in five minutes.”ThemanIdon’tknowabout,and bus availability variesfrom city to city, but she’sright about the stock. Thereare so many good ones dayafter day that there’s never a

reason to be upset about anopportunitylost.It’sbetter tolose an opportunity than tolose money. So decide inadvance what price isattractive to you and spell itoutonalimitorder.Should you ever use

market orders? Sure. Thereare times when you stumbleon something that you thinkis sohot that it’snot comingdownforyears.Alimitorderspecifyinga lowerprice than

the current one might missthe chance to buy this risingstar. I would caution youabout jumping on somethinginstantaneously, though. I’vediscoveredovertheyearsthatwhat’s a good buy today isusually still a good buy nextweek. The market movesaround,butnot asquickly asyou might think. Emotionsmove a lot faster than themarket. They also movefaster than intelligent

thoughts.Sogivetherationalpart of your brain time tocatchuptotheexcited,frothypart. Never forget the powerof clear thinking,predeterminedprices,andthelimitorder.

MakeGradualPurchases

From your reading of themaster investors and thehistory of the stock market,

you’ve come to see theimportance of reactingintelligently to the market’smoves. That means buyingmore of a good company onsale, and more of a goodcompanythat’sonaroll.Butyou can never be absolutelysure you’re investing in acompany whose stock willperformwell. That being thecase, I recommend puttingonlyaportionofyourmoneyinto a stock you’re

considering. If it drops inprice, you can reassesswhether to move yourremaining money in at thediscount or steer clear untilyou’re truly convinced thatthe stock has bottomed outand is on its way back up.O’Neilwouldshudderat thatadvice, but it has been asplendid technique for BillMiller, and for me. Goodstocks drop in pricefrequently and speculation

bids the price of crummystockshighonaregularbasis.Because it’s an unreasonableforce causing such gyrations,you can’t think your waythrough it. You can improveyouroddsbyinvestinginthebestcompaniesout there,butyou can’t know what theunreasonablemarketwilldo.So ifMisterMagazine has

you salivating over itsawesome future and you’vegot $50,000 to invest, put

only$25,000inatfirst.Ifyouhave $5,000 to invest, putonly$2,500inatfirst.Ifyouhappened to time it justwrongandthestockdrops50percent with no significantchanges in the company’sfundamentals, move yourremaining capital in. Insteadof just recouping your losseswhen the stock recovers,you’ll double the value ofyoursecondpurchase.Puttingthesameamountof

money into a declining stockasyouinvestedinyourinitialposition is called doublingdown if it’s your secondpurchase. I do it all the timeinTheKellyLetter.Ibelievedin some stocks enough totriple and even quadrupledown,anditpaidoff.On October 5, 2005, I

bought footwear makerDeckers Outdoor stock at$23. It owns the brandsSimple, Teva, and UGG. It

looked undervalued to me,andIthoughtitwouldbenefitfromastrongholidayseason.Thestockdropped26percentafterIbought,butIdidn’tseeany changes in the reasonbehind my investing in thefirstplace.Itlookedtobejusta better bargain. I doubleddown at $17 on October 28,puttingmyaveragepricepaidat $19.55. On December 8,only six weeks after mysecond buy, the stock closed

at $30 for a 53 percent gain.Two years later, it topped$160 for a 718 percent gain.It fell 50 percent by the endof2008,butwasstillupsome300 percent from itsOctober2005prices.Now, to review something

you learned earlier, it’simportant that you believe ina stock’s strength before youinvestmoremoneywhen theprice is falling. I believed inDeckersOutdoor.It’sasolid,

well-managed company. Iknew it would recover. Thesame can’t be said for allstocks.Doubling and triplingdown on a falling stockbacked by a crummycompany on the far-fetchedhope that it will make acomeback is called puttinggoodmoney after bad.Don’tdoitoryou’llfindyourselfina value trap. Investing in afalling price requiresthorough research and a

strong belief in the positivesigns you turn up in thatresearch.

BuyThatBaby!

You’ve decided on yourkiller stock—certainly ahundred-bagger by anyone’sreckoning—and you’vechosen either a market orlimit order. All that remainsis contacting your broker.

Because you’ve read thisbookandperusedall the finebrokerage choices inChapter5, you probably have anaccount with a discountbroker.Goodforyou!Contact your broker by

phone, computer, or inperson. Specify your orderandsitbackasecond.Soakitup. You’ve just become abusinessowner ifyouplaceda market order, and you’llsoon be a business owner if

you placed a limit order andthestockhitsyourprice.Thenext time you’re in Omaha,stop by Berkshire Hathawayto swap a few stories withWarren Buffett. The two ofyou are in the samebusinessnow.

WhentheMarket’sUp,Down,andAll

Around

Flipforwardafewpagesinyour calendar from thathalcyon day of your firststock purchase. “Egads,”you’re thinking, “how did Iever let that Kelly guy talkme into this mess? Myhundred-bagger is a minustwobagger and the headlinesare getting worse.” Yes,

friend, I know what it’s liketo see that happen. TheRealm of Riches is a toughplace. A lot of yourhenchman will never comeback. Those that do comeback to the fortress aresometimesprettybeatenup.Since this book’s first

edition in 1998, theU.S. hasexperiencedtwomonsterbearmarkets:thedot.comcrashof2000-2002 and the subprimemortgage crash that began in

2008andisstillgoingonasIwriteinearly2009.The bull market of 1990-

2000 took the S&P 500 andthe NASDAQ Composite up426percentand1,490percentrespectively. The dot.comcrashthatfollowedtookthemdown 50 percent and 78percent. The bull market of2002-2007 took themup105percentand158percent.Thesubprime crash that followedtook them down 53 percent

and52percent,sofar.Fortunes come, fortunes

go.That’s what we’ll explore

inthissection:volatility.Themarket rises and falls, yourstocks rise and fall, youremotions rise and fall. It’stimetogetahandleonallofthis.

BeSkepticalofGurus

Beware the so-calledmarket gurus. They’re alsocalled experts, analysts,forecasters, pundits, andsoothsayers. By and largethey don’t know anythingmore than what you know.Always keep in mind themarket forecast of J.P.Morgan, “It will fluctuate.”That’saboutallthereistosayandit’sneverwrong.I’m keenly aware of the

fallibility of gurus because I

am one. My forecasts havebeen tracked by anindependent auditor calledCXO Advisory Group. Thebest I’ve ever achieved is anaccuracyof76percent,butiteroded over time to mycurrent 60 percent. In almostanyother field,ascoreof60percent is terrible. In school,that’s a D- in danger ofbecoming an F. In stockforecasting,however,itranksinthetop5percent—andthat

shouldtellyousomething.IntheongoingCXOstudy,

which in early 2009 hadtracked 4,500 forecasts from51 gurus, the averageaccuracy score is just 48percent. A coin flip hasperformed better than thetypical market expert. Thegurus tracked in the CXOstudy include famous peoplewho have their own TV andradio programs. Most of theother gurus regularly join

those and other programs todispenseviewsonthemarket.Whenever you see or hearone of us, remember thesefive syllables: 48 percent.Those are the odds of theexpertbeingright.Which may explain why

experts dither somuch.Overthe years, I’ve collected myfavoritenoncommittalmarketforecasts, including thesegems:“Markets may shift focus,

but will it be toward upbeatevidence about growth or amore negative look at twindeficits?”“The longer-term picture

stilllacksclarity.”“TheNYSEandNASDAQ

aresayingdifferentthings.”“Stocks have more upside

ahead. . . . A move up hereprobably won’t have thepower tomove us out of thedown channel we’re caughtin.”

“Tradersmust be decisive,butwillingtochange.”“TheS&Pisgearingupfor

anOctobershowdown.Eitherthe downside of this year’strading range will be brokeninOctober,ortheupsidewillbe.”“Ithinkit’sgoingtobeon

balance a quiet week. Butthere is the distinctpossibility,dependingonwhosays what, that it couldbecomeamuchmorevolatile

and exciting week thananybodypredicted.”“Will the market

consolidate or will it shakeout—or will it do somethingworse?”“Based on trends in

corporate operating earningsand the inflation rate, one ofour models projects a retreatfor the S&P 500 index overthenextfourquarters,andtheotherprojectsanadvance.”“S&P thinks the key to

whether the latest weaknessturns into a correction issimplytheactionofthemajorindexes.”“The odds are 50/50 as to

which way the index willswingnext.”“If the pattern and tone of

the market are indeedchanging,itwouldbepositivefortheshortterm.”“There is an opening for

eitherthebullsorthebearstotakeover.”

Now, to be fair, analyzingstocks and predicting thefuturecourseofthemarketisexceedingly difficult. I likewhat Michael Santoli wroteintheOctober30,2006,issueof Barron’s: “The job of astock analyst isn’t an easyone, never mind the facileridicule thrown at WallStreet’s stockpickers. Toconfirm this, just let yourview on a couple of dozenstocks be a matter of public

recordforafewmonths.”That’sagoodpoint,oneto

keep inmindwhen you hearsomebody using hindsight tocriticize a public marketvoice. It’s easy to be rightlooking back. Try lookingforward.Nonetheless and with due

respect to those trying toprovidemarketguidance, it’simportant to remember thatnobody, absolutely nobodyknows for certain what the

market will do. You need toremain skeptical and makeyourowndecision.

YouKnewThisWasComing,SoWhyWorry?

From all your reading tothispoint,youshouldbewellaware that the marketfluctuates. Always, friend. Itwon’t stop because yourmoney has finally arrived

there. In fact, from yourvantage point it will startfluctuatingmore thanever. Itwon’t of course, butsomehow the numbers meanmore when it’s your moneyontheline.Don’t worry about it.

Money you invest in stocksshouldn’tbemoneyyouneedfor groceries next month orcollege tuition next year. Ifyoudefineyourgoalsclearlyand invest by those goals,

you’re geared for whatevercomes. The money you doneed for groceries is safelydeposited in a bank account.The money you do need forcollege tuition next yearmight also be in a bankaccount or perhaps aconservative mutual fund.The money you haveearmarked for long-termgoals such as retirement or anewhomecanwithstandanyshort-term market

fluctuations. It’s a science.Themore timeyouhave, themore risk you can take. Theless time you have, the lessriskyoucantake.

ReviewYourReasonsandLimits

At some point, you’regoing to want to reevaluateyour holdings. The hardesttime to do so is when

something serious hashappened. That’s not alwaysa huge drop, by the way.Sometimes it’s a huge gainwhereyour stockhas pushedbeyond your wildest dreams.It’s hard to make rationaldecisionswhenyou’vetripledyour money and want sobadly to believe it’ll happenseveralmore times. Itmight,but as with every “might”statement,itmightnot.That’s where your R&L

worksheet comes into play.You filled it out before youeven owned the stock, soyouremotionswereatafairlyeven level. You wereinterested in the stock, butyou just completed thoroughresearchandweremakinganobjective decision.Now, youown the thing and it’s up,down, and all around. Whatshouldyoudo?Look at that R&L sheet.

Pulloutyourportfolio folder

and scrutinize your everyscribble about this company.Diditreachyourpricetarget,oroneofyourratiotargets?Ifso, has anything changed togiveyoureasontobelievethestockstillhaslegs?If the stock is falling, has

anything fundamentalchanged at the company? Itmight be the same companyyou first invested in,butatacheaper price. Sometimesthat’s all it means when a

stock drops in price. AftercheckingoveryourR&L,it’stime to follow the advice inthenextsection.

ReverseYourEmotions

Remember that BenjaminGraham said nobody everknows what the market willdo, but we can reactintelligently to what it doesdo.Aha. If you’re at a point

where your investment hasfallenintothemud,thewordsof Ben Graham are muchmore than ink on paper.They’re good guidanceindeed.In “Where the Masters

Agree” (page 87), Isummarize the majoragreements of our sixmasterinvestors. They say to buymore of what’s working andto take advantage of pricedips.Thatseemstomeanthat

no matter what’s happening,you should buymore. That’sonlytrueregardingprice.Areyou starting to get thepicture?Priceisnotreallythemost important thing. Itseems to be and it’seventually the bottom line,but in the course of stockownership there are a lot ofthings more important. Forinstance, Warren Buffettkeeps an eye on profitmarginsandreturnonequity.

If the company remainsstrong and keeps doingeverything right, the marketwill eventually catch on andthepricewillrise.You’re beginning to see

why it’s so important tothoroughly research yourcompaniesandtohaveaclearunderstanding on your R&Lsheet for why you invested.Such grounding enables youto see if the company is stillas good, perhaps better, or

worse than when you firstinvested.If the price is rising and

everything you liked aboutthe company still persists,such as strong earnings, highmargins,lowdebt,andsteadycash flow, then you mightdecide to invest more. Themarket is finally recognizingwhatagreatcompanyyou’reinvested in and people arebeginningtobuy.AsWilliamO’Neil recommends, you

should move more moneyinto that winner. Businessowners buy more of what’sworking.If the price is falling and

everything you liked aboutthe company still persists,youjuststumbledontoagreatcompany at a bargain price.It’s incidental that youhappentoalreadyownsharespurchased at a higher price,you still have the chance tobuyagreatcompanyonsale.

Think of owning property.Say you bought a 10-acreparcel at $5,000 an acrebecause of its beautifulmeadows and stream. Youbuildyourdreamhomethere.Two years later, another 10-acre parcel adjacent to yoursgoes on sale for only $2,000an acre. It contains differentparts of the same beautifulmeadows and a differentsection of the same stream.Would you react by selling

the land and home youalready own? Of course not!It’s still beautiful. Instead,you’dsnapuptheadjacentlotbecauseofitsidenticalbeautyandthefactthatit’ssellingat60percentlessthanwhatyoupaidforthefirstparcel.That,inasense,isexactlyhowyoushouldreactwhenaperfectlysolidcompanydrops inpricewithout any fundamentalreasonfordoingso.React intelligently to the

market. It freaks out fromtime to time, but you don’tneed to. If the market goeshaywire and drops the priceof your company for noreason, smile coolly and buymore shares. If the marketgoes haywire and drives theprice of your stock throughthe clouds, buy more on thewayup.If you bought quality

companies after conductingthorough research, you have

little to fear in the markets.You will prosper over time.Themarketwillriseandfall,gurus will claim to knowwhere it’s going and when,you will hold winners andlosers, and by reactingintelligently to all thiscacophony your profits willmount. Your henchmen willreturn to the fortress withmore money than you spentto fund their excursions intotheRealmofRiches.

AftertheCrashof2008

Fromwhat you’ve read sofar, what do you think wasthe right reaction, in March2009,toastockmarketdown57percent intheprevious17months? If you said “buy,”youmayhaveafutureinthisbusiness.As I write these words in

March 2009, I have no ideawhat path the market willtake. You will read these

words after that, however,and can look back. Pull up achartoftheS&P500andseewhathappened.I’m sure it fluctuated. It

probably went up from itsMarch lows,probablymovedsideways for a while, andprobably dipped back downat some point. Eventually,though, you know where ithad to go? Higher. Themarket moves higher overtime, and it does best from

extreme lows wherevaluations are cheap. Itdoesn’tmatterifMarch2009was the lowof thebear.Thepoint is that a stockenvironment down that farpresents a time to get in, notout.In post-crash markets like

we saw in 2009, I suggestusing indexes to overcomeyourfear.It’snaturalaftertheworld almost ends to swearoff stocks forever. It’sat just

such times, however, thatthey make the most sense.Therewasalotlessriskafterthe57percentdropinMarch2009thantherewasbeforeitinOctober2007,butinwhichmonthdoyouthinkinvestorsshowed more confidence?October2007,ofcourse.The leveraged strategies

you read about in Chapter 4would have been good waysto benefit from the recovery.If they had been too volatile

for your tastes, a goodcompromisewouldhavebeenplain vanilla indexinvestments such as SPY forthe S&P 500, MDY for theS&P MidCap 400, and IJRfortheS&PSmallCap600.With a foothold in an

index, you could have nextused some of your capital tograb quality companies fromthe bargain bin. Themeasurementsyoureadaboutearlier in the book turned up

some incredible sales in thepost-crashmarket.Ifsomeofthemwerestocksyoualreadyowned, the deep discountsstillpresentedachancetoputmore money to work. Doingso would have lowered youraveragecostandbroughtyouback to break-even morequicklyintherecovery.Stocks occasionally go

down, and sometimes a lot.Investing when they do is agoodwaytogetahead.

SellYourStocks

Alas, the day will comewhen it’s time to part withyour stocks. You’ll receivereportsfromtheRealmaboutthe successes and hardshipsof your henchmen. One day,you’ll decide to give one ortwo or all of them a rest.You’ll sell your shares andplace your profits in a tidy

money market account untilthe next happy henchmencomealong.Let’sgooverafewrulesof

selling,shallwe?

IgnoreRumorsandPopularOpinion

I’ve probably convincedyou of the need to rely onyourselffordecisions.Just incase, however, I must

reiterate this point.Only youfully understand your goalsand tolerance for risk.Nobody cares more aboutyourmoneythanyoudo.Youworked hard for it, yousearched the world forcompanies that meet yourrequirements,youbecameanowner of those companies,and you should count onyourself alone for the righttimetosell.It’s not always easy to

stand alone. Imagine thiscommon scenario.Yougo towork on an average day andthere’s big news in thehallway. Mark McGillicuddyinthemailroomreadthatoneof your companies missedearnings last night. “Well,”Mc-Gillicuddysighs,“it’saworn story in Americanbusiness. You just can’t stayat the top of your gameforever. I sold all my sharesthismorning.Youguysbetter

do the same.” The hallwayclears and you hearkeyboards come to life inevery direction. There youstand, a previously proudowner of 3,000 shares of thestock.Whatdoyoudo?The first thing to do is

confirm that McGillicuddyread the darned newsaccurately. You’d besurprised at the number oftimes this simple step takescareof theproblem.Inmany

cases, the information isnothingmorethanarumor.Inthis case, it turns outMcGillicuddy is correct. Thecompany really did missearnings.Rather than join your

colleagues in rushing to sell,you’d be a much happierinvestor if you paused tothinkbacktothattrustyR&Lsheet. Can you rememberwhat you wrote on it?Probably not. In that case,

forget about it. That’s right,just forget about the currentsituation all day long. Whenyou go home that night, pullout your R&L and move ontothenextsection.

RelyonYourReasonsandLimits

With your R&L sheet inhand, you can arrive at aprudent decision. The

McGillicuddys of the worldwon’t be offering theiropinions, and you’ll beoblivious to the impressionthat everybody but you hasflownthecoopjustbeforethefoxbreaksin.Anditisjustanimpression, by the way.Rarely is the entire worldfollowing the path of youracquaintances, but becauseyouracquaintancesformyourlittle view of the world itoftenappearsthatway.React

intelligently,friend.ReadthatR&Lsheet.What did you write in the

“WhytoSell”section?Ifyouresearched thoroughly, youshould be aware of most ofthe challenges and risksfacingthecompany.Ifitwasmakinganacquisition,maybeyou wrote that if the pricepaid exceeds a certainamount, you would sellbecause that’s too much topay. If the company was

breaking into a new market,maybe you wrote that youneed to see a certain saleslevelbyacertaindateoryouwould consider sellingbecausethepayoffwouldnotbe commensurate with theexpense. There’s no end towhat youmight havewrittenas possible reasons to sell,and you’ll be surprised athow rarely you’re surprisedby events. Good researchpays.

Maybe in this case thecompany missed earningsbecause of a one-timeacquisition that used a lot ofcash for the quarter. Youwereawareoftheacquisitionandthinkitwillcreatehigherearnings in the future. If soandthemarketmisinterpretedthe meaning of the miss—whichhappensall thetime—there’slittlereasontosell.If instead you wrote on

your R&L, “Slowing sales

momentum? Watch earningstrend closely,” then the missmight be precisely the signalyou need to get out of thestock. I doubt you wouldneedMcGillicuddytotellyouaboutthecompany’searningsreport, though. You’d tellhim!So, there will be times

whenyoupulloutyourhandyR&L and notice that one ofyour sell conditionshasbeenmet,oroneofthecompany’s

key strengths has genuinelydisappeared. If nothing hascomealongtobalanceoutthechange, sell. The R&L sheetis there to help you navigatedifficultdecisionsintimesofemotion.Ifitsaysyourstockisfine,holdorbuymore.Ifitsays your stock is in trouble,sell. Unless new informationchanges the conclusions youdrew on the R&L sheet, payattention to what you wrotethere.

ReviewYourStockstoWatch

YourR&Lsheet isagoodway to keep an eye onindividual stocks.But it’s allrelative. Don’t forget yourstocks to watch worksheet.It’s called that for a reason,namely, because you shouldwatchthosestocks.Before you decide to sell,

glance over your stocks towatch. Is there a better

company available than theoneyou’recurrentlyholding?Often, that quick questioncombined with clear signalsfrom your R&L sheet makethe decision a breeze. Forinstance, if twoofyourR&Lsheet’s reasons to sell havebeen met in a company youown and a company you’vebeen wanting to own justdropped 20 percent in price,sell the current holding andbuythestocktowatchata20

percent discount. Sometimes,one of your stocks to watchwill present such anoutstanding opportunity thatyou’ll sell the least attractiveof your current holdings justto take advantage of theopportunity. That’s alegitimatestrategy.Justasthecompanies on your stocks towatch worksheet mustwithstand constantcomparison to new stocksyou encounter, so must your

portfolio withstand constantcomparison to your stocks towatch. It’s survival of thefittest, and you want to ownthebestcompaniesaround.Even if there are no

outstanding candidates onyour stocks to watchworksheet, you might stillelect to sell one of yourcurrent holdings. Often, amoney market account is abetter place than certainstocks. But don’t forget to

take a look at your stocks towatch. Your decision mightbemadeforyou.Remember you’re

managing a portfolio. Don’tmake decisions in a vacuum.Afteryousellsomething,youhave to put the proceedssomewhere. Sell one of yourcurrent holdings if a betteronesurfacesfromyourstockstowatchworksheet. Sell oneof them if it reaches apredetermined reason to sell.

If a stock drops dramaticallybut it is still a qualitycompany,buymoresharesorat least hold on to what youalready own. That is, unlessoneofyourstockstowatchismore deserving. In that case,move themoney to themoredeserving stock. See how itworks? Everything isinterwoven.

WatchtheChart

Don’t forget the chartingtechniques you learned inChapter4.Onereasontosellcould be that SMA,MACD,and RSI say you should.Those three are helpfuladvisors and worth anoccasionalconfab.The best case is that you

bought a stock at or near thebeginning of an uptrend andare now keeping an eye outfor the end of the run. Youwould watch for it to start

falling back to its simplemoving average, then below,thenfailtomovebackabove;for MACD to show a trendchange with a downwardcrossover; for RSI to signaloversoldconditions.Ideally, the chart will hint

beforethenewsthattroubleisbrewing. If the chart says tosell and then the newsconfirmsbyprovidingoneofyour R&L reasons to sell,you’ll have good reason to

pressthebutton.

ChooseanOrderType

You can place a marketorder to sell at the currentprice,alimitordertosellatapriceyouspecify,oratrailingstop to limit how muchyou’re willing to lose fromthe high. I sometimes try toanticipate the end of amovehigher by placing a limit

order to sell at a price nearwhere I think the stock willturnsouth.Evenifthemarkethas driven your stock totremendous highs, a limitorder placed just a littlehigher usually comesthrough.IfIthinkthestockisalready out of steam, I’llusuallygowithatighttrailingstop, such as 5 percent. Ialmost never use marketorders, but many people do.Sometimes the stock backs

off for a few days, but itusually creeps up to mytarget.If you don’t care about a

fewextrabucks andyou justwanttosellrightaway,placeamarketorder.Thebeautyofan immediate sell is thatyou’re not in limbo for anunspecified time period,unsure whether you’ve gotcash in your account or willbewaitingthreemonths.

MakeGradualSells

As with buying stock, Iprefer to make gradual sells.The market is just asunpredictable when it comesto choosing the right time tosellasitiswhenchoosingtherighttimetobuy.Ifyoumoveeverythingoutbecauseyou’reafraid of losing it all, howwill you feel if the stockrecovers to your buy priceand then pushes beyond? If

the stock doubles after youbuy it and you selleverything,howwillyoufeelwhen it becomes one of thelegendarytenbaggers?Inbothcases, you’ll feel terrible. Iknow because I’ve beenthere.Gradualmovesintoandoutofpositions takesomeofthe pressure off becauseeverything doesn’t need tohappen just right for you tomakemoney.Thingscanbealittle fuzzy on the buy and

sell. As long as you’remakinggradualmoves,you’llbefine.Combining gradual moves

with limit orders is a goodway to reduce investmentstress. Let’s say you own2,000 shares of MisterMagazine. A couple of theR&L sheet’s reasons to sellhave been met, but thecompany has just opened anew distribution center thatyou didn’t know aboutwhen

you first bought. You’re notsureifthat’senoughreasontohold on.The stock is tradingfor $30—three times whatyou paid for it. You feelcomfortable taking that kindof profit now, but somethingabout that new distributioncenter has you thinking thestockwillgohigherstill.If you sell nothing, you’re

going to blow a vessel ifMisterMagazinedropsto$12a share. If you sell

everything, you’re going toblowavesselifitrisesto$40a share, or even$32.Soyoucompromise on both the sellprice and the amount you’regoing to sell. You place agood till canceled limitorderto sell 1,000 shares at $32.Then you go hiking, orgolfing,orswimming,ortakea run. Three weeks laterwhile you’re not paying anyattention, Mister Magazinehits$32andyourbrokersells

1,000shares.Now,nomatterwherethestockgoesyoucantake comfort in your interimprofits. If the price begins todrop, you will considerselling the remaining sharesor buying additional shareswiththemoneyyoujustmadeat $32. If the price rises,you’llmakeevenmoreprofitonyourremainingshares.

SellThatBaby!

You’ve decided to sellsome of your stock. Simplypickupthephone,getonline,or walk into your localbrokerage branch and placetheorder.Amarketorderwillgo through that day with aconfirmation statement sentto you immediately. A limitorder will go throughwheneveryour targetprice isreached.You’llknowaboutitwhen the confirmationstatementshowsup.

TrackYourPerformance

TheLordorLadyofeveryfortress expects reports fromthe fieldnowand then.Mostofyour reportswillbe in theform of periodic marketupdates, stock quotes, andstatements from yourdiscount broker. In additionto those, however, you must

track your performance tofindareastoimprove.Iliketokeeptabsonevery

stock to watch. If youfollowed the advice fromearlier in this chapter, thatmeans you’ll follow around20stocks.Youcandothatinyour spare time. I track theirprices from the time theymake it on my stocks towatch worksheet until theyexit. If they exit at the sametime I sell them from my

portfolio, I still track theirprices for another month ortwojusttoseewhathappenedtotheirpricesafterIsold.Fromthere,you’regoingto

look at two components ofyourperformance.Thefirstisyouroverallportfolioprofits,losses,andcommissions.Thisis what most people meanwhen they talk aboutperformance, how they didlast year, who’s a greatinvestor, and so on. But

you’re also going to drill alittle further into your ownperformance by looking at“the fearsome foursome,” aterm describing four pricesyou’ll use to gauge yourindividualstockrecord.

PortfolioProfits,Losses,andCommissions

Either in a softwarepackage or on a ledger page,

recordwhatyoupaidforyourstocks and mutual funds,what you sold them for, andthe commissions you paid.Periodically,sayonceayear,note how the marketperformed as judged by theS&P 500 and compare yourown performance. Are youaheadorbehind?Statements from your

brokerwillhelpa lot inyourcalculations—especially ifyou consolidate all your

investments at the sameplace, suchasFidelityorTDAmeritrade. You can see onyour statement how muchyoustarted theyearwithandhow much you ended with.Such numbers takeeverything into accountincluding commissions. Ifyou didn’t invest anyadditional money, simplycompareyourendingbalancewith your beginning balanceto see how your investments

performed. If you did investadditional money, refer toyour notebook or financialsoftwareforspecificbuyandsellprices.I use Yahoo! Finance. It’s

easy and free to track myportfolio, and I can check itfrom any Internet-connectedcomputer in the world.Entering new transactions issimple.Then,Ijustlookovermy transaction history at taxtimeforanysalestohide,er,

report.

TheFearsomeFoursome

Once you’ve got a handleon your overall performance,it’s time to investigate howyou’ve done on individualinvestments.ForthatIuseaneasy but strict system calledthe fearsome foursome. It’sfearsomebecause it shows inno uncertain terms how you

did.It’s a foursome because

you write down four pricesforeverystockyou’veboughtand sold: the price threemonths before you bought,your buy price, your sellprice, and the price threemonths after you sold. Theonly one of these numbersthatmightnotbehandyisthepricethreemonthsbeforeyoubought. If the stock was onyour watch list and you

tracked the price before youbought, then you’ll have thenumber. Otherwise, you cancallabrokertofindoutwhatit traded at, find its pricehistory on the Internet, orconsult a stock database onyour computer. Here’s whatyou might write down forMisterMagazine:

Well, you did the rightthing on the buy. The stockhad been rising and youpickeditupbeforeitrosetoomuch. The sell, on the otherhand,couldusea littlework.The stock doubled in the

three months after you sold.Of course, gradual moveswould have eased some ofyour pain since you mighthaveleftalittlemoneyinthestock to grab some of thatjourney to $36. But it’s spiltmilknowandthebestthingistolearnfromitandmoveon.With this system, you’relooking to improve your buypointsandyoursellpoints.

GoodBuyPoints

Did you buy at a goodtime? For most growthinvestors, the price threemonthsbeforethebuyshouldbe lower than the buy price.Growth investors expect tobuy stocks on an upwardmove. For value investors,thepricethreemonthsbeforethebuyshouldbehigherthanthebuyprice.Valueinvestors

expecttobuywhenstocksgoonsale.Try to get your buy prices

rightaroundthepriceofthreemonths before. That meansyou’ll be buying growth atthe beginning of its rise orvalue right near its bottom.It’sraretocatchastockattheabsolute beginning of anupward launch or the bottomof a fall, but that’s the idealyou’restrivingtoward.

GoodSellPoints

Did you sell at a goodtime? Everybody wants thesamethinghere:tosellatthetopjustbeforethestockdivesto lower prices. Growth andvalue investors can agree onthispoint.Aswithbuyingattheexact

perfect moment, it’s nearlyimpossibletosellatastock’speak. They almost always

bounce a little bit higher.Bypushing your tracking periodout to three months, youavoid killing yourself over asmalluptickthedayafteryousell.Suchoccurrencesareupto thewhims of the universeand no amount of studyingpriceswillimproveyouroddsoftimingitright.That’swhywe look at three-month timeframes. You’re interested intrends,notflukes.

HowtoImproveYourBuyandSellPoints

Isupposetheultimatecoupwould be a sky high pricethreemonths before the buy,a dirt cheap buy price, a skyhigh sell price, and a dirtcheap price three monthsafterthesell.Youcouldbragabout that one for years. Toluxuriate in this dream amoment, pretend this is your

veryownfearsomefoursome:

The Realm of Richeswouldwhisperyournameforeons. $10,000 became$400,000. You would havetricked themallbygetting injust after a tremendous

tumble and getting out justbefore another tremendoustumble.Youcouldmove that$400,000 back in at $10 foranotherrecoveryifyourR&Lsheet indicated that thecompanywasstillsound.Now, back to reality. If

there are drastic differencesbetweenthefournumbers,goback to the file you keep onthe company and see if youcan recreate your thoughts atthebuyand sell.Your folder

should have clipped newsstories, company mailings,updated research reports, andso on. Did you buy at theright time based onsomethingyou read?Perhapsyousold toosoonbecauseofashort-termscarethat turnedoutfineintheend.Look over several

fearsome foursomes fordifferent stocks you’veowned. Watch for trends. Ifyou’re consistentlybuyingor

selling too soon or too late,make note of that tendency.Inmanycases,yourfearsomefoursome numbers will tellentirely different stories fordifferentstocks.Ifso, there’slittle you can do because allthe evidence is contradictoryandthat’sparforthiscourse.Every adage learned on thelaststockwillbereversedonthenext.That’s why you’re

searching for trends. I

discoveredafter lookingoverseveral fearsome foursomeresultsfrommyownportfoliothat I tend to sell too soon.My buy tendencies are toomixed to draw conclusions,butmysellsalmostinvariablycome early. That means Ishould trust my judgment infinding good companies andstart letting them do theirthing. I need to constantlyread what Warren Buffettsays: Time helps wonderful

businesses but destroysmediocre ones. Sincediscovering this tendency ofmine to sell too soon, I’veimprovedmyreturnsbyafewpercentage points on thestocks I’ve sold. Others Ihaven’tsoldatallandamstillholding on as they continuemounting profits. Before thefearsomefoursomeanalysis,Iprobably would have soldaftertheydoubled.You can do the same.

Whenever you sell a stock,wait three months and writeup the fearsome foursomeresults. Put the results in thecompany’s folder whenyou’re finished. Take a hardlookatthenumbers,comparethem to your other results,andlookfortrends.

8

BonVoyage

That’s about it. This bookshould help you get goingsafely with a stockinvestmentprogram.Ilikethefact that you won’t run out

and throw all your extradollars into a $2 startupbecause of something youreadhere.Ontheotherhand,you won’t languish for thenext 20 years in TreasuryBillsforsafety’ssake.It’snotsafe to underperforminflation.For you this book’s

strategy is going to be alifelong friend. It’s not theonly way to make money instocks, but it’s a way that

anybody can follow fromtheir kitchen table. You startgradually, perhaps in a banksavings account, then workyour way into a discountbroker’s core money marketaccount, then into permanentportfolios,andfinallyintotheopen market itself, whereyou’ll search for stocks thatmeasureuptohighstandards.It’s a safe, profitableprogressionthatallowsyoutolearnmoreasyougowithout

payingbigmoneytodoso.I’d like to part with some

wise words from CharlieMichaels, my friend who isPresident of Sierra GlobalManagement, LLC, a hedgefund company in New YorkCity. Charlie helped me onthe first edition of this book,and has provided a closingcommentforeachsubsequentedition. He’s worth reading.In 2008, when the S&P 500lost 38 percent and the FT

Europeindexlost41percent,Charlie’sSierraEuropeFundgained8percent.For the 2004 edition, he

wrote, “Being patient andbuying great businessfranchises with stronggrowing cash flows willnevermakeonepoor.Almosteveryotherformofinvestinghas the potential to destroyone’scapital.”For the 2008 edition, he

warnedthat“thestockmarket

is being propped up by thehundredsofbillionsofdollarsallocated to private equityfunds. These funds arelevering their capital andbuying companies right andleft. There will come a timewhenthesefundsbecomenetsellers(thedayofreckoning)as their performance fees arebased on realized profits.Hencetheprivateequitypropwillturnintoaprivateequitydrag. It is vital to invest in

high quality companies withstrong business franchisesthat are most likely to beresilient in the next bearmarket. Timing is importantin most walks of lifeincluding investing. Hence, Iadvocate being patient andbuying shares whenvaluations are attractive(low/cheap) so that whenprice earnings multiplescompress, the securities youhave bought will be resilient

andholdup.”For this edition, hewrites,

“In2007,whichturnedouttobe the peak of the last bullmarket, I warned that thestock market was beingpropped up by private equityfunds levering their capital.The key to my warning wasleverage. Today, we arewitnessingthemostprofounddelevering of the world’sfinancial markets, theunwindingofspeculationthat

built up over past decades.We can clearly see the valueof investing in ‘high qualitycompanies with strongbusiness franchises’ becausethey have indeed beenresilient. The good news isthat this very deep bearmarket is bringing the pricesof stocks to the mostattractive levels in ourlifetime. For the foreseeablefuture,investorsdon’tneedtoworry about investing in

overvalued stocks. This islikely a great time to slowlybuild a portfolio of greatbusinesses using theprinciples described inprevious chapters of thisbook.”Like our master investors

in Chapter 2, Charlie looksforqualitycompaniesatgoodprices.Nowyouknowhowtofindthem,andyouknowhowto determine if their currentprice is a bargain. All the

research you need is sittingsomewhere at this verymoment, justwaiting foryoutotakealook.Drop me a line sometime.

You can email me directly,jason@jasonkelly.com, orstop by www.jasonkelly.comto send me a message fromthere.

ReasonsandLimitsWorksheet

Copyright©2010JasonKelly.AllRightsReserved.FromTheNeatestLittleGuidetoStockMarket

Investing.StockstoWatchWorksheet

Copyright©2010JasonKelly.AllRightsReserved.FromTheNeatestLittleGuidetoStockMarket

Investing.

Appendix1:

WhatYouShouldRetainfromThis

Book

The principles of successfulinvesting never change

because thegoal isalways toput your money in thestrongest companies. Theyeventually win. This bookshows how to find them andthat’s why its advice worksnomatterwhat themarket isdoing.Herearethekeypointsofthatadvice:

Chapter1:SpeaktheLanguageofStocks

✔ You need toinvest in stocksbecause they allowyou to ownsuccessfulcompanies.Whenacompany prospers,so do its owners.Stocks have beenthe best

investments overtime.✔ You makemoney from stocksthrough capitalappreciation anddividends. Capitalappreciation is theprofit you keepafter you buy astockandsellitatahigher price.Dividends areshares in the

company’searnings,which arepaid to stockowners everyquarter. Not allcompanies paydividends.✔ You should usea discount brokerandmakeyourowninvestmentdecisions. Theadviceyougetfromfull-service brokers

is worthlessanyway, and theychargetoomuch.✔ The most basicdivision amonginvestors is growthand value. Growthinvestors look forsuccessfulcompanies that areincreasing earningsevery quarter, andthey are willing topay a price for

them. Valueinvestors look forcompanies that areoverlooked orstruggling,andtheywant to buy theirstocks on sale.These disciplinescoexist nicely. Forexample, you don’twant to pay toomuch for a growthstock, nor do youwanttobuyavalue

stock that has noprospect for futuregrowth.

Chapter2:HowtheMastersTellUsto

Invest

✔ Yourinvestmentstrategy should beclearly defined andmeasurable. Thisway, you avoid thecommon emotionaltraps of greed andfear. Rely on a setof specific criteria

to find superiorcompanies.✔ Look for strongincome statementsand balance sheets.Every company ishelped by highprofit margins, lotsofcash,andlittleornodebt.✔ Lookforinsiderstock ownershipand companybuybacks. Peter

Lynch writes,“There’s only onereason that insidersbuy: they think thestock price isundervalued andwill eventually goup.”✔ Conductthorough research.WarrenBuffettsaystoexercisethesamescrutiny whenbuying shares in a

company as you’dexercise whenbuying thecompany itself.Never act on tips.Always know whatyou’re buying andprecisely thereasonswhy.✔ Know thereasonsthatledyouto buy a stock, soyou know the righttime to sell. In two

minutes,youshouldbeabletorundownthe factors thatmade the stockattractivetoyou.✔ Buy at a pricebelow thecompany’spotential. If it’s anexpensive growthstock, it had betterbe growing quicklyenough to justifythe high price. If

it’s a depressedvalue stock, it hadbetter have somegood plans forrecovery and beexecuting themwell.✔ Buy more ofwhat’s working. Ifyou identified agood company andits stock is rising,consider buyingmore if the

company’sstrengths haveimproved as thepricerose.✔ Take advantageofpricedips.Ifyouown a qualitycompany and itsstock drops, verifythat it remains aqualitycompany. Ifit’sjustasstrongaswhen you firstinvested, consider

buying more at thediscount price. AsBill Miller says,“Lowest averagecostwins.”

Chapter3:HowHistoryTellsUsto

Invest

✔ The best all-purpose valuemeasureisprice-to-sales.✔ Dividend yieldis a great valuemeasure againstlarge, market-leadingcompanies.

✔ Thebestgrowthmeasure is relativestrength.Specifically:

•Amonglargecompanies,lookforstockswithhigh

relativepricestrengths.•Amongallstocks,avoidatallcostslastyear’sbiggest

losers.•Overthepreviousfiveyearsamongallstocks,lookforlaggardsbecause

they’reprobablyabouttorecover.

✔ Even growthstrategies need toinclude somemeasure of value,such as price-to-sales, to avoidpaying too muchforacompany.

✔ The simplestandoneof thebestvalue strategies isto buy large,market-leadingcompanies withhigh dividendyields. A perfectexample of thisapproach is theDow dividendstrategies explainedinChapter4.✔ Shareholder

yield combines thevalue of dividendswith thebenefitsofcompany sharebuybacks. Large,market-leadingcompanies withhigh shareholderyields outperformtheir low-yieldpeers.✔ Thebestgrowthstrategy is to buycompanies that

have:•Amarketcapgreaterthananinflation-adjusted$200million•

Aprice-to-salesratiobelow1.5•Earningshigherthanintheprevious

year•Athree-monthpriceappreciationgreaterthanaverage•Asix-month

priceappreciationgreaterthanaverage•Thehighestone-yearpriceappreciation

✔ Combining a

value and a growthstrategy is anexcellent way toboost your returnswhile keeping risktolerable.

Chapter4:PermanentPortfolios

✔ Valueaveragingis an automatedwaytobuylowandsell high as themarket fluctuates.You’ll use it withthe IJR small-company ETF toachieve steady 3percent quarterly

growthinyourcoreportfolio.✔ TheDow JonesIndustrial Averagecomprises30ofthemost powerfulcompanies inAmerica includingAmerican Express,Coca-Cola, Disney,Exxon Mobil,Home Depot, Intel,IBM, McDonald’s,Microsoft, and

Wal-Mart. Thedefiningcharacteristic of all30 Dow companiesis their gargantuansize. To take oneexample, Wal-Marthad sales of $405billion in 2008, afull 3 percent ofAmerica’s grossnationalproduct.✔ Because Dowcompanies are so

dominant, theyusually reboundfrom depressedstock prices. Thatmakes the Dow aprime huntingground for bargainstocks. As youlearned in Chapter3, the best way tofind undervaluedlarge companies isby looking at theirdividendyields.

✔ There are threeDow dividendstrategies that havebeaten the overallDow’sperformanceover time. Eachinvolves screeningout the 10 highest-yielding of the 30Dow stocks, theninvesting in all 10of them, the fivehighest-yielding ofthe 10, or the five

lowest-pricedofthe10. The best of thebunch, the DowLow 5, averaged9.4percentperyearin the 37 yearsended December31, 2008. Duringthat same time, theoverall Dowaveraged just 6.4percent.✔ As good as theDow dividend

strategies are,there’s a simpleway to beat all ofthem: leverage theentireDowtotwiceits return.Leveraging is atechnique thatmagnifies aninvestment’s returnwith borrowedmoneyandoptions.Both gains andlosses are

magnified.✔ The simplestway to double theDow is through theProFundsUltraDow30 mutual fund,symbol UDPIX. Itreturns roughlytwicewhattheDowreturns on a dailybasis.✔ The S&PMidCap 400 indexhas outperformed

theDow. In the 10years endingDecember 31,2008, the Dowreturned-4percent,buttheMidCap400returned37percent.Like the Dow, theMidCap400canbeleveraged to twiceits performance.This approach,what I call myMaximum Midcap

strategy,hasprovento be even betterthan doubling theDow.✔ The elephant inthe china shop ofthese leveragedstrategies is anextreme bearmarket. Themagnified loss isdevastating, andruins long-termperformance.

✔ Therefore, youshould try to avoidthe downside withtiming signalscreated by SMA,MACD, and RSI.These threecharting tools helpidentifypricetrendsandwilloftenwarnyoutogetoutofthestrategies beforebigdrops.✔ Because the

Dow and the S&PMidCap 400 aregroups of stocksand not individualstocks, theyeventually recouplosses. Thatprovidesconfidencethrough thevolatility. Extremevolatility coupledwith assuredrecoveryisapotentcombination.

Buying when thesevolatile strategiesare down in pricehas led totremendousgains.

Chapter5:GetReadytoInvest

✔ Choose one ofthe followingdiscount brokers:E*Trade, Fidelity,Firstrade, Schwab,Scottrade, TDAmeritrade, orTradeKing. Youmight also considera super discounter

such asBuyandHold,ShareBuilder, orZecco.✔ Uselimitordersto specify the priceat which you wantto buy and sellstocks, along withthetimeframe.Usemarket orders toexecute your buysand sellsimmediately. The

situation and yourpersonal preferencewill guide you tochoose the righttype of order. Ialmost always uselimitordersbecausethey enable me totake advantage ofthe market’sfluctuationswithoutgetting emotionallyinvolved.✔ Trailing stop

orders enable youto own a stock aslong as its uptrendcontinues, then getout when itreverses. They“trail” behind theprice as it risesupward but lockintoplacewhen thepricebegins to fall.Limit orders andtrailing stops arejust about the only

ordertypesIuse.

Chapter6:ResearchtoRiches

✔ Pay attention toyour personalexperience and theinvestmentgrapevine for goodideas.✔ I provide aselection ofmagazines,newspapers,

newsletters, andspecialtypublicationsforyouto consider. Themost useful areInvestor’s BusinessDaily with itsSmartSelect stockratings and TheValue LineInvestment Surveywhichprintsalmosteverything youneedtoknowabout

astock.✔ Contactcompaniesthemselves torequest an investorpacket. It shouldinclude an annualreport, balancesheet, and incomestatement. Readingthemwillshowyouthe company’shealth in terms ofwhat it owns, what

it owes, and howmuch profit itkeeps.✔ Stock screenersare helpful forrunning criteriafilters across allstocks to find justthe ones you want.TheoneIuseeveryday is Yahoo!Finance StockScreener.✔ There’s a

handful ofinvestmentwebsitesthat I recommend,the most usefulbeing Yahoo!Finance. For aconvenientclicklistofthesiteslistedinthis book, visitwww.jasonkelly.com/investonline

Chapter7:ThisBook’sStrategy

✔ Build a coreportfolio with oneof the permanentportfolio strategiesin Chapter 4.Choose either aDow dividendstrategy, myDouble the Dowstrategy, or my

Maximum Midcapstrategy. I useMaximum Midcapbecause it returnsthe most over thelong term. BothDouble the Dowand MaximumMidcaparetwiceasvolatile as themarket.✔ Fill andmaintain yourstocks to watch

worksheetusingtheinvestmentresources youlearned about inChapter 6. Theworksheet isprovided on pages262-263.✔ Keymeasurements ontheworksheetare:

•Net

profitmargin.Shouldbeinthetop20percentofitsindustryandbigger

isbetter.Foundintheinvestorpacket,ValueLine,andontheInternet.•

Salespershare.Shouldbeincreasingoverthepastfiveyears.FoundinValue

LineandontheInternet.•Cashflowpershare.Shouldbepositiveand

increasingeachyear.FoundinValueLineandontheInternet.•Earningsper

share.Shouldbepositiveandincreasingeachyear.FoundinValueLineandon

theInternet.•DividendYield.Shouldbehighforlargecompanies.Foundinmost

newspapers,ValueLine,andontheInternet.•Returnonequity.Shouldbe20

percentorhigher.FoundintheinvestorpacketandontheInternet.•Insider

buys/ownership.Shouldbehighbecauseinsidersbuytheirstockonlywhentheythinkit

willgohigher.FoundinValueLine,Investor’sBusinessDaily,andYahoo!Finance.•

Stockbuyback.Youwantacompanybuyingbackitsstock.Foundbycallingthe

company.•EPSrank.Growthinvestorsshouldinsiston85orhigher.Foundin

Investor’sBusinessDaily•Relativepricestrengthrank.Growthinvestorsshouldinsiston80

orhigher.FoundinInvestor’sBusinessDaily•Five-yearsalesandearningsgain.

Shouldbeatleast10percentforallcompaniesand15percentforsmall

companies.FoundinValueLineandontheInternet.•Projectedsales.Largecompanies

shouldbeexpectedtogrowatleast10percentayear,mediumcompaniesat

least15percent,andsmallcompaniesatleast20percent.FoundinValueLine,

manyotherpublications,andtheInternet.•Projectedstockhigh/low.Biggerisbetterfor

boththehighandthelow.FoundinValueLineandtheInternet.•

ValueLinetimeliness/safety.Timelinessshouldberanked1or2,thesafetyrankis

uptoyourvolatilitypreference.FoundinValueLine•S&PSTARSfairvalue.

BothSTARSandfairvalueshouldberanked4or5.FoundinS&P’s

weeklynewsletter,TheOutlook•Currentprice-to-earnings.Forvaluecompanies,shouldbe

equaltoorbelowtheearningsgrowthrate.FoundinValueLine,mostnewspapers,

andontheInternet.•Averageprice-to-earnings.Shouldbehigherthanthe

currentP/E.FoundinValueLine•Price-to-sales.Forallcompaniesexcept

utilities,smallerisbetter.FoundininvestmentmagazinesandontheInternet.•Price-

to-book.Smallerisbetter.FoundinValueLineandontheInternet.•

Currentratio.Shouldbeatleast2.FoundinValueLine,theinvestorpacket,

andontheInternet.•Quickratio.Shouldbeatleast.5.Foundin

ValueLine,theinvestorpacket,andontheInternet.•SMA,MACD,andRSI.

Shouldshowastronguptrendorabreakout.Foundoncharts,suchasthe

onesatYahoo!FinanceandStockCharts.com

✔ Constantlytrackand prune yourstocks to watchworksheet.Compare thecompanies on it tocompetitors,

maintain aninformation folderon each company,andkeepallofyourinformationcurrent.Inthisway,youareprepared foropportunities thatthe market servesup by lowering thestock price ofcompanies youknowtobesolid.✔ Make gradual

purchases.Everybody iswrongaboutastockpricenowandthen.Limit the damageby using only partof your money forthe first buy. Youcan always buymorelater.✔ Avoid commonemotionalinvestment traps byfillingoutareasons

and limitsworksheet,orR&L,for each of yourstocks. Theworksheet isprovided on page261.Circlewhetherthe stock is growthor value, list thecompany’sstrengths andchallenges, andwrite the reasonsyou’re buying and

what would causeyoutosell.✔ Be skeptical ofso-called gurus ormarket experts. Anongoing study byCXO AdvisoryGroup shows theaverage marketexpert’saccuracytobejust48percent—less reliable than acoin flip. For acollection of

noncommittalforecasts, see page243.✔ The market isvolatile. Yourmoney invested instockswillfluctuatein value.Understand thatbeforeyouinvestsoyouareemotionallyequipped to dealwith thefluctuations.

✔ Reviewingyourreasons and limitsworksheet is awonderful way tokeep a cool headwhen things heatup. You wrote itwhen youwere notunder duress. Relyon those steadiertimes for guidanceas you decidewhether to sell.Your R&L will

prove a morereliable investmentcompanion thanmost coworkers,relatives, oranalysts.✔ Keep an eyeonthe chart. SMA,MACD, and RSIwill often signal achanging trend. Iftheydosobeforeorjust as the newsbrings one of your

R&L sheet’sreasons to sell,you’ll have goodreason to press thebutton. To reviewthe three,seepages131-141.✔ Make gradualsells for the samereasons you makegradualbuys.✔ Track yourperformance in asoftwarepackageor

ledger page. Usethe fearsomefoursome to followfourpricepointsforeach of your stockinvestments: theprice three monthsbefore you bought,your buy price,your sell price, andthe price threemonths after yousold. Learn fromyour mistakes and

improve yourabilitiesovertime.

Chapter8:BonVoyage

✔ This book’sstrategy takes youonasafe,profitableprogression thatallows you to learnmore as you gowithout paying bigmoney to do so.Youstartgradually,perhaps in a bank

savings account,thenworkyourwayinto a discountbroker’s coremoney marketaccount, then intopermanentportfolios, andfinallyintotheopenmarketitself,whereyou’ll search forstocks thatmeasureup to highstandards.

✔ Follow CharlieMichaels’s lead inbuying high-qualitycompanies withstrong businessfranchises—onsale.✔ I wish you allthebest.Youcane-mail me directly,jason@jasonkelly.com, orstop bywww.jasonkelly.com

to send me amessagefromthere.

Appendix2:

ASamplingofExchange-Traded

Funds

The following are ETFtrading clusters that I follow.

You can get them on aprintablesheetatmywebsite,www.jasonkelly.com/resourcesU.S. LARGE-COMPANYSTOCKS

DDM | 200%theDow(2x)DIA |SameastheDow(1x)DOG | Inverseof the Dow(-1x)

DXD | 200%inverse of theDow(-2x)SSO | 200%the S&P 500(2x)SPY|Sameasthe S&P 500(1x)SH|Inverseofthe S&P 500(-1x)SDS | 200%

inverse of theS&P500(-2x)BGU | 300%the Russell1000(3x)IWB|Sameasthe Russell1000(1x)BGZ | 300%inverse of theRussell 1000(-3x)

U.S.MEDIUM-COMPANYSTOCKS

MVV | 200%the S&PMidCap 400(2x)MDY | Sameas the S&PMidCap 400(1x)MYY|Inverseof the S&PMidCap 400

(-1x)MZZ | 200%inverse of theS&P MidCap400(-2x)

U.S. SMALL-COMPANYSTOCKS

TNA | 300%the Russell2000(3x)UWM | 200%the Russell2000(2x)

IWM | Sameas the Russell2000(1x)RWM |Inverse of theRussell 2000(-1x)TWM | 200%inverse of theRussell 2000(-2x)TZA | 300%inverse of theRussell 2000

(-3x)SAA | 200%the S&PSmallCap 600(2x)IJR | Same asthe S&PSmallCap 600(1x)SBB | Inverseof the S&PSmallCap 600(-1x)

SDD | 200%inverse of theS&PSmallCap600(-2x)

U.S.NASDAQSTOCKSQLD | 200%the NASDAQ100(2x)QQQQ |Sameas theNASDAQ 100(1x)PSQ | Inverse

of theNASDAQ 100(-1x)QID | 200%inverse of theNASDAQ 100(-2x)

U.S.SECTORSTOCKSUGE | 200%the DJ U.S.ConsumerGoods(2x)

IYK |Sameasthe DJ U.S.ConsumerGoods(1x)SZK | 200%inverse of theDJ U.S.ConsumerGoods(-2x)UCC | 200%the DJ U.S.ConsumerServices(2x)

IYC |Sameasthe DJ U.S.ConsumerServices(1x)SCC | 200%inverse of theDJ U.S.ConsumerServices(-2x)FAS | 300%the Russell1000FinancialServ.(3x)

UYG | 200%the DJ U.S.Financials(2x)IYF | Same asthe DJ U.S.Financials(1x)SEF | Inverseof theDJU.S.Financials(-1x)SKF | 200%inverse of theDJ U.S.Financials

(-2x)FAZ | 300%inverse of theRussell 1000FinancialServ.(-3x)RXL | 200%the DJ U.S.Health Care(2x)IYH |Sameasthe DJ U.S.Health Care

(1x)RXD | 200%inverse of theDJU.S.HealthCare(-2x)UYM | 200%the DJ U.S.Materials(2x)XLB|Sameasthe S&PMaterials(1x)SMN | 200%inverse of the

DJ U.S.Materials(-2x)ERX | 300%the Russell1000 Energy(3x)DIG | 200%the DJ U.S.Oil&Gas(2x)IEO | Same asthe DJ U.S.Oil&Gas(1x)DDG | Inverse

of theDJU.S.Oil & Gas(-1x)DUG | 200%inverse of theDJU.S.Oil&Gas(-2x)ERY | 300%inverse of theRussell 1000Energy(-3x)URE | 200%the DJ U.S.

Real Estate(2x)IYR |Sameasthe DJ U.S.Real Estate(1x)SRS | 200%inverse of theDJ U.S. RealEstate(-2x)USD | 200%the DJ U.S.Semiconductors

(2x)IGW|Sameasthe S&P N.AmericanSemiconductors(1x)SSG | 200%inverse of theDJ U.S.Semiconductors(-2x)ROM | 200%the DJ U.S.

Technology(2x)IYW|Sameasthe DJ U.S.Technology(1x)REW | 200%inverse of theDJ U.S.Technology(-2x)LTL | 200%the DJ U.S.

Telecom(2x)IYZ | Same asthe DJ U.S.Telecom(1x)TLL | 200%inverse of theDJ U.S.Telecom(-2x)UPW | 200%the DJ U.S.Utilities(2x)IDU |Sameasthe DJ U.S.

Utilities(1x)SDP | 200%inverse of theDJ U.S.Utilities(-2x)

INTERNATIONALSTOCKS

FXI | Same astheFTSE/XinhuaChina25(1x)FXP | 200%inverse of the

FTSE/XinhuaChina25(-2x)EFA|Sameasthe MSCIEAFE(1x)EFZ | Inverseof the MSCIEAFE(-1x)EFU | 200%inverse of theMSCI EAFE(-2x)

EEM | Sameas the MSCIEmergingMarkets(1x)EUM| Inverseof the MSCIEmergingMarkets(-1x)EEV | 200%inverse of theMSCIEmergingMarkets(-2x)

EWJ|Sameasthe MSCIJapan(1x)EWV | 200%inverse of theMSCI Japan(-2x)

CURRENCYUUP|SameasUS Dollar vsEuro, Pound,Yen,etc.(1x)UDN | Inverse

of US Dollarvs Euro,Pound, Yen,etc.(-1x)

Appendix3:

ValueAveragingtheS&PSmallCap600

InChapter 4, you read aboutusing the iShares S&PSmallCap 600 ETF, symbol

IJR, with value averaging.The table on the next pageshows value averaging usedonIJRtoachievea3percentquarterly growth rate fromDecember2002 toDecember2008, a period that saw theETF rise from $31.21 to$70.37, then fall to $43.97.Toseehowtheplan isdoingtoday, visitwww.jasonkelly.com/strategies

Index

Note:Pagenumbersinitalicsdenotechartsandtables.

Abelson,AlanAbnormalReturnsaccountingaccumulation/distribution

ratingacquisitionsAdvancedMicrosystemsAffiliatedPublicationsairlinestocksAkamaiTechnologiesAlcoaAlicoalphaAltriaGroupAmazon.comAmerican Association ofIndividualInvestors

AmericanExpressAmerican InternationalGroup(AIG)American Stock Exchange(AMEX)analysis of stocks. See alsotechnicalanalysis.analyticaladvantagesannualearningsannualratesannualreportsAppleComputerappreciation,capital

AsYouLikeIt(Shakespeare)askpriceassetplaystocksassets.Seealsocashandcashflow.AT&Tautomation of stockpurchasesaveragingdollar-cost-averaging

(DCA)expertagreementonMilleron

O’Neillonandpricedipsvalueaveraging

A&W

balancesheetsBankofAmericabankruptcybargainstocks.Seealsovalueinvesting.Buffetton

andcashflowanddividendsexpertagreementonandfutureperformanceandgrowthinvestingMilleronandmyopiclossaversionandpermanentportfolios

Barnes&NobleBarron’sonaveragingand insider stock

ownership

andInternetresourcesandMillerandresearchonstockanalysts

bearmarketsBearStearnsBeatingtheDow(O’Higgins)BeatingtheStreet(Lynch)behavioraladvantagebenchmarksBerkshireHathawayBernhard,ArnoldBespokeInvestmentGroup

best-of-breedstatusbidpriceTheBigPictureBigchartsBloombergbondsbookvalueBordersGroupboringstocksBostonGlobebrandloyaltyBriefing.combrokers. See discount

brokerages; full-servicebrokerages.Buffett,WarrenbackgroundoncashflowoncircleofcompetenceonevaluationofcompaniesandFisherandGrahamonholdinginvestmentsonhonestyinvestingstrategyofandLynch

onnetprofitsand Outstanding Investor

Digestonpricedipsonresearchonreturnonequityonstockcomparisonsontimingofpurchasesonvalueinvestingonvolatility

bullmarketsBusinessWeekBuyandHold

buybacksofstockand automation of stock

decisionsdataonexpertagreementonandhistoricalreturnsandidealvaluestrategyandincomestatementsLynchonstrategyguidelinesandValueLinerankings

buyingstocksandgradualmoves

keypointsandordertypesplacingordersreasonstobuy

CalculatedRiskCANSLIMSystemcapitalallocationcapitalappreciationCapitalCities/ABCcapital expenditures

(CAPEX)capitalstructureCarnegie,Andrewcashandcashflowand automation of stock

decisionsBuffettonFisheronforecastingfreecashflowand growth vs. value

investingLynchon

MichaelsonMilleronper-sharecashflowandquickratioandstockcomparisonsandstrategyguidelinesunderstandingandvalueinvestingandValueLinerankingsandworksheetdata

categorizationofstockschallengesofcompaniesCharlesSchwab

charts. See also specificmeasures.cheapstocksChevronChryslercircleofcompetenceCiscoSystemsCitigroupclassificationofstocksClearStationclosingpriceCNNMoneyCoca-Cola

Buffettonand the Dow Jones

IndustrialAverageLynchonandsalesandsteadybusinessandstockpriceassessmentand “two-minute

monologue,”Cognizant TechnologySolutionsColumbiaPicturescombinedstrategies

commissionscommoditiescommonstockCommon Stocks andUncommonProfits(Fisher)companybasicscompanyhealthCompaqcomparingstockscompetitioncompositeratingscompoundingcomputerized trading. See

alsoInternetresources.ComputstatconcentrationofportfoliosconflictofinterestconformityconsolidationperiodsconsumerbehaviorcontrarianismConversation with a MoneyMasterCook,ScottcostcontrolsCostco

Cramer,JamesJ.crashescreditCrocscurrencyfundscurrentratioCXOAdvisoryGroupcyclicalstocks

dailydollarvolumedayorders

debtDeckersOutdoorsdeclining prices. See alsobearmarkets;crashes.DelldemandforstocksDiamondMultimediaDiamondsTrustDickDavisDigestdiscountbrokeragesdiscounted stock prices. Seealsobargainstocks.Disney

diversificationdividendsBuffettondividendyieldand the Dow Jones

IndustrialAverageand growth vs. value

investingandhistoricalreturnsandidealvaluestrategyandinvestingprofitsand measurement

performance

MilleronandpermanentportfoliosandsafetyandstockpagesandstrategyguidelinesandtotalreturnsandvalueinvestingandValueLinerankingsandworksheetdata

Dodd,Daviddogsofthedow.comdollarchangedollar-cost-averaging(DCA)

dot.combubbleDouble-TakeSoftwareDoubletheDowstrategyandcoreportfoliosdescribedanddownsideriskhistoricalperformanceandInternetresourcesandmarketvolatilityand Maximum Midcap

strategydoublingdownDow,CharlesH.

DowJones&CompanyDow Jones IndustrialAverage(DJIA)componentstockscreationofanddividendstrategiesanddownsideriskandhistoricalreturnsandidealvaluestrategyandleveragetechniquesandmarketvolatilityandmidcapscomparedandpermanentportfolios

andsimplemovingaverageand“themarket,”

Downes,JohnDryShipsDuPont

earnings. See also earningspershare(EPS);profits.BuffettonexpertagreementonFisheron

GrahamonandgrowthinvestingLynchonprojectedearningsandselldecisionsstrategyguidelinessurprisesandvalueinvestingandValueLinerankings

earningspershare(EPS)andCANSLIMSystemandincomestatementsandSmartSelectratings

andstockevaluationandstrategyguidelines

EastmanKodakeBayeconomic conditions. Seealso bear markets; bullmarkets;crashes;recessions.EDGAREdleson,MichaelEisenstadt,SamuelEmerson,RalphWaldoemotionininvestingexpertagreementon

Grahamonandlimitordersand personal investing

trendsand “reasons and limits”

worksheetandvolatility

EnronentrepreneurshipequitiesequitypremiumpuzzleE*TradeEuronet

evaluating stocks. See alsoresearch.expertagreementonfundamentalmeasurementsfundamental vs. technical

analysisgrowthvs.valueinvestingandmarketvolatilityandportfoliomanagementandstockmeasurementsandstockpagesand technical stock

measurements

exchange-traded funds(ETFs).Seealsospecificfundnames.exclusiverightsexpansionofcompaniesexpensesexperts’investingmethodsagreementamongexpertsBuffettFisherGrahamkeypointsLynch

MillerO’Neillandskepticism

exponential moving averages(EMAs)ExxonMobil

FairValuerankingsfallingstocks“fearsomefoursome,”FederalReserveBank

FidelityFidelityMagellanFund52-weekpricesfinancialstatementsfinancialstocksFinancialTimesFirstMarbleheadFirstradeFisher,Philipfloatfluctuations in the market.Seevolatility.focusedinvestments

Footnoted.orgForbesFordFord,HenryFortunefraudFreddieMacfreecashflowFTEuropeindexfull-servicebrokeragesfundamentalanalysisFundsNetworkprogramfutureperformance

gamblingTheGapGatewayGEICOGeneralElectricGeneralMotorsGillettegood-till-cancelled (GTC)ordersGoogleGoogleFinanceLynchonMilleron

andSmartSelectgradualmovesandinvestingstrategyO’Neillonandperformancetrackingandpurchasingstocksandselldecisionsandstrategyguidelines

Graham,BenjaminbackgroundandBuffettonhistoricalstockbehaviorinvestingstrategy

onmarginofsafetyonpricedipsonprice-to-bookratioonqualitycompaniesonvolatility

Grant’s Interest RateObservergrowthinvestingandasking“why?”andbargainpricesBuffettonandearningspershareandevaluationofstocks

expertagreementonFisheronandgoodbuypointsandgoodsellpointsGrahamonandhistoricalperformancekeymeasuresandmarketvolatilityMilleronandO’Neillandpriceappreciationandprice-to-bookratioand price-to-cash-flow

ratioandprice-to-earningsratioandrecessionsandrelativepricestrengthandsalespershareandslow-growthindustriesstrategyguidelinesandvalueaveragingvalue investing contrasted

withworksheetsfor

Grubman,JackGulfmarkOffshore

Hagstrom,Robert,Jr.HanesHansenNaturalhedgefundsHewlett-PackardhistogramshistoricalreturnsandcombinedmeasuresandDowstrategiesindexescomparedkeypointsandpopularmeasuresandvalueaveraging

andValueLinerankingsholdingcompaniesholdinginvestmentshonestyHoneywellhousingmarketHow to Make Money inStocks(O’Neill)How to Trade in Stocks(Livermore)Hulbert,MarkHulbertFinancialDigest

IBMandbalancesheetandbest-of-breedstatusandcompanybasicsandcompetitionanddividendyieldandidealvaluestrategyandincomestatementsandstocksplitsandValueLinerankings

income. See also dividends;profits.incomestatements

andreturnonequityindexes. See also specificindexnames.industryclassificationsindustryleadersInfectiousGreedinflationinformationaladvantagesinitialpublicofferings(IPOs)insideinformationinsiderstockownershipand automation of stock

decisions

expertagreementonLynchonO’Neillonstrategyguidelinesandworksheetdata

InstantX-Rayinstitutionalinvestorsinsuranceintegrity.Seealsohonesty.IntelThe Intelligent Investor(Graham)interest

InternationalPaperinternationalstocksInternetresourcesandcompanybasicsandcurrentinformationandinvestorpacketsandperformancetrackingandprice-to-earningsratioandprice-to-salesratioandstockscreeners

intrinsicvalueinvestmentbankersinvestmentclubs

investorpacketsInvestor’sBusinessDailyandcompanybasicsandearnings-per-sharedatafoundedandindustryleadersand insider stock

ownershipandmarketdirectionandprice-to-earningsratioandrelativepricestrengthandstockresearchandtradingvolumedata

iPhoneiPodiShares

jasonkelly.comJohnson&JohnsonJoy,BillJPMorganChase

Kahneman,Daniel

Kelly,JasonTheKellyLetterKFCKiplinger’sTheKirkReportKodakKohl’sKraftFoodsKroc,Ray

LaQuinta

largecapstocksandcompanybasicsanddividendyieldandexchange-tradedfundsandhistoricalperformanceandprojectedgrowthandrelativepricestrengthandvalueinvestingandworksheetcriteria

lawsuitsleadershipLeggMasonValueTrustL’eggspantyhose

LenovoleverageandDowstocksanddownsideriskandmarketvolatilityMichaelsonandpost-crashmarketsprosandcons

liabilities.Seealsodebt.librariesLifePartnersHoldingslimitorderslimitinglosses

liquiditylistingcriteriaforstocksLivermore,JesseLongJohnSilver’slong-terminvestingLosAngelesTimeslossesandearningspersharelimitingandmyopiclossaversionandperformancetrackingandstop-lossorders

Lynch,Peter

backgroundoninsiderstockpurchasesinvestingstrategyon“perfectcompanies,”onprice-to-earningsonstockbuybacksonstockresearchontimingofpurchaseson “two-minute

monologue,”

Macy’smagazinesmanagementofcompaniesBuffettonandcashflowFisheronandhonestyand insider stock

ownershipandprofitmarginandstockbuybacks

managinginvestmentsmanipulationofdata

marginofsafetymargintradingmarginalcapitalmarketaveragesmarket capitalization. Seealso large cap stocks;mediumcapstocks;smallcapstocks.andcompanybasicscompanyclassificationsanddividendyieldandgrowthstrategiesandhistoricalreturns

andmeasurementtestsandtradingvolumeandworksheetcriteria

marketdirectionMarketLaboratorymarketleaderstrategymarketordersmarketpressuremarketvaluationMarketWeekMarketWatchMaximumMidcapstrategyandcombinedmeasures

andcoreportfoliosdescribedand the Dow Jones

IndustrialAverageanddownsideriskhistoricalperformanceandmarketvolatility

May-Day and Other Pieces(Emerson)McDonald’sMcGraw-HillCompaniesMcNeilmedium cap stocks.See also

Maximum Midcap strategy;S&PMidCap400.MerckMichaels,CharlieMicrosoftandbest-of-breedstatusandcashflowand the Dow Jones

IndustrialAverageandearningstrendsandidealvaluestrategyand insider stock

ownership

Milleronandnetprofitsandsteadybusinessandstockpriceassessmentandstocksplits

mid cap stocks. See alsoMaximum Midcap strategy;S&PMidCap400.Miller,Billonaveragingbackgroundoncashflowongradualmoves

investingstrategyonstockcomparisonsontimingofpurchasesonvalueinvesting

MinyanvillemomentuminvestingandCANSLIMSystemandearningspershareandgoodbuypointsO’NeillonandrelativepricestrengthandValueLinerankings

moneymanagement

moneymarketaccountsmonitoringinvestmentsMorgan,J.P.MorganStanleyMorningstarMotleyFoolmoving average convergencedivergence(MACD)andDowstrategiesanddownsideriskMACDsignallineandmarketvolatilityandselldecisions

andstockevaluationstrategyguidelinesandworksheetdata

MSNMoneymultiple. See price-to-earnings(P/E)ratio.Munger,Charliemutualfundsandcommissionsanddiscountbrokersand Doubling the Dow

strategyandearningspershare

andInternetresourcesmyopiclossaversion

National Association ofSecuritiesDealersAutomatedQuotations(NASDAQ)andcomputerizedtradingandexchange-tradedfundsandgrowthinvestinghistoricalreturnsandindustryleadersandpublicofferings

and“themarket,”netprofitmarginNetflixnewmarketsnewproducts/servicesNew York Stock Exchange(NYSE)AlternextUSandfull-servicebrokersandindustryleadersandInternetresourcesandO’Neillandpublicofferings

newslettersnewspapersNiemond,GeorgeNike

O’Higgins,MichaelOne Up on Wall Street(Lynch)O’Neill,Williambackgroundonearningsacceleration

onemotionsininvestingonevaluationofcompaniesongradualmovesongrowthinvestinginvestingstrategyand Investor’s Business

Dailyonprice-to-earningsratioonstockcomparisonsontimingofpurchasesonvalueinvesting

online trading. See alsoInternetresources.

operatingcapitaloperatingcostsoptimismOracleorder types.See limit orders;market orders; stop orders;trailingstoporders.organizationofresearchO’Shaughnessy,Jamesonasking“why?”andcombinedmeasuresondividendyieldkeypoints

andpopularstockmeasuresonprice-to-salesratioand value vs. growth

investingTheOutlookOutstandingInvestorDigestover the counter (OTC)market

patentspatiencePebbleBeach

PenultimateProfitProspectPepsiCo“perfectcompanies,”performanceofcompaniesBuffettonanddividendyieldprojectionstrackingandvalueaveraging

permanentportfoliosanddividendstrategiesand Doubling the Dow

strategy

and the Dow JonesIndustrialAverageanddownsideriskkeypointsandmarketvolatilityand Maximum Midcap

strategyandvalueaveraging

personalexperiencePfizerpharmaceuticalcompaniesphonenumbersforcompaniesPizzaHut

pointspopularopinionportfolioselectionpreferredstockpresentvaluepriceappreciationandgrowthstrategiesO’Neillonandworksheetdata

price-to-bookratioGrahamonandgrowthinvestingLynchon

andstockevaluationandstrategyguidelinesandvalueinvestingandworksheetdata

price-to-cash-flowratioprice-to-earnings(P/E)ratioaverageP/EcurrentP/EGrahamonandgrowthinvestingLynchonandmeasurementtestsMilleron

O’Neillonandselldecisionsandstockevaluationandstockpageinformationandstockscreenersandstrategyguidelinesand the “two-minute

monologue,”andvalueinvestingandValueLinerankingsandworksheetdata

price-to-sales(P/S)ratioandgrowthinvesting

andhistoricalreturnsand performance of

measurementandselldecisionsandstockevaluationandstockscreenersandstrategyguidelinesandvalueinvestingandworksheetdata

primarymarketprivateequityfundsProcter&Gambleproductresearch

profitsand automation of stock

decisionsBuffettonanddividendsandearnings-per-shareand evaluation of

companiesFisherongrossprofitsand growth vs. value

investingMilleron

andperformancetrackingprofitmarginsandreturnonequityandsmallcapstocksandSmartSelectratingsfromstocksalesstrategyguidelinesandValueLinerankings

ProFundsprojectedperformanceProSharesprospecttheoryProulx,Tom

Public Register’s AnnualReportServicepyramiding

qualitybusinessesquarterlyfinancialstatementsquickratioQuicksilverResources

RadioShack

railroadsRealClearMarkets“reasons and limits”worksheetsandgradualmovesandmarketvolatilitysampleandselldecisionsandstocktrendsusing

recessions. See also bearmarkets.recordkeeping

recoveringlossesreevaluationofstocksrelative price strength. Seealso relative strength index(RSI).andCANSLIMSystemandgrowthinvestingandhistoricalreturnsand measurement

performanceandSmartSelectratingsstrategyguidelinesandvalueinvesting

andworksheetdatarelativestrengthindex(RSI)andDowstrategiesanddownsideriskandmarketvolatilityandselldecisionsandstockevaluationandstrategyguidelinesandworksheetdata

researchasking“why?”Buffettonandcircleofcompetence

andcompanybasicsandcompanyhealthcompany-provided

informationanddiscountbrokersandDowstocksandexpertagreementFisheronandfull-servicebrokeragesInternetresourcesand the investment

grapevinekeypoints

knowingyourcompaniesandmagazinesandnewslettersandnewspapersandpastperformanceandpersonalexperienceandprojectedperformancesharedinformationandstockhealthandstockpagesandstockrankingsandstockratiosandstockscreening

andstockwatchlistsand the “two-minute

monologue,”andValueLinerankingsandverifyingandwatchlistsandworksheetcriteria

ResearchInMotionreturnonequity(ROE)BuffettonandSmartSelectratingsandstockevaluationandstrategyguidelines

andworksheetdatarevenues.Seeincome.RGEMonitorriskandbearmarketsandcombinedstrategiesGrahamonandgrowthinvestingandleverageandmarkettrendsandpost-crashmarketsandprospecttheoryandstandarddeviation

andstockmeasurementsRockefeller,JohnD.Roubini,NourielRoubini Global Economics(RGE)roundlotsrumors

SABMillersafetyofstockssalesdata

Fisheron5-yearsalesand growth vs. value

investingandprojectedsalessalespershareandSmartSelectratingsandstockbuybacksandstrategyguidelinesandworksheetdata

SalomonSmithBarneySantoli,MichaelSaraLee

SBCCommunicationsscandalsSchultz,HowardSchwabScottradescreeningstocksandcompanybasicsandcompanyhealthInternetresourceskeypointsandpastperformanceandprojectedperformanceandstockhealth

andstockrankingsandstockratiosandstockwatchlistsandworksheetcriteria

secondarymarketsectorstocksSecurities and ExchangeCommission(SEC)SecurityAnalysisSeekingAlphasellingstocksandchartdatacompanysaleofstock

expertagreementonandfull-servicebrokeragesgoodsellpointsandgradualmovesandordertypesand “reasons and limits”

worksheetsandrumorsandsecondaryofferingsandstockwatchlists

SevenOaksInternationalShareBuildersharedinformation

shareholderequityshareholderyieldshoppinghabitsSierraEuropeFundSierraGlobalManagementSimplebrandsimple moving average(SMA)andDowstrategiesanddownsideriskandmarketvolatilityandselldecisionsandstockevaluation

strategyguidelinesandworksheetdata

size of companies. See alsolargecapstocks;mediumcapstocks;smallcapstocks.anddividendyieldand the Dow Jones

IndustrialAverageandidealgrowthstrategyandmarketcapitalizationandmeasurementtestsandmediumcapstrategiesandprojectedgrowth

sizeclassificationsandvalueaveragingandValueLinerankings

“slowgrowers,”Small&Mid-capSurveysmall cap stocks. See alsoS&PSmallCap.andexchange-tradedfundshistoricalreturnsandinvestorpacketsand Maximum Midcap

strategyandnetprofits

andprojectedgrowthandsalespershareandtradingvolumeandvalueaveragingandValueLineand value vs. growth

investingandworksheetcriteria

SmartMoneySmartSelectmeasurementsSmith,JasonA.S&Panddownsiderisk

historicalperformanceandmarketcrashesandmeasurementtestsandMillerand“themarket,”and valuation-based

strategiesS&PMidCapandDowstrategiesanddownsideriskhistoricalreturnsandmarketvolatilityand Maximum Midcap

strategyand“themarket,”

S&PplatinumportfoliolistS&PSmallCaphistoricalreturnsandmarketvolatilityand“themarket,”andvalueaveraging

speculationsplitsofstocksspreadStandard & Poor’s. See alsoS&P500;S&PMidCap400;

S&PSmallCap600.andInternetresourcesand measurement

performanceSTARSrankingsandstockresearchandtickersymbols

Standard & Poor’s StockGuidestandarddeviationStarbuckssteadybusinesssteelcompanies

SternSchoolofBusinessStock Appreciation RankingSystem(STARS)stockexchangesstockpagesStockCharts.comstockholderequityStockInvestor“stocks towatch”worksheet.Seewatchlists.StockScouterstopordersstrategyforinvesting

andcompanybasicsandcompanyhealthandcoreportfolioskeypointsandmarketvolatilityandpastperformanceandperformancetrackingandprojectedperformanceand “reasons and limits”

worksheetandsellingstocksandstockhealthandstockpurchases

andstockrankingsandstockratiosandstockwatchlistsandworksheetcriteria

streamliningTheStreet.comstrengthsofcompaniesSunMicrosystemssuperdiscountersSuperDOTsuperiorcompaniessupplyanddemand

TacoBellTargetTDAmeritradetechnicalanalysistechnologycompanies10-K10-QTevabrandThaler,RichardTheTickerSymbolBooktickersymbolstimelinessofstockstimingthemarket

TommyHilfigertotalmarketvaluetotalreturnTradeKingtrademarkstradingcoststrailingstopordersTransoceanTravelerstrendsturnaroundstocksTversky,Amos“two-minutemonologue,”

UGGbrandUltraDow30(ProShares)UltraMidCap400(ProShares)UltraDow30(ProFunds)UltraMid-Cap(ProFunds)updatinginformationuptrendsutilities

valuation of stocks. See alsobargainstocks.

bestvaluemeasuresBuffettonexpertagreementonGrahamonMilleronO’Neillonand performance

measurementandsuperiorcompaniesundervaluation

valueaveragingValue Averaging: The SafeandEasyStrategyforHigher

InvestmentReturns(Edleson)valueinvestingandasking“why?”BuffettonearningspershareexpertagreementonfindingbargainstocksgoodbuypointsgoodsellpointsGrahamongrowth investing

contrastedwithhistoricalreturns

keymeasuresLynchonandprice-to-bookratioandprice-to-earningsratioand “reasons and limits”

worksheetsandrelativepricestrengthandstockevaluationand stock price

appreciationandstrategyguidelinesworksheetfor

The Value Line Investment

SurveyandannualratesandbusinessbasicsandcapitalstructureandcompanybasicsandcurrentpositionandcurrentratioanddividendyieldandearningspershareonGeneralMotorsandgrowthprojectionsand historical

measurementsand insider stock

ownershipandmarketcapitalizationandpricehistoryandpriceprojectionsandprice-to-bookratioand price-to-cash-flow

ratioandprice-to-earningsratioandquarterlyfinancialsandresearchandsalesdataandsampleprofilessourcesfor

andstockanalysisandstockpricedataandstockrankingsandstockresearchandstrategyguidelinesand timeliness/safety

measuresandworksheetcriteria

valuetrapsValueTrustVanguardTotalStockMarketventurecapitalistsVerizon

volatilityBuffettoncopingwithanddownsideriskandemotionsandgradualmovesGrahamonandinvestmentstrategiesandleverageandlimitordersandmarketcapandmarketcrashesand monitoring

investmentsandpricedipsand “reasons and limits”

worksheetsandskepticismofexpertsandstrategyguidelinesandvalueaveragingandvalueinvesting

volumeoftradingvolumepercentchangerating

Wal-Martandcompetitionand the Dow Jones

IndustrialAverageLynchonMilleronnetprofitsstockpriceassessment

TheWallStreetJournaland the Dow Jones

IndustrialAverageand insider stock

ownership

andO’NeillandSmartMoneyandstockpagesand stock

recommendationsandstockresearch

The Warren Buffett Way(Hagstrom)WashingtonPostWasteManagement,Inc.watchlistsWatson,Thomaswebsites. See also Internet

resources.TheWeekWendy’s/Arby’sGroupWhat Works on Wall Street(O’Shaughnessy)WorldWideWebWorldCom

Yahoo!Financechartsandcompanybasics

and insider stockownershipandnetprofitdataandperformancetrackingandresearchdataandstockscreeners

year-to-date percentagechangeYum!Brands

ZacksInvestmentResearchZecco