A while ago I read investor Phil Town’s two books, “Rule #1” and “Payback Time”. Although there wasn’t much new for me in books, the amount of index sticky notes and margin writing I ended up with reminded me: When there’s too much information, revert to the basics.
Humble Beginnings
For many years after serving in Vietnam with the US Special Forces, Phil Town worked as a river guide in the Grand Canyon. Living a humble life without much concern for the future, life changed in 1980. While making their way through the rapids, the currents turned dangerous. Phil ended up saving a man’s life from an accident, who post-incident felt an intense gratitude to his savior. The saved man is referred to as “The Wolf” and he was a Graham-Buffett style investor. To repay, The Wolf offered to teach his craft to Phil, a “Teach-a-man-to-fish type lesson”.
Today Phil Town has helped millions achieve their investment goals through his speaking tours, seminars, books and educational videos. He’s coined a term for our style of investing, which he calls “Rule #1 Investing”. This rule came originally from Ben Graham and later preached by Buffett: “The first rule of investing is: Don’t Lose Money. The second rule is: Don’t forget the first rule.” Phil also hosts the InvestED podcast with his daughter Danielle, which I HIGHLY recommend, especially for those starting from scratch. His books make a compelling case that individuals can learn to invest and achieve satisfactory returns, as long as they never stray from some key fundamentals. Let’s take a look at some of his main lessons.
The Scam of “Professional” Money Managers
We expect to get value for money when we pay a doctor, a dentist, a lawyer or other professional. Unfortunately, this is not the case when you hand your money to a professional money manager. Time and time again, active money managers fail to beat the market. Pick almost any random year, the same headline will appear. There are plenty of reasons for this, including the Institutional Imperative, but it’s the truth. Would you hand your money to the “professional” and hope he is part of the single digit tiny percentage who are actually able to deliver? If your small capital is accepted in the first place.
No. The industry does not exist to make their clients money, but rather to gather assets. In industry jargon, the name for this is AUM, or Assets Under Management. They are incentivized to increase the size of the pie, not the returns it generates. They gain fees for holding your funds and through transaction costs. As Buffett says, they get paid through activity, you get paid through inactivity. The industry has convinced millions of people that they should hand their money to the “professionals” and investing for above average returns is something the layman cannot do. In his books, Phil Town makes a compelling case for why this is not the case and intelligent investing is not rocket science. If you want to start investing, it is absolutely necessary to learn how to do it intelligently. Even if you are just buying index funds.
The Four M’s
In order to make intelligent investing decisions, you need to make sure the business passes what Phil Town calls the “Four M’s”. Here’s what they stand for.
#1: Meaning
Ask the question: “Does the business have meaning to you?”. If the business has no meaning to you, you should not buy it. This means you only buy if you’d be willing to make this business the sole financial support of your family for the next 100 years. In other words, the M of “Meaning” is closely related to circle of competence and the punch card mental models.
#2: Moat
Profits attract competition, that is the natural law of a marketplace. Your business is an economic castle, constantly fending off hordes of barbarians who want the gold your castle is guarding. You want to make sure the business has an intrinsic characteristic, that gives it a durable competitive advantage for the foreseeable future. This competitive advantage is known as a moat. But how do you know if a business does indeed have a moat? There is a clue in the numbers, and it is a consistent high return on invested capital, aka ROIC.
#3: Management
This is one of the harder ones to figure out. You want the business you invest in to be run by honest and able management who think of themselves as owners. Most of us are not in a position to speak with company management, but thanks to the internet, the democratization of information is in full swing. When assessing management, think of yourself as an investigative journalist, or even a writer for an “OK!” or “Reveal” type gossip mag. Your job is to make sure that management incentives are aligned with you, the business owner. Preferably in a way that favors long term intelligent decisions. And as you read annual reports of the business from years past, look at the tone of the letter to shareholders. Compare it to the numbers. Did the business have a crappy year, and the CEO says the company is making “solid progress” or “aligning our integrated solutions”? If so, watch out! Be on the lookout for news articles. It is possible the the CEO has given interviews. Dig through the web to find these.
#4: Margin of Safety
Finally, possibly the most important M is Margin of Safety. Since we are prone to errors in our evaluation of a business and its future, we must insist on a margin of safety price. This means that once we have an assessment of value for the business, we only buy when it’s trading at half or lower of said value. A business is not inherently a good or bad investment, the most important part is the price you pay. The margin of safety protects us from ourselves. If we make an error we are much, much more likely to get back our capital. Remember, the return of capital is more important than the return on capital. If you don’t loose money on most of your investments, the winners will take good care of you. But still there are no guarantees. Obviously you will loose money sometimes. But the key is in not getting wiped out. We minimize the chances of this by always insisting on buying “below retail”.
Removing Fear
The books are inspirational and will make you want to start investing. Ben Graham’s Intelligent Investor was the foundation for me, but I believe Phil Town’s book are the better alternative to the absolute beginner without a much knowledge in accounting or finance. How do you recognize a good teacher? It’s someone who can break down concepts that are perceived as difficult into information that’s understandable to most people. Phil is phenomenal at this, and as you read his books, a common question that might pop up in your mind is: “Is it really this simple?”. In my opinion the answer is yes, if you are willing to put some work into it.
There is much more to cover, including dealing with fear and how to think about growth. This will be a two-part post, and the next upload will tackle these topics. Stay tuned!
-IGTSKasimir
Further Reading
Warren Buffett – The Partnership Days (1956 – 1969)
Philip A. Fisher – Lessons From The 15% Man
The Best of Ben Graham – Security Analysis
Sir John Templeton – Wisdom From Global Value Investing Legend
Margin of Safety – The Most Important Thing
Intelligent Investing = Thinking In Probabilities
The Emotional Stages of a Value Investor
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