Hi Jack, Here's some more from Mr. Phelps' book........
"In general there seem to be four categories of stocks that have turned in the 100-to one performance records...
The four categories I see are these:
1) Advance primarily due to recovery from extremely depressed prices at bottom of greatest bear market in American history. Special panic or distress situations at other times belong to the group too.
2) Advance primarily due to change in supply-demand ratio for a basic commodity, reflected in a sharply higher commodity price.
3) Advance primarily due to great leverage in capital structure in long periods of expanding business and inflation.
4) Advance primarily due to the arithmetical result of re-investing earnings at substantially higher than average rates of return on invested capital."
At the time of his writing this book we had yet to fall into the abyss of 1974. This, too, qualified as one of those wonderful opportunities as he describes in #1 above. I think we could add the panic of 1987 and the 1990 Gulf War scare as well. Last Fall's dip hardly qualified for the broad market, but there were some dandy stocks that did fall on hard times for a very short while. Through the active management of my own accounts with AIM (or AIM-like activity prior to my adopting AIM) I've profited nicely in each of the setbacks from 1987 to the present.
I have no personal experience with #2 while being an investor. I've avoided #3 in the form of margin borrowing as I have come to the conclusion that the added risk doesn't fit my personal expectations of reward. In a way, our AIM Cash Reserve acts as our Leverage Tool as we utilize this asset in conjunction with #1 above. I can conceive of a situation where all my Cash Reserve had been expended through buying in a deep market shock like 1987 and then extending my buying via use of leverage (Margin). However, I've not reached that situation as of yet in my years of investing. I have, however, "borrowed" cash from my more prosperous holdings to extend my buying in another less fortunate stock. However, during those times I was acting as my own banker.
#4 is where I've probably sought my "fortune" more than any of the others. After all, we can't just sit around waiting for Bear Markets before we invest. Much of what I look for has been long term growth of sales and book value. It's been my opinion that if those first two grow, then earnings will eventually follow. Because of the nature of business competition it is important to look at the company's ability to sustain its growth. A great idea that has a low threshold for others wanting to enter the same business will most likely not create great investment opportunity. Mr. Phelps says, "It is vitally important that the high rate of return be protected by a 'gate' making entry into the business difficult if not impossible. Such gates may be patents, incessant innovation based on superior research and invention,ownership of a uniquely advantageous sources of raw material, exceptionally well-established brand names - you can fill in others as you choose. Just be sure the 'gate' is strong and high."
I think that a lot of what Dave (JZGalt) is attempting to do with his "Confirmatory Analysis" approach is to compile stock lists that have the potential of being in category #4 above. It takes further study to see if those companies also have the necessary "high gate" to protect their potential growth.
I find if I review my own equities using the four ideas presented above that many have "fit" one or more of the concepts in the past. I constantly review my equities to see if they still have some fit. I've not perfected either the initial analysis nor the ongoing analysis. (Those who have followed my thread for a long time will recognize my errors in Roberts Pharmaceuticals and most recently Integrated Device Technologies.)
I hope this review of some of Mr. Phelps' ideas will in turn stimulate some productive thinking on the part of everyone here.
Best regards, Tom |
