Sir John Templeton
"To buy when others are despondently selling and to sell when others are avidly
buying requires the greatest of fortitude and pays the greatest ultimate rewards."
buying requires the greatest of fortitude and pays the greatest ultimate rewards."
Sir John Marks Templeton - (1912 – 2008) was an American-born British stock investor, businessman and philanthropist. His investment record was extremely impressive indeed, from it's inception in 1954 to it's sale in 1992 the Templeton Growth Fund achieved a compound annualized growth rate of 14.5%. Below is a summary of his investing approach.
To determine whether a stock was undervalued Templeton employed a method he called 'triangulation', this method involves valuing a stock based on 3 or more valuation models/ratios in order to be sure that it is definitely undervalued. Relying on one model/ratio alone is problematic as each one has its own unique strengths and weaknesses and a company which may appear cheap based on one model/ratio may in fact be overvalued when analysed using several different ones. If a company looks cheap when viewed from multiple points it's far more likely to be undervalued.
- Look for frequent takeovers at high premiums in a given industry, this could be a signal that many companies within that industry are undervalued.
- Look for companies in essential industries that are about to be wiped out by some catastrophic event. Templeton invested in a basket of the most beaten-down airline stocks after 9/11 since he knew that the Government would be forced to step in and save them given the industry's importance to the economy (Templeton instructed his broker to only buy low P/E stocks which had lost over 50% of their value when the markets reopened).
- Look at companies with complex or limited accounts. Templeton made a fortune in the 1960's investing in Japanese companies thanks to the non-transparent accounting standards in operation at the time. In the 1980's he invested in Telefonos de Mexico, convinced that their numbers were inaccurate he took it upon himself to count the number of telephones in the country for his calculations and correctly determined that the market was drastically undervaluing the company.
- Pay attention to small/micro-caps. Templeton invested in a small company called 'Haloid' which had developed a new photographic technique. The company, which was receiving little to no attention at the time, later became known as the Xerox Corporation and Templeton made a gain of 1000%.
- Seize upon political or economic events. In 1939 Templeton made investments in U.S. industrial and transportation companies as it became clear that the country would become involved in WW2. He reasoned that the drive to support the war would mean that even the most average firms would prosper. To mitigate his risk and maximize his return Templeton bought a large basket of diversified stocks and selected those which were the most disliked and over sold by the market (all stocks selling below $1).
- Look at secondary markets. When investing in Japan Templeton rarely bought on the main exchange as he knew the best bargains were to be found elsewhere.
- Look at the most hated markets to find bargains. During the Asian financial crisis of 1997-98 Templeton profited by investing, through a mutual fund, in the Korean stock market.
- Use stop-losses for short ideas. Templeton would employ stop-losses on short ideas in order to limit damage if his thesis didn't play out.
- Check lock-up periods for overvalued IPO's. Templeton correctly calculated the collapse of the dotcom bubble in 2000 by studying the lock-up period (typically 6 months) for overvalued tech stocks. He knew that insiders would begin to sell in large volumes when the lock-up period expired as they sought to cash in on the absurd valuations, and that this would trigger an implosion of the tech bubble.
- Maintain a watch-list of high growth companies. Templeton would maintain a list of companies which were consistently growing at >20% per year. He would only buy these companies when some temporary problem depressed their market price creating a reasonable entry point.
Sir John Templeton Leverage Ratios*
*Total Debt/(TTM) EBITDA (Templeton considered a ratio of < 3 to be a conservative benchmark).
*EBITDA Coverage ratio = Earnings + Interest expense + Taxes + Depreciation/Interest expense. (Templeton considered > 6 to be a conservative bench mark).
*Free cash flow-to-Short-term debt ratio
= FCF/Short-term debt
If the figure is < 1 the company doesn't generate enough FCF to cover it's short-term debt obligations.
= cash & equivalents / Short-term debt
This ratio expresses a company's ability to repay it's short-term creditors out of it's total cash. If the value is > 1.00 it means the short-term debt obligations are covered.
Sir John Templeton's 16 Rules for Investment Success
1. Invest for maximum total real return - Investors must be aware of taxes and inflation as these can have a significant impact upon purchasing power and investment returns. Where possible, maximize the opportunities for investing through tax sheltered investment vehicles. Inflation is often called the 'stealth tax' as it steals the purchasing power of one's capital through an ongoing debauchment of the currency, If inflation averages 4% it will reduce the buying power of a $100,000 portfolio to $68,000 in just 10 years. This means that one would need a 47% gain over those 10 years just to remain even.
2. Invest - Don't trade or speculate - The intelligent investor should avoid speculation and frequent trading. The pursuit of speculation is dependent upon the individual accurately predicting the future, this is foolhardy since the number of variables at play is beyond comprehension, it may work for a time but sooner or later it will come back to bite you. The intelligent investor avoids this folly and instead focuses on determining the fundamental value of a given investment opportunity. Frequent trading should be avoided as the associated frictional costs (commision fees, fx conversion fees, taxes etc) eat away at one's capital. Avoid trading in market hours, aim to keep frictional costs <5% of capital being allocated to a given investment, make sure your investment thesis is well reasoned and that you could explain it to a lay-person in a few sentences.
3. Remain flexible and open-minded about types of investment - Investors now have access to global markets and there is always value to be found, for every bull market there is a bear market to be found somewhere else. Be open to investing in common stocks, preferred shares, warrants, bonds, options etc and if cash is the most sensible option so be it. Be sure to understand an investment instrument before buying or selling it and always weight up the costs and benefits of investing for yield or holding cash for liquidity. Over the long-term common stocks have historically yielded the greatest return. From the 1950's-1980's the S&P 500 rose at an average rate of 12.5%, compared with 4.3% for inflation, 4.8% for US Treasury bonds, 5.2% for Treasury bills, and 5.4% for high-grade corporate bonds. In fact, the S&P 500 outperformed inflation, Treasury bills, and corporate bonds in every decade except the ’70s, and it outperformed Treasury bonds—supposedly the safest of all investments—in all four decades.
4. Buy Low - This seems so obvious as to be absurd to mention but this simple piece of advice is lost upon the wider investment community. Most market participants buy on good news or a hot tip, enter bull markets when euphoria is high and then despondently sell when panic ensues. Little to no attention is paid to price relative to fundamental value and investments are made on nothing more than a hunch or a hope. The following three quotes should be etched into the minds of all intelligent investors;
"Price is what you pay, value is what you get." - Warren Buffett
"Mimicking the herd invites regression to the mean." - Charlie Munger
" Be fearful when others are greedy and greedy when others are fearful." - Warren Buffett
5. When buying stocks, search for bargains among quality stocks - Quality may take many different forms. A company may be a low cost producer/operator, it may have a sticky business model, it may have a strong brand, it may be well capitalized with low levels of debt and strong liquidity, it may be led by a management team with a proven track record of success. Possessing one of these characteristics alone does not ensure that a company is high quality but if it scores on multiple counts there is a greater likelihood that it is.
6. Buy value, not market trends or the economic outlook - Buying based on predictions of future market or macro-economic trends is speculation, not investing. The sheer number of variables at play means that it is extremely difficult to make reasonable estimates of the future and one cannot account for 'black swan' events which have not been considered but which drastically change the outlook for markets and economies. It is also worth noting that individual companies can rise in a bear market and fall in a bull market. In general, the value of the market does not tally with that of the individual company. The intelligent investor should concern themselves with analyzing the fundamentals of individual companies to ascertain their business model and intrinsic value, and to determine the difference between value and price, acting only when they have an advantage.
7. Diversify. In stocks and bonds, as in much else, there is safety in numbers - There is always an element of risk in investing, one may be conservative in estimations of value and seek to mitigate risk but it cannot be eliminated completely. For this reason investors should diversify, by asset class, industry, by risk profile and by country. Investors should also seek out stock brokers who offer a wide coverage of different assets and markets in order to widen the pool of potential investment opportunities.
8. Do your homework or hire experts to help you - Investigate before you invest, various companies should be studied in order to learn what makes them successful.. In most instances investors are buying either earnings or assets. If you are buying a company with the expectation that it will grow and prosper you are buying based upon future earnings. Since most companies are valued on future earnings, as the earnings of a company increases so should it's stock price. If you are buying a company with the expectation that it will be acquired or dissolved at a premium to its market price you are most likely buying assets. Special care should be taken when considering these type of investments since activist investors and corporate raiders are quick to seize upon these opportunities leaving behind the most problematic investment situations.
9. Aggressively monitor your investments - Expect and react to change, neither bull markets nor bear markets are permanent and no stocks can be bought and then forgotten about. Companies will come and go, some may merge, some may go private, some may decline and some will go bankrupt Above all one should remember, no investment lasts for ever.
10. Don't panic - Sometimes you may still be holding stocks when the crowd is buying and thus you may be caught in a market crash when panic ensues, this is not the time to panic. Instead you should study your portfolio, if you didn't own the stocks in your portfolio would you consider buying them after a crash, chances are you would. Thus, the only reason to sell them would be to buy more attractive stocks. If more attractive stocks cannot be found hold onto what you have.
11. Learn from your mistakes - It is inevitable that you will make mistakes whilst on your investing journey, the key is to not become discouraged by them and to instead learn from them. Do not attempt to recoup losses by taking greater risks, make a note of what went wrong and add it to your investment checklist. It is also highly beneficial to study the mistakes of great investors as one can learn as much from these as one can from their successes. As James Joyce once said "Mistakes are the portals of discovery."
12. Begin with a prayer - There is value in clearing one's mind before approaching a task or endeavor, this may involve a prayer, meditation or spending time in nature. Whatever method is chosen one can always make better decisions when the mind is not cluttered or distracted.
13. Outperforming the market is a difficult task - The vast proportion of fund managers under-perform the indexes, if you are not confident that you can beat the market the most prudent option is simply to invest your capital in an index fund. If, however, you are confident that you can outperform the market you must bear in mind that it will require consistent hard work and dedication. A proven strategy must be employed and rigorously adhered to without allowing emotions and temptations toward speculation to creep in.
14. An investor who has all the answers doesn't even understand all the questions - As in all things, the only thing which remains constant is change. It is therefore imprudent to assume that one can rely on a fixed set of principles to arbitrarily apply to all prospective investments. A successful investment approach should involve a continued process of seeking answers to new questions.
15. There's no free lunch - Don't expect to have great investments handed to you on a plate. Never invest based upon sentiment, a hot tip or some other appealing but whimsical notion. All investment decisions must be reasonably based upon a fundamental analysis of the empirical data at hand.
16. Don't be fearful or negative too often - Markets have seen booms, busts, bear and bull markets, economies have seen inflation, deflation, recessions, depressions, currency crashes and a whole host of other events yet onward and ultimately upwards they go. Do not become fearful or negative and view crisis as an opportunity. Don't be afraid to stand alone from the crowd or to trust your own judgement and conviction. There is a big difference between risk and uncertainty, as Warren Buffett points out, risk come from not knowing what you are investing in. Chose a proven method, stick to it and ignore the noise and emotions of the crowd.