The Value of a Thief
“Every human problem is an investment opportunity if you can anticipate the solution,” the old gentleman told me. “If not for thieves, who would buy locks?”
I just met this remarkable fellow, full of wisdom on investing, yet hardly known beyond a small group of fans. His name is Thomas Phelps, and he’s had quite a career. He was The Wall Street Journal’s Washington bureau chief, a former editor of Barron’s, a partner at a brokerage firm, the head of the research department at a Fortune 500 company and, finally, a partner at Scudder, Stevens & Clark (since bought out by Deutsche Bank). Phelps retired in Nantucket after a varied 42-year career in markets.
Along the way, Phelps figured out a few things about investing. He conducted a fascinating study on stocks that had returned $100 for every $1 invested. Yes, 100-to-1. Phelps found hundreds of such stocks, bunches available in any single year, that you could have bought and enjoyed a 100-to-1 return on — if you had just held on.
This was the main thrust of our conversation: The key is not only finding them, but keeping them. His basic conclusion can be summed up in the phrase “Buy right and hold on.”
“Let’s face it,” he said, “a great deal of investing is on par with the instinct that makes a fish bite on an edible spinner because it is moving.” Investors, too, bite on what’s moving and can’t sit on a stock that isn’t going anywhere. They also lose patience with one that is moving against them. This causes them to make a lot of trades… and never enjoy truly mammoth returns.
Investors crave activity. Wall Street is built on it. The media feed it all, making it seem as if important things happen every day. Hundreds of millions of shares change hands every session.
But investors need to distinguish between activity and results. “When I was a boy, a carpenter working for my father made this sage observation: ‘A lot of shavings don’t make a good workman.’” As you can see, Phelps is a man of folksy wisdom.
“Investors,” Phelps continued, “have been so thoroughly sold on the nonsensical idea of measuring performance quarter by quarter — or even year by year — that many of them would hit the ceiling if an investment adviser or portfolio manager failed to get rid of a stock that acted badly for more than a year or two.”
What investors should do is focus on the business, not on market prices. Phelps showed me financial histories of a long list of companies — earnings per share, returns on equity and the like. No stock prices. After one example, he asked: “Would a businessman seeing only those figures have been jumping in and out of the stock? I doubt it.” But if they just sat on it, they’d be rich.
And this is the nub of it. Phelps is not a fan of selling good businesses.
He talked about how his friend Karl Pettit — an industrialist, inventor and investor — sold his shares of IBM stock many years ago to start his brokerage business. He sold them for a million bucks. That stake would eventually go on to be worth $2 billion — more than he ever made in his brokerage business.
Phelps told me the story of how he sold his Polaroid stock to pay a steep doctor’s bill of $7,415 back in 1954. “Here is the confirmation of the sale,” he said, which he keeps as a reminder of his folly. Less than 20 years later, his Polaroid stock was worth $843,000. That’s an expensive doctor’s visit.
Phelps also stands against market timing. He told me about how he predicted various bear markets in his career. “Yet I would have been much better off if instead of correctly forecasting a bear market, I had focused my attention through the decline on finding stocks that would turn $10,000 into a million dollars.”
Because of his bearishness, he missed opportunities that went on to deliver 100-to-1. “Bear market smoke gets in one’s eyes,” he said, and it blinds us to buying opportunities if we are too intent on market timing.
“He who lives by the sword shall perish by the sword,” he added. “When experienced investors frown on gambling with price fluctuations in the stock market, it is not because they don’t like money, but because both experience and history have convinced them that enduring fortunes are not built that way.”
Phelps showed me a little schematic that reveals how much a stock must compound its value to multiply a hundredfold:
35 years — 14%
30 years — 16.6%
25 years — 20%
20 years — 26%
15 years — 36%
You’ll note that these are very long holding periods, but that’s the point. The greatest fortunes come from gritting your teeth and holding on. You’ll also see it’s a fairly high hurdle. You need growth.
(Several stocks we own are giving us annualized returns above Phelps’ tough 100-fold hurdles so far: IAG (39%), FLS (28%), MEOH (32%), TIE (25%) and GTLS (70%) — to name those we have held for at least one year. Twenty years is a long time, though…)
Phelps advises looking for new methods, new materials and new products — things that improve life, that solve problems and allow us to do things better, faster and cheaper. There is also an admirable ethical streak to Mr. Phelps’ style. He emphasized investing in companies that do something good for mankind. Finally, focus on cheap stocks, though you have to look beyond past figures.
“There is a Wall Street saying that a situation is better than a statistic,” Phelps said. Relying only on published growth trends, profit margins and price-earnings ratios is not as important as understanding how a company could create value in the years ahead.
Phelps is quick to add that he is not advocating blindly holding onto stocks. “My advice to buy right and hold on is intended to counter unproductive activity,” he says, “not to recommend putting them away and forgetting them.”
And so what if you don’t get a hundredfold return? The point of Phelps’ brilliant teaching method is to focus your attention on the power of compounding, to forget the day-to-day burps and ripples of stock prices. You can see the power of such ideas in the stocks we own: If you had bought Canadian Natural Resources (NYSE:CNQ) 10 years ago, for example, and held on no matter what — through recessions, bubbles, credit crises — you’d have multiplied your money 11-fold. Brookfield Asset Management (NYSE:BAM) went up nearly sevenfold. Buy right and hold on, indeed.
It is an investment tragedy of a sort to think that people have owned these stocks and not reaped those gains because they were trying to time the market or trade in and out. Sometimes stocks take a long time to get going. Phelps had plenty of examples of stocks that went nowhere (or down) for years, but still delivered the big 100-to-1.
“One of the basic rules of investing is never, if you can help it, take an investment action for a noninvestment reason,” Phelps advises. Don’t sell just because the price moved up or down, or because you need to realize a capital gain to offset a loss, etc. You should sell rarely, and only when it is clear you made an error. One can argue that every sale is a confession of error, and the shorter time you’ve held the stock, the greater the error in buying it — according to Phelps.
I love Mr. Phelps’ ideas. They are hard to implement, I know. But some people have. He related the experiences of individuals, former clients and old associates who got rich by buying right and holding on. Only the most-exceptional individuals can do it. Phelps wishes he had learned these insights when he was younger.
Now, I have a little confession to make about Mr. Phelps… I didn’t actually meet him. He’s been dead since 1992, reaching the ripe old age of 90. Every quote above comes not from a conversation, but from his book, 100 to 1 in the Stock Market: A Distinguished Security Analyst Tells How to Make More of Your Investment Opportunities, published in 1972.
I recently picked up a near mint copy for $22. This forgotten book should be a classic. Do not let the implausibility of making 100-to-1 on your stocks distract you. The main idea is to know how such returns have happened and what investors needed to do to get them. Aiming a little closer to that goal is bound to improve your results.
Phelps wrote as much. “Just a slight change in a golfer’s grip and stance may improve his game, so a little more emphasis on buying for keeps, a little more determination not to be tempted to sell… may fatten your portfolio. In Alice in Wonderland, one had to run fast in order to stand still. In the stock market, the evidence suggests, one who buys right must stand still in order to run fast.” I think it is superb advice.
I recommend the book, which is a pleasure to read and has plenty of good ideas, analogies and stories. They are particularly relevant now, given all the trouble in the world. I am inspired by his philosophy of buying right and holding on. I think you should try to do more of that, too.