The Twelve Days of Christmas: Three Rules for New Investors

Stansberry & Associates Top 10 Open Recommendations
(Top 10 highest-returning open positions across all S&A portfolios)

As of 06/25/2013

Editor's note: In January, Porter wrote in The S&A Digest one of the most useful essays a new investor could possibly read. I can say with 100% certainty that if you print this essay off, post it near your computer, and re-read it a few times each year, you'll easily outperform 99% of your fellow investors – including professional asset managers. Also attached is Porter's often-requested "Top 10 Books About Investing."

Three Rules For New Investors

Originally published in the January 14 edition of the S&A Digest

Last week I got a call, out of the blue, from an old friend who has done very well in business.

He's now the CEO of a large, private company, which, were it public, would be valued at around $1 billion. He didn't mention what he wanted to talk about, but I knew it was important. This is the kind of man who values his time and measures his words.

He'd arranged for us to have a very private table, in the back of a nice Italian restaurant. After some small talk, he picked up a plastic folder packed with papers.

"Porter," he said, "while I've done well with my company, my personal finances are a mess. I don't have time to manage my money, so I keep stuffing cash into low-return savings accounts. I've got a few stocks – mostly your picks, actually – and they've done well. But not nearly as well as your S&A 16 did last year. How can I organize all of this to finally put my money to work? Should I put all of my money into the new S&A 16?"

"Well, you could. It's a good portfolio. It's relatively diversified," I said. "But... you've bought and sold entire companies, some of which are worth hundreds of millions of dollars. You're an expert in accounting. You know more about a lot of businesses than I do, and you surely know more about accounting and valuation. Why wouldn't you put your expertise to work on your account?"

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"I know you're right," he said. "But I simply don't have time. When I'm not at work, I don't want to think about money. I'm playing with my kids. The last thing I want to do is sit down at a spreadsheet and figure out what a public company is worth, what I should pay for it, etc. That's what you do. That's why I read your letters."

I have heard this explanation many, many times before. It's logical and reasonable. But it has always felt wrong to me to entrust your life's savings to another person... especially if you have the means and the skills to manage your own money. No, taking on this responsibility yourself doesn't ensure success... but it ensures that you deserve to succeed.

"As you know," I told my friend, "I can't give you any personal advice. And you also know that I put my best ideas in the newsletter, which you've already seen. But I don't think you should 'outsource' your investing – to my Advisory or any other person. You have the ability to make high, safe returns, even if you only spend 10 hours per month on your investments."

"Okay, okay... I know you're right. How should I get started?"

Here's what I told him:

There are three things you can do to greatly increase your chances at success, as an individual investor.

First, only invest in companies that pay a substantial dividend (say, at least 3%) and that have a long history of increasing their dividend. You may count money spent on share buybacks when measuring the dividend yield. This will do several things for you. It will narrow your possible choices substantially, giving you an investment "universe" that's more manageable. It also will automatically prevent you from buying stocks that are speculative or overpriced. And finally, it will greatly reduce the odds that your account will ever show a loss. Earning 3% a year isn't much, but it adds up, especially if the company continues to increase its dividend. After a year or two, even if the share price dips, you'll probably still show a gain, thanks to the dividend.

Second, out of the companies that are paying a good dividend, only buy companies whose businesses you're able to easily understand and that you judge to have a solid competitive advantage. As a test of your understanding, read the company's 10K (annual report) filed with the SEC. You can get a copy online for free. Or you can call the company and they'll send you a copy. If you're not willing to spend an hour or two reading a company's 10K, are you really ready to invest 4%-6% of your life savings in its stock? It baffles me that investors will readily pile money into companies that they don't understand... and that they make no effort to understand. (Keep in mind, I'm not talking about trading here. I'm talking about investing – buying a position and keeping it for years.)

Third, only buy stocks when they are very attractively priced, i.e. when there's a substantial margin of safety in the stock. This means waiting to buy until the company's shares are priced so low that the company can afford to buy back all of its shares. I perform this test on all of the stocks that make it into my "no risk" portfolio – which is almost always my best performing portfolio every year. This step makes it nearly impossible for you to lose money investing and will ensure you garner the benefits of compounding, because your entry price will be small relative to the company's assets and future earnings.

What I've learned about finance and investing has taught me that it's very hard, nearly impossible, for anyone to beat the compound returns of high-quality common stocks held for the long term. If you will follow these three rules – good dividends, understandable businesses with competitive advantages, and buying only at very safe prices – you can achieve world-class investment results.

You can do this without anyone's help (including ours) in about 10 hours per month.

Good investing,

Porter Stansberry

P.S. Of course... if you read our letters... the chances of you finding such great investments are greatly increased.

Porter's Top 10 Books About Investing

Last week, I said Mohnish Pabrai's new book (The Dhandho Investor: The Low-Risk Value Method to High Returns) was one of the 10 best books I'd ever read about common stock investing.

Logically, many subscribers have asked about the other nine books in my top 10 list.

I thought about the question over the weekend... and all day Monday. It's easier to think "wow, that's a great book" than to accurately quantify where it falls, precisely, in terms of all the books you've read before. (I read at least one new book per week, so it's hard for me to even remember all the books I've read in the last year.) So, before you skip down to see my list, please understand: I reserve the right to add, subtract, and rearrange.

Also, you should know this list only includes books that deal, nearly exclusively, with common stock long-term investing.

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There are many other great books on trading, economics, the psychology of investing, the history of finance, etc. that I haven't included in this list, but that contain valuable insights for investors. This list strictly deals with how-to books for successful long-term investing.

If you read these 10 books (one isn't even a book, it's an essay) and you follow the basic precepts (buy value, buy safety, buy businesses with a durable competitive advantage, allow your investments to compound over many years), I have no doubt you can easily earn 15%-30% per year, after tax. My only other assumptions are that you're capable of reading English on a 10th-grade level and that you can handle basic math with the help of a calculator.

Your investing shouldn't require more than 10 hours per week. If you make more than two to three investments per year, you're working way too hard. (One more thing... you don't need to read investment newsletters to do well as an investor, though we hope you'll keep reading ours out of fondness.)

You can buy all of the books on this list easily and cheaply (except for Seth Klarman's book, which is out of print). If you study them all carefully, it might take you six months. Your total tuition wouldn't equal $1,000 – and you'd know far more about how to be a successful investor than 99% of the world's top MBA graduates.

Being a successful investor takes a little bit more than just knowledge. You've also got to master the traits listed in the very first "book" on my list. It's an essay written by Richard Russell. It contains the only real secret to becoming wealthy: the power of compound interest. It also demonstrates the key emotional distinction between wealthy people and everyone else:

"...The wealthy investor tends to be an expert on values. And if no outstanding values are available, the wealthy investor waits... But what about the little guy? This fellow always feels pressured to 'make money.' And in return he's always pressuring the market to 'do something' for him. But sadly, the market isn't interested... And because the little guy is trying to force the market to do something for him, he's a guaranteed loser. The little guy doesn't understand values so he constantly overpays. He doesn't comprehend the power of compounding, and he doesn't understand money. He's never heard the adage, 'He who understands interest ­– earns it. He who doesn't understand interest – pays it.'"

With this emphasis and my earlier caveats, here are my personal top 10 books on common stock investing.

Best,

Porter Stansberry

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