One Up on Wall Street

It’s simple to keep track of insider purchases. Every time an officer or a director buys or sells shares, he or she has to declare it on Form 4 and send the form to the Securities and Exchange Commission advising them of the fact. Several newsletter services, including Vicker’s Weekly Insider Report and The Insiders, keep track of these filings. Barron’s, The Wall Street Journal, and Investor’s Daily also carry the information

Data on institutional ownership are available from the following sources: Vicker’s Institutional Holdings Guide, Nelson’s Directory of Investment Research, and the Spectrum Surveys, a publication of CDA Investment Technologies.

ometime in the next month, year, or three years, the market will decline sharply.
• Market declines are great opportunities to buy stocks in companies you like. Corrections—Wall Street’s definition of going down a lot—push outstanding companies to bargain prices.
• Trying to predict the direction of the market over one year, or even two years, is impossible.
• To come out ahead you don’t have to be right all the time, or even a majority of the time.
• The biggest winners are surprises to me, and takeovers are even more surprising. It takes years, not months, to produce big results.
• Different categories of stocks have different risks and rewards.
• You can make serious money by compounding a series of 20–30 percent gains in stalwarts.
• Stock prices often move in opposite directions from the fundamentals but long term, the direction and sustainability of profits will prevail.
• Just because a company is doing poorly doesn’t mean it can’t do worse.

Stalwarts with heavy institutional ownership and lots of Wall Street coverage that have outperformed the market and are overpriced are due for a rest or a decline.
• Buying a company with mediocre prospects just because the stock is cheap is a losing technique.
• Selling an outstanding fast grower because its stock seems slightly overpriced is a losing technique.
• Companies don’t grow for no reason, nor do fast growers stay that way forever.
• You don’t lose anything by not owning a successful stock, even if it’s a tenbagger.
• A stock does not know that you own it.
• Don’t become so attached to a winner that complacency sets in and you stop monitoring the story.
• If a stock goes to zero, you lose just as much money whether you bought it at $50, $25, $5, or $2—everything you invested.
• By careful pruning and rotation based on fundamentals, you can improve your results. When stocks are out of line with reality and better alternatives exist, sell them and switch into something else.
• When favorable cards turn up, add to your bet, and vice versa.

Some people ascribe my success to my having specialized in growth stocks. But that’s only partly accurate. I never put more than 30–40 percent of my fund’s assets into growth stocks. The rest I spread out among the other categories described in this book. Normally I keep about 10–20 percent or so in the stalwarts, another 10–20 percent or so in the cyclicals, and the rest in the turnarounds. Although I own 1,400 stocks in all, half of my fund’s assets are invested in 100 stocks, and two-thirds in 200 stocks. One percent of the money is spread out among 500 secondary opportunities I’m monitoring periodically, with the possibility of tuning in later. I’m constantly looking for values in all areas, and if I find more opportunities in turnarounds than in fast-growth companies, then I’ll end up owning a higher percentage of turnarounds. If something happens to one of the secondaries to bolster my confidence, then I’ll promote it to a primary

STOCKS IN GENERAL

• The p/e ratio. Is it high or low for this particular company and for similar companies in the same industry.

• The percentage of institutional ownership. The lower the better.

• Whether insiders are buying and whether the company itself is buying back its own shares. Both are positive signs.

• The record of earnings growth to date and whether the earnings are sporadic or consistent. (The only category where earnings may not be important is in the asset play.)

• Whether the company has a strong balance sheet or a weak balance sheet (debt-to-equity ratio) and how it’s rated for financial strength.

• The cash position. With $16 in net cash, I know Ford is unlikely to drop below $16 a share. That’s the floor on the stock.

In the recovery, Company A’s profits have increased almost 50 percent, while Company B’s profits have more than tripled. This explains why depressed enterprises on the edge of disaster can become very big winners on the rebound. It happens again and again in the auto, chemical, paper, airline, steel, electronics, and nonferrous metals industries. The same potential exists in such currently depressed industries as nursing homes, natural gas producers, and many retailers.

I flip past all that and turn directly to the Consolidated Balance Sheet printed on the cheaper paper on of the report (see charts). (That’s a rule with annuals and perhaps with publications in general—the cheaper the paper the more valuable the information.) The balance sheet lists the assets and then the liabilities. That’s critical to me.
In the top column marked Current Assets, I notice that the company has $5.672 billion in cash and cash items, plus $4.424 billion in marketable securities. Adding these two items together, I get the company’s current overall-cash position, which I round off to $10.1 billion. Comparing the 1987 cash to the 1986 cash in the right-hand column, I see that Ford is socking away more and more cash. This is a sure sign of prosperity.
Then I go to the other half of the balance sheet, down to the entry that says “long-term debt.” Here I see that the 1987 long-term debt is $1.75 billion, considerably reduced from last year’s long-term debt. Debt reduction is another sign of prosperity. When cash increases relative to debt, it’s an improving balance sheet. When it’s the other way around, it’s a deteriorating balance sheet.
Subtracting the long-term debt from the cash, I arrive at $8.35 billion, Ford’s “net cash” position. The cash and cash assets alone exceed the debt by $8.35 billion. When cash exceeds debt it’s very favorable. No matter what happens, Ford isn’t about to go out of business.

Spinoffs of divisions or parts of companies into separate, freestanding entities—such as Safety-Kleen out of Chicago Rawhide or Toys “R” Us out of Interstate Department Stores—often result in astoundingly lucrative investments. Dart & Kraft, which merged years ago, eventually separated so that Kraft could become a pure food company again. Dart (which owns Tupperware) was spun off as Premark International and has been a great investment on its own. So has Kraft, which was bought out by Philip Morris in 1988.
Large parent companies do not want to spin off divisions and then see those spinoffs get into trouble, because that would bring embarrassing publicity that would reflect back on the parents. Therefore, the spinoffs normally have strong balance sheets and are well-prepared to succeed as independent entities. And once these companies are granted their independence, the new management, free to run its own show, can cut costs and take creative measures that improve the near-term and long-term earnings.

The autos and the airlines, the tire companies, steel companies, and chemical companies are all cyclicals. Even defense companies behave like cyclicals, since their profits’ rise and fall depends on the policies of various administrations.
AMR Corporation, the parent of American Airlines, is a cyclical, and so is Ford Motor, as you can see by the chart. Charts of the cyclicals look like the polygraphs of liars, or the maps of the Alps, as opposed to the maps of Delaware you get with the slow growers.