Rule #1, by Phil Town is a relatively new book about value investing. Phil Town is a student of Buffett and Graham. As the story goes, he spent the early part of his adult life living in a teepee in the wilderness out west. He made a few thousand dollars a year working as river boat guide for travelers and tourists in the rivers around the rocky mountains. During the off-season, he lived off of unemployment and spent his time riding his motorcycle around the west coast.
During one of his stints working as a river boat guide for a group of rich travelers, they came across some trouble and the raft, which they were riding, nearly fell off a cliff. Phil’s experience in the wilderness allowed him to barely escape the cliff and save the lives of the travelers that he was guiding. One grateful traveler decided to teach Phil how to invest as an effort to reward him for saving their lives.
Phil then borrowed $1000 from a friend, and using his newly learned principles from Buffett and Graham, he claims to have turned it in to a million dollars in five years.
To summarize his investing philosophy, Phil recommends finding a company that you understand, has a competitive moat, great management, and a 50% margin of safety. He recommends a very concentrated portfolio too, with perhaps just one or two stocks. When choosing stocks, he uses fundamental analysis, concentrating on a high return on equity, and very consistent and predictable growth rates in sales, equity, EPS, book value, etc. He provides a formula to calculate the fair value (what he calls “sticker price”) of a stock, and then he buys only when the stock is selling at 50% of fair value. He also recommends keeping an eye on a few technical indicators to know exactly when to get in and out.
That overview of his investment philosophy probably sounds very familiar to most value investors and students of Buffett and Graham, but there are quite a few nuggets of wisdom within the book. For instance, even though I have read virtually all of Buffett’s annual reports, I have to admit in retrospect that I never truly understood the concept of competitive moat. Like most investors, I thought that I understood what a competitive moat was, but it wasn’t until I read Rule #1 the concept became much more lucid to me.
As the title suggests, the author constantly reiterates how your main focus should be to not lose money, and how the highest returns are made on the most undervalued, and therefore safest, investments. He methodology is so strict, that I can honestly say that if you were to follow the book exactly step by step, you would keep your capital extremely safe and have very acceptable returns.
The only thing that I disagreed with was the fact that he uses historic PE when calculating the fair value of a company. Many people might disagree with me here, but just because a company has a historic PE of 60, I still wouldn’t consider buying it at 30. To me, no matter what company or industry, any PE above the mid teens is way to risky.
I have attempted to tell you about the book, with out spoiling it or giving away any of his secrets. All in all, I would say that the best thing about the book is his ability to explain some of the more abstract concepts in investing. Novice investors would probably do well to read Rule #1 as an introduction to value investing. More experienced investors, such as the people that frequent gurufocus.com, would probably already be familiar with the concepts presented in the book. However, I can honestly say that after already being familiar with the concepts and principles of value investing, Rule #1 did a great job of giving me a much deeper understanding of such concepts as margin of safety and competitive moat. For that reason, I would recommend any fan of value investing to read the book if you would like to get a much deeper understanding of some of Buffett and Graham’s more abstract principles.
For those of you that don’t want to read the book but would like to see his calculation for the fair value of a stock, you can sign up for free at his website, http://www.ruleoneinvestor.com/ and find automatic calculators for margin of safety and various growth rates._____________
The author of this article can be reached by email at firstname.lastname@example.org.