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Book Review: Phil Town's Rule #1

August 20, 2007
10qk

Matt Clarke

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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 mattclarkeinc@hotmail.com.

About the author:

Matt Clarke
GuruFocus - Stock Picks and Market Insight of Gurus

Rating: 3.0/5 (12 votes)

Comments

billytickets
Billytickets - 7 years ago
Matt i concur with you about the historic PE turning me off and i doubt Buffett would condone how he "values" companies

Also buying a dollar for 50 cents is not as easy as he makes it out. I doubt Munger read this book and gave it his blessing

I doubt seriously that he actually turned 1000 into amillion ito 5 years and would like to se his tax returns.

As the author of a book myself I know how "difficult" it is to write one but Buffettolgy was 20 times better than this one
billytickets
Billytickets - 7 years ago
Matt i concur with you about the historic PE turning me off and i doubt Buffett would condone how he "values" companies

Also buying a dollar for 50 cents is not as easy as he makes it out.

I doubt seriously that he actually turned 1000 into amillion and would like to se his tax returns.

As the author of a book myself I know how "difficult" it is to write one but Buffettolgy was 20 times better than this one
billytickets
Billytickets - 7 years ago
Matt i concur with you about the historic PE turning me off and i doubt Buffett would condone how he "values" companies

Also buying a dollar for 50 cents is not as easy as he makes it out.

I doubt seriously that he actually turned 1000 into amillion and would like to se his tax returns.

As the author of a book myself I know how "difficult" it is to write one but Buffettolgy was 20 times better than this one
vooch
Vooch - 7 years ago
> 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.

Many people are fooled by thinking "above mid teens (PE) is way too risky", but if you research Bill Miller (a guru here), you will learn about making competent bets (with a portion of the portfolio) towards high PE stocks.

The reason is twofold: compounding and growth rate. If you're willing to allow the growth rate to compound, and you believe the company will be a long-term winner, then there's a good chance you'll succeed. The "Circle of Competence" has a lot to do with this. With high PE stocks, you need to know who/what/when/where/why/how you're buying. In essense, you need to really examine all the opportunities and threats and very intelligently because there's a higher risk and higher reward.

As for a risky stock, I've bought GOOG recently. Many of you probably do not know this, but they stopped selling the #1 ad for 1 penny above the #2 bidder, and instead, are selling the #1 ad for the #1 bid. This will be a windfall of new revenue for the company come Q3.

GOOG trades at 7.92 times Book. You would think that's ridiculous, but if you look at other long-term winners in the past, they'll trade at 10x Book Value for long periods of time while they're ruling their industry. I believe GOOG will hit $625 and move up from there, assuming they keep growing the business properly.

I also see a market share discrepancy which has never been reported yet. I think GOOG's market share is way above what the general press is reporting.

- Vooch

billytickets
Billytickets - 7 years ago
Vooch as you know iam familar with Millers track record of buying higher PE companies but MOST( did nt say all but most)"regular guys" do not posess the skills and aptitude of aguy like Miller to separate the"value traps" from the bargians with any consistency.

GooG book value is irrelevant. If you ( or anyone ) feels they can estimate the companies future EPS in the next 5 years with any degree of certaintity than by all means buy"value" . Especially if like yourself you have a good "technology mind". However the WEB Munger Graham types would not have done it that way though

Web has made over 150 billion dollars investing as you well know and more than 95% of those profits were made of purchases of stocks or whole companies with Pe's in the teens.Buying high PE companies while possibly being profitable IS NOT practicing "value investing" in the Buffett Graham Munger style of investing

Of my 5 major purchases of the past 14 years.WEB bought BUD WMT JNJ and although he didnt buy MO he did buy KFT in the 30s when you could have gotten it for 8 dolars a share 7 years ago,it is safe assume that he would have bought Mo if not for his refusal to have direct investment in tobacco. BrkB my only other purchase was bought at the same time Gates bought it almost excatly 2 years ago. I have to believe WEB would have mentioned that he thought the stock was priced "fairly" given their friendship and can assure you that he "approves" of management ,especially the views on CEO comp and options grants. Iam not saying my"stocks" are better than Phil town's or anyone elses but simply saying WEB would say my "formula" is alot more Graham Buffett Munger than Phil Town's talk about stochastic and charts

Alex WEB's best investments SEE's candies, Coke AXP Gilette Scott Fetzer GEICO and all the other insurance purchases were companies with LITTLE ACTUAL ASSETS but high ROEs and ROCS which are MUCH MORE IMPORTANT than Book value to WEB.peace

vooch
Vooch - 7 years ago
billytickets,

Re: High P/E: I said, "The Circle of Competence has a lot to do with this." One shouldn't buy a high P/E stock unless there's reason(s).

- Vooch

billytickets
Billytickets - 7 years ago
Vooch my friend absolutely right and as you and me have actually met and talked I "know" you have agreat knolwedge of "technology" and the greatest"library" of value investing Ive ever seen.( including my book.lol).

It is clear to me you are a "true" student of Munger and WEB although you have amuch higher proppensity to"gamble" than they( or me) does. Yopu aremuch more aggressive and action oriented than me who has adopted the Sit on your AZZ style of investing practiced more by Munger and WEB. I get all my action from tickets as you saw.lol

My point( especially to many"newbies" who read thisis)Goog while it may turn out to be agreat investment( like SGt Shulz from hogan heroes i know nothing about tech) . HoweverBuying a stock with a high PE is not a Buffett Graham Munger idea of value investing ( more like Millers as you stated).Good lUck with capital one
vooch
Vooch - 7 years ago
billytickets,

Agree. GOOG is not a value stock per the Buffett, Graham, or Munger crowd.

However, GOOG is my speculation (ie. Miller) (and long-term) play, and I am buying it at these levels because of my reasoning. Could I be wrong? Yes.

- Vooch

billytickets
Billytickets - 7 years ago
Agree totally vooch

Whats ironic about Phil town is he quotes Buffett alot but his stock picks using stochastics and moving averages and high PES is not "warrenlike"

He does believe in a concentrated portfolio and mentions WEBs rule( dont lose money which is not highly profound) but I cant picture WEB studying"charts" Vooch have you read Phil Town and if u did what did u think?
vooch
Vooch - 7 years ago
billytickets,

Yes, I've read Phil Town's "Rule #1 Book". In some respects, I thought he was taking already known ideas and slapping his new name on it (ie. Sticker Price) and making it like he came up with original ideas.

I do not agree with Phil Town's version of Technical Analysis - it's faulty.

As for his stock picks (eg. GRMN), it's kept going up since publication, until recently.

I recall him talking about COH on CNBC, but I'm not sure if that was before or after it's rise.

If Phil Town would have stuck with the same nomenclature as within the Value Investing group/industry/mindset (whatever you call it), I would have had more respect for him. Unfortunately, he created new terms (as if, he's enlightening the general public and inventing these ideas) and thus lost a lot of my respect.

It makes me respect Mohnish Pabrai more! At least he calls himself a "shameless cloner" - nothing wrong with that, imo.

- Vooch

freehling
Freehling - 7 years ago
I liked the book, but I thought it was overly simplistic. If it were easy to find a boatload of consistent growers trading way below intrinsic value, we'd all be rich!

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