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Stepan Lavrouk
Stepan Lavrouk
Articles (605) 

John Neff's Investment Philosophy

An overlooked investor with a great track record

August 27, 2020

Some investors, like Howard Marks (Trades, Portfolio), seem to go out of their way to give as many interviews and public appearances as possible. Others, like Seth Klarman (Trades, Portfolio), are more reclusive. However, both Marks and Klarman are probably equally well-known and have achieved a certain status among value investors.

However, there is a third category of investor - those whose records deserve a lot more attention than they get. John Neff belongs in this category. Neff ran Vanguard's Windsor Fund, which during his time at the helm grew into the largest mutual fund in existence. Between 1964 and 1995, the fund achieved average annual returns of 13.7% - not bad for a 31-year stretch. Here are some of his core principles, as catalogued in the excellent book "Strategic Value Investing."

The hunt for low price-earnings

Neff was a textbook value investor, so it is perhaps unsurprising that he considered companies with low price-earnings ratios to be good starting points when constructing his portfolio. Like any contrarian, he went off the beaten path to find businesses that had fallen out of favor, and stayed away from whatever the popular glamour stocks of the day were. The average Windsor stock had a price-earnings ratio of up to 60% below the market average, giving the fund a very wide margin of safety.

Look for strong growth

With that being said, it's not like Neff only invested in boring cyclical stocks. He liked companies that had underlying earnings growth above 7%. The trick is in finding companies that are both cheap on a price-earning basis which also have strong earnings growth. One generally precludes the other.

Total return is everything

The total return ratio, a metric which Neff is credited for inventing, is calculated as the sum of earnings growth and dividend yield, divided by the price-earnings ratio. A high total return ratio signifies that a business is generating high earnings and is paying good dividends to its shareholders, whilst being cheaply priced. Dividends were also very important to Windor's strategy - in fact, Neff believed that many investors severely discounted the real value of dividend payouts. His rule of thumb was to look for businesses whose total return ratios were twice as good as the market average.

Investing is not for the faint of heart

Neff did not believe in being excessively diversified, preferring to stick to Warren Buffett (Trades, Portfolio)'s approach of investing only in companies that he really understood and could spend a lot of time and resources studying. If you have 100 companies in your portfolio, it's hard to realistically be an expert on all of them. Better to put your money where your mouth is than to sit on the fence and get nowhere.

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About the author:

Stepan Lavrouk
Stepan Lavrouk is a financial writer with a background in equity research and macro trading. Specific investing interests include energy, fundamental geoeconomic analysis and biotechnology. He holds a bachelor of science degree from Trinity College Dublin.

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