Rule One Investing Blog

Have you finished reading Rule #1 Investing by Phil Town? Have you started searching for a stock that’s under the MOS? Are you starting to get frustrated that you haven’t found anything that meets the Rule #1 requirements?

Here’s a few tips and tricks to ensure that you don’t give up on the rule one technique.

• Just start by looking at the stock numbers. Ignore, the other three M’s for now. Ensure that the growth rates are appropriate. This will weed out lots of companies. Then you can finish you’re four M analysis.
• Once you’ve assembled your initial stock list. Run the numbers through a Margin of Safety calculator. These calculators normally show the numbers all on a spreadsheet. From the spreadsheet, you can simply see if all the numbers are above 10%. This way you don’t go through all the necessary pages on Yahoo or MSN.
• When assembling a list of potential companies be sure to branch out. This means ensuring that you select all industries that are related. You might not have as much meaning but it should be easier to perform the research necessary later.
• Try looking at stocks that have large moats that you can simply think of a company and crunch numbers. The company might not have meaning for you but it’ll show you that these companies to exist. Coke (KO), Nike (NKE) or Apple (AAPL).

Remember. The reason the requirements for your business are so stringent is so that you don’t get a predictable company without a solid background. You absolutely NEED strong consistent numbers to be able to predict a future stock price, current evaluated stock price and the margin of safety stock price.

Either way. Don’t give up. Continue to search and follow this blog. You’ll eventually find a company worth of rule one status.

I’m taking a close look at the stock list that I created from last post about creating a meaningful stock list.  I’m going to go through the specific stocks and eliminate stocks that don’t fit the Rule #1 criteria.  The criteria I’m using are

• 7 years+ of history
• 10% Return on Investment Capital (ROIC) for the 5 year and 1 year numbers
• 10% Equity growth rate
• 10% EPS growth rate
• 10% sales growth

I’m not specifically going to discuss the margin of safety, sticker price, moat or management.  As well, I’m going to be less harsh on EPS and sales growth.  I’m doing this so that I can keep these companies in my radar and have a closer look at these companies in the future.

• Sports
  • Nike (NKE)
    • Yes
  • Timberland (TBL)
    • No – ROIC 7$ last year & Equity less then 10%
  • Sketchers (SKX)
    • Yes
  • Crocs (CROX)
    • No – Less then 7 years of data
  • Deckers (DECK)
    • Yes – but EPS less then 10% last year
  • KSwiss (KSWS)
    • Yes – but EPS and sale less then 10%
  • FootLocker (FL)
    • No – ROIC less then 10%
  • Under Armour (UA)
    • No – Less then 7 years of data
  • Calaway (ELY)
    • No – ROIC less then 10%
  • Harley Davidson (HOG)
    • No – Use to be a Rule #1 stock but with diminishing growth rates the past few years it is removed from our radar.
  • Brunswick (BU)
    • couldn’t find data on Brunswick
  • Polaris (PII)
    • NO – Lower then 10% on Equity, EPS, Sales
  • Pool Corporation (POOL)
    • Yes – But Equity 1% last year
  • Jakks Pacific (JAKK)
    • Yes
  • Artic Cat (ACAT)
    • No – ROIC less then 10%
  • Columbia Sports Wear (COLM)
    • Yes
  • Dicks Sporting Goods (DKS)
    • Yes – but only 5 years of data
  • Volcom (VLCM)
    • No – but with the numbers being put up could be worth a second look as a risky business
  • QuikSilver (QZK)
    • No – ROIC less then 10%

This is considered step two of my stock selection process.  I’m left with eight potential rule #1 companies.  Now the hard work begins, determining if each of these companies has some sort of moat, margin of safety and managment.  One ‘M’ and three to go.

This is part two of my posts on the three circle exercise.

In the first part I did the exercise of writing things that I’m passionate about, am good at and spend my money on. From the results I found that companies with meaning would be companies that deal with sports, travel, cooking. In addition, when looking over that article and doing research for this article I found that I missed the technology industry. I am an engineer and spend quite a bit of time on technology related things… So to be fair I’m adding technology to my list.

I now have four main categories (Sports, Travel, Cooking and Technology). Today, I’ll investigate sports a little deeper, one of my greater passions!

So what are some big companies that are related to sports? Nike, Reebok, Under Armour…. If I go to Google and type in NKE I can see that Nike is in the Sector: Consumer Cyclical and Industry: Footwear

Other companies (on the NASDAQ) in the same industry include Timberland, KSwiss, Crocs and Sketchers. I do shop at Eastbay quite often and have different size feet, so, I guess this industry does have meaning to me.

What about actual sports equipment though? Things like Golf, Tennis, Skiing, Soccer, etc… Companies that come to mind are Calaway, Prince, Yonex, Umbro. Let’s type in a few companies and see what we get for an industry. Calaway (ELY), Prince. Similar to Nike Calaway is in the Sector: Consumer Cyclical and Industry: Recreational Products

Looking at companies in this Industry I see Harley Davidson, Brunswick, Polaris, Calaway, Pool Corporation, Jakks Pacific, Head and Artic Cat.

So now I have a list of companies that I can investigate further. I’ve added all these companies to my current Watch List and will update that list as I remove non-Rule #1 companies from the list.

Note: I only mentioned companies that I recognized. My assumption is that if I know the company it will have a greater chance of having a moat.

Neat Google Tip: You can simply type the area of interest in Google Finance and you’ll come up with a list of companies that deal in that industry. For example: Golfing

In the Book Rule #1, Mr. Town describes a method to find stocks that have meaning to you. He names the method the three circle exercise. The idea is you put things you’re passionate about, talented at and spend money on, in three circles.

You then analyze what is overlapping in each circle and pick companies to investigate further based on a common theme in each circle. I thought it’d be a good exercise to complete this exercise right now, without the circles.

Things I’m passionate about (Passion)

• Sports
• Cooking
• Traveling
• Relaxing

Things I’m good at (Talent)

• Sports
• Cooking
• Engineering
• Research
• Finding deals

Where I Spend my Money (Money)

• Sports
• Traveling
• Shopping
• Food

As you can see the common theme in all the circles (bullets) are sports, traveling and cooking. This shows that I have meaning in these areas of business. The next post I’ll discuss the various companies that are available options in these categories.

Since selling my Lowes stock I’ve been searching for another great company to buy. However, since I’ve completed my first two trades I thought a little reflection is necessary.

First off, don’t get me wrong I’d love to own Lowes (LOW) forever. However, the big guys are weary about this industry right now. This is because of the weakness in the housing market in the US. Therefore, the money is coming out (or is out) so my money is out too. As I discussed in my last post selling Lowes. I figured that looking at a chart to see if I used the technical indicators correctly would be smart. I plotted a chart with the SMA, MACD and Slow Stochastic below. This chart is from February 7th, two days after I sold the stock.

As we can see from this graph all the indicators have actually trended downwards. The MACD is just starting to cross downwards, the slow stochastic has pass downwards and the SMA has crossed the stock price. This demonstrates that I got out at the correct time, therefore, minimizing any losses and thus maximizing my gain. It could be argued that maximizing my gain would be to get out at the top of the spike but I had no sign that the stock wouldn’t rebound.

Now let’s look at my other stock trade which I discussed in analyzing coldwater creek. In this article I discussed purchasing the stock because of the low price and that the stock was under the margin of safety. Furthermore, the chairman is buying back stocks, which is usually a positive sign. So, I purchased 25 stocks at $6.20.

Upon discussing this at a forum, roicommunity.com, a poster pointed out that I might have entered too soon. Meaning that the stock might be trending sideways for a while. Therefore, I won’t see any increase in the price of the stock (possibly for a while) and therefore my money would be tied up and I won’t be able to use it at other places. By the chart posted below I can see that this poster might have been correct. The technical indicators are tough to judge at the moment as the price seems to have crossed back over the average but the MACD and the slow stochastic is under. I’m guessing this is a sign of a sideways sliding stock.

That being said, I still believe that this company has a large potential of increase and I won’t be surprised to see a $12 (or higher) price sometime this year. That would be a great return on investment. Therefore, I’m leaving my money in the stock and trying a buy and hold strategy with this stock. In fact, if it decreases below $5, I’ll consider increasing my position.

Well, it’s a good learning process so far. Now I just need to find the next undervalued company. In the meantime I’m growing my cash in order to take full advantage when I do find the undervalued stock.

I’ve been watching the technical indicators carefully since analyzing and buying Lowes (LOW) stock. It’s not that I’m super worried about my calculations as my sticker price is in the range of $32-42. The stock is no where near these values, however, the market is so volatile right now that it could drop quickly and for no real reason (good old Mr. Market).

Anyway, today I received the signal to sell. To determine when to sell I’ve used the following tools:

• 10 day simple moving average
• Slow Stochastics
• MACD (with 8, 17 & 9 as my settings)

Looking at the chart below we can see that all three symbols are trending downward today.

So, I followed the Book Rule #1 advice and sold. I’m now waiting and watching the symbols for them to tell me when the big guys are getting back in.

• Sold – 25 shares @ $24.60 = 615 – 9.95 (trade fees) = $605.50
• Total Profit = $605.50 – $567.45 = $38.05
  

An easy way to expose yourself to stocks that you don’t really know exsist is to find a movers and shakers list. This is a great way to find a group of stocks that you may or may not be familiar with or are in a different industry then you typically follow.

The drawback of this method is that the companies might not have any meaning to you. Thus creating more work for you when researching the company. And will create more work then the typical 15 minutes per day to keep up on the stock as you’ll have to watch the industry / company more carefully.

The advantage, however, is that it exposes yourself to many other companies. I typically find a list and then run a few (or all) of the companies through a rule one calculator. This shows me the growth rates for each company. From here I can decided whether the company has any meaning or could have meaning to me.

An example of one of these list is the following image from Minyanville. You can see the attachment below in a larger format if you click