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Sir John Templeton, the famed value investor who passed away in 2008, was my great-uncle, and he seeded my investment business when I was 24 years old. At my firm, Templeton & Phillips Capital Management, we are always asking the question: “What would Sir John do?”
Of course, Sir John’s investment genius was too brilliant and creative for us to answer with detailed accuracy. Yet experiences with him as a mentor created profound lessons and principles that are a guide to the current market climate. Thankfully, Sir John took the time to record certain principles into his “16 Rules for Investment Success.” In light of today’s unusual market environment, which I have no doubt he would have found interesting, let’s take a quick review of the rules and how we can use them in 2020.
1. Invest for maximum total real return: Investors are especially prone to this mistake in the current environment of share price volatility. While it may feel comfortable hiding out, Sir John paid close attention to the potential loss of purchasing power. Even with today’s low rate of inflation, most of the U.S. Treasury yield curve is losing money in terms of purchasing power. In order to obtain even a less-than 1% real return (the value of an investment after taxes and inflation), Treasury bond investors must venture into 20- and 30-year issues, which exposes them to the risk of sharp paper losses if inflation and/or interest rates rise. It’s not much better in the muni-bond market, where issuers face declining sales taxes and underfunded pensions that could undermine investors’ safety. On the corporate side, investment-grade debt has 50.3% of its issues in the lowest BBB tranche (compared to 7% in 2000), leaving bondholders vulnerable to downgrades into junk status. Accordingly, investors looking to “play it safe in bonds” should tread carefully now; they’re effectively searching for nickels and dimes on the train tracks.
2. Invest — don’t trade or speculate: Trading leads to unforced errors. First, traders deprive themselves of the market’s greatest gift: compound interest through earnings, cash flows and dividends. Second, traders probably underestimate their competition: high frequency algorithms, artificial intelligence driven hedge funds, and pro desk traders, to name a few. If you would not bet your life savings in a tennis match against Roger Federer, why would you bet your savings against stock-trading pros?
3. Remain flexible and open-minded about types of investments: We routinely challenge the consensus, and this includes our own consensus. Many investors label themselves as value or growth and become closed-minded. We insist on investing in bargains, but even atypical growth firms can become value. When Amazon.com AMZN, +0.74% traded at 14x cash flow in March, it matched its low valuation from November 2008, and having come to understand the company better over the preceding years, we did not hesitate to purchase the shares for the first time at our firm. We still own them today. Do not unnecessarily limit yourself as an investor, stay open minded to possibilities.
4. Buy low: “Buying at the point of maximum pessimism” as Sir John put it, is critical to investment success. Panics and bear markets are a reliable source for excess return. Everyone wins in a bull market, and investor returns will be determined by their behavior in a bear market.
5. When buying stocks, search for bargains among quality stocks: Quality has become a casual term today, but our definition includes prudent balance sheets, low capital intensity and the “rinse and repeat” effect of reinvesting corporate cash flows into sustainable growth projects. Quality stocks create wealth through compounding the latter effect, when bought at a discount. Most important, they eliminate common investor mistakes such as trading into worse investments or paying too much in commissions and taxes. See Rules No. 1 and 2.
6. Buy value, not market trends or the economic outlook: Owning a rising stream of earnings and cash flows builds wealth, not guessing at market moves or economic outcomes. Numerous studies have shown that a selection of firms can produce rising sales and earnings, leading to positive share price returns in a recession. The current environment is a time for active investors to show their meddle through bottom-up stock picking. We are focused on firms with the ability to take market share in this challenging economy.
7. Diversify. In stocks and bonds, as in much else, there is safety in numbers: It is impossible to track all of the variables and probabilities that could affect a particular business, much less a market of stocks in a given industry or country. Some level of diversification is necessary, or as Sir John also said, “The only investors who shouldn’t diversify are those who are right 100% of the time.”
8. Do your homework or hire wise experts to help you: In the digital era of today, doing your homework and educating yourself is more possible than at any time in history. If want to select an expert apply Rules 1-8 as a filter, and pay close attention to performance and whether it justifies their fees.
9. Aggressively monitor your investments: Even iconic blue-chips can unravel. Despite spending more than 100 years as a member of the Dow Jones Industrial Average DJIA, -0.68% , and along the way navigating the Great Depression, numerous recessions, crises, and wars, the bottom fell out on GE GE, -2.55% shareholders when it began to suffocate under the weight of poor acquisitions from the preceding 10 years. By the time COVID-19 wreaked its economic havoc, GE shareholders had lost 83% from its recent high in 2016.
10. Don’t panic: Selling your portfolio amounts to market timing, and if you are thinking of selling following a share price panic then you have already proven that you are not a good market timer. Remember Rule No. 4. Focus on the long-term and try to become a buyer. During the 1987 stock-market crash Sir John was elated, claiming his purchases would make their returns “for years to come.”
11. Learn from your mistakes: All investors make mistakes, and they should be expected. Every investing mistake should be seen as an opportunity to improve, and it is important to take the lesson and move on. Whenever I saw Sir John make an investment mistake his demeanor never changed, and he moved on to the next idea. It was a powerful example that I revisit often.
12. Begin with a prayer: Sir John’s use of prayer to begin meetings was an act of mindfulness and focus. Investors and executives today are better grasping the benefits of thought control, mindfulness, and meditation in their daily routines. Sir John said, “If you fill your mind to capacity with thoughts that you think are good and productive, you won’t have room for the bad ones.”
13. Outperforming the market is a difficult task: Sir John’s view was that once an investor grasps the complexity of the markets and their fellow competition, it is difficult to beat savvy peers, much less the passive indices that are both fully invested and do not charge fees. Taking these factors into account he thought that investors generating long-term outperformance versus the market are doing much better than the casual observer realizes, and that outperforming by a significant degree represents a “superb job.” In our view, for an investor to outperform the market it requires an edge over the competition, and therefore investors must seek and develop an edge through methods including better information, better selection methods, or wiser behavior (i.e., contrarian). We focus on the latter.
14. An investor who has all the answers doesn’t even understand all the questions: I am always suspicious of investors who offer certainty to every single investment question, as I feel it harms their credibility. In my experience, seasoned and successful investors are intellectually humble and have no problem admitting that some answers cannot be known.
15. There’s no free lunch: On my first day of college economics the professor wrote on the board the “universal law” he labeled “TANSTAAFL” – “There Ain’t No Such Thing As A Free Lunch.” This rule has proven so inviolable that its real meaning is elevate the role of critical thinking in all business and investment matters. Most often, any offer disguised as a free lunch is either not free, or not lunch.
16. Do not be fearful or negative too often: This rule reminds me of a quote from Socrates that my father has kept on his desk since I was a child, “Nothing is stable in human affairs, therefore, avoid undue elation in prosperity or undue depression in adversity.” Based on our studies the average investor should expect to spend approximately a third of their life in a bear market. These events are to be expected, and once an investor learns how to harness share price declines into stronger future investment returns these unexpected events will become sought after. In reality, optimists will carry the day and corporate profits, as well as the share prices that track them will rise even higher than most professionals anticipate.
Lauren C. Templeton is the founder and president of Templeton & Phillips Capital Management.
