Tuesday, July 29, 2014

Book Review #9: How I made $2 Million in the Stock Market: Author: Nicolas Darvas

After taking a long time (approximately two weeks) to read and then write a review of the books that I had reviewed previously, it is a happy feeling to complete reading a book and then finishing the review in a span of three days !!


'How I made $2 Million is a book for the traders. In this respect the tactics in this book are more relevant to the book 'Reminiscences of a stock operator' that I had reviewed previously. (There are significant differences between the two books. Mr.Livermore, the protagonist in 'Reminiscences' was an Operator [some of his actions may be considered illegal here in India] while Mr.Darvas is a Trader, a perfectly legal operation).

Nicolas Darvas is a professional dancer who came across Stock Market Investment by accident. For one of his dance performances, he was paid (well not exactly. The performance did not go thru and he purchased the shares) in the form of equity shares of a company which almost quadrupled in about a month.

The premise of this book is simple. Observe the trends in the stock prices, and trade when the price is at the lower end of a price band and keep owning the stock till the price is going up and maintain a strict trailing stop loss to limit your losses. The key decision is when to buy the stock. You don't want your stock price to fall immediately after you buy the stock. Mr.Darvas keeps a very tight trailing stop loss at the time of purchase and as the stock prices start moving upwards, he loosens the stop loss.

In his introduction to this book, Mr.Clem Chambers, comes out with a few concepts and points. He talks of 'Observer Bias', a tendency of the mind to highlight the profits while hiding the losses. Mr.Darvas was a medium term trader. Medium term trading is more profitable than short term trading. The strategy followed by Mr.Darvas was simple. Look for increase in trade volume. This indicates that something is afoot in this stock. Take a small position to validate your initial assumption. Buy more if your assumption is validated. Keep strict trailing stop loss and exit if your assumption is not validated. As the price goes up cover your profits by keeping strict trailing stop loss.

The last point in the above paragraph is a gem. Keeping strict trailing stop loss and selling out when the price goes adversely is the simplest tool available to remove emotions from your trading. As any expert will tell you, emotions are the enemy of wealth creation.

The book is divided into 10 chapters covering four section. In the section titled 'Gambler' covering Chapter 1, the author talks about his initial foray into the stock market. The section 'The Fundamentalist' covers Chapters 2 and 3 and section 'The Technician' covers Chapters 4 and 5. Last 5 Chapters (6-10) are covered in the section 'The Techno-fundamentalist'.

At the end of Chapter 10, the book ends abruptly. No epilogues or post-scripts.

While the overall idea covered in this book may be simple (buy low, sell high, keep stop loss, watch your purchase price), what makes this a good read are the innumerable life lessons that are sprinkled in at various pages of the book.

The book commences by describing author's initiation into stock market. As described earlier in this post, he came into Stock Investing entirely by chance when he was paid a remuneration for a dance performance in the form of stocks of company named BRILUND in which he tripled his investment in a span of a month. He became intrigued by the potential and started dabbling in Stock Market. Just like any amateur investor started investing in 'hot tips' and lost money. He randomly read finance magazines and invested in the tips mentioned in those magazines and lost money. He found that his purchasing the share was a clear signal for the market that the stock is due for a correction, a signal which the market acted on from the moment his purchase was formally registered in the books of the market. ('The sudden drops in prices immediately after he has invested his money are one of the most mystifying phenomena facing the amateur', says the author. Talk about an understatement !)

He decided that he was losing money only because he did not know how the market worked. So he methodically went about studying and learning how market works. From his gambler days, he moved to investing based on fundamentals. He decided that he will 'Trade' only fundamentally sound companies. He searched for those companies and bought them and sold at a loss. He followed the advice 'You don't go broke taking a profit' and sold winners at meagre profit. He followed the maxim 'Buy Cheap Sell Dear' (what could be more simple than that?) and tried 'Over the counter' stocks and lost money (he didn't know how OTC worked).

Based on the lessons learned, he came up with the following rules of investing.

1. I should not follow advisory services. They are not infallible
2. Brokers advice can be wrong.
3. Ignore Wall Street sayings how noble and ancient they are.
4. Do not trade OTC
5. Do not listen to rumours
6. Fundamental approach is better than gambling.

While following the fundamental approach, he often found that while the Industry moved in line with his fundamental analysis, the stocks did not. For example, he knew that Textiles will be going up, but the strong companies in the sector did not move up and a small company did. This puzzled the author.

Author felt so confident of his fundamental approach that he studied Steel Industry and identified a company called Jones & Laughlin. Everything was going for it. Strong Industry, Good rating, Good Dividend payout....But immediately after he invested, the share started falling. He sold off at a loss and his entire capital was about to be wiped off.

Having lost money by following a fundamental analysis, author then moved on to investing based on Technical Analysis. He decided to follow Price / Volume data and make his trades based on that analysis. He found that the stock price has a tendency to consolidate within a range. Once the consolidation is over, the stock can either move below the lower end of the band (sell signal) or move above the upper end of the band (buy signal). The author called this band a 'Box'. As long as the stock stayed within a band, you keep observing. Once it crossed the band you take action.

One criteria that he chose was to identify those companies whose price behaviour is normally inactive. Once those companies become active, that is the time to focus on them. Even when he followed this method, he found that he was making losses. That is when he discovered the power of 'Stop Loss'. Once he incorporated this into his buying habit, his performance improved.

Author uses a metaphor to distinguish an 'Inactive Stock'. When a normally tempestuous lady starts jumping and dancing normally pays any attention. But if a dignified matron were to do the same, eyebrows will be raised. Inactive stocks with sudden movement were like dignified matron.

One fascinating aspect of this book is the amount of time the author spends in analyzing his losses and learning the right lessons. At the end of his Technician phase the author summarized his Objectives and Tools at his disposal.

Objectives:
1. Right stock
2. Right timing
3. Small losses
4. Big profits

Tools:
1. Price and volume
2. Box Theory
3. Automatic buy order when the stock touched a specific price
4. Trailing stop-loss

As he progresses in his trading behaviour, refined over the months based on lessons learned in the past, the author learned to separate his emotions from his action. He no longer felt proud when he made profits or felt sad when he made loss. In addition, he also learned that the stock do not move in isolation to the market. Based on his learning he started factoring in the overall market conditions before making any trades and this significantly improved his performance in the market.

The biggest lesson that he learned was that his method of using trailing stop loss was allowing him to get out of trend reversals much ahead of reversal cycle. While discussing this, author derides the habit of people to hold on to stocks even when they are falling. The trailing stop loss was helping him to remove emotions out of the 'Sell' decision.

In the remaining chapters, the author talks about his conversion from a pure Technician to a Techno-Fundamentalist. The market was going thru a correction, and he totally refused to trade in the market. He knew that market was a slave of earnings. He kept his eye open for Companies which have high earnings power 'In the Future'. Those stocks may not be cheap, but he will buy high and sell even higher.

Another lesson that he learned during this period was that the brokerage was low when he purchased higher quantities of stocks. Also, higher quantities of stocks could give you higher profits when the price goes up and cuts your losses (brokerage commission) when the prices go down.

Once the correction was over and market started reversing, the author's strategy began to work. He made huge profits in most of his investments. Where he made losses, they were minimal since he had covered the losses through stop loss mechanism. Soon his profits hit $500000. That is when he came to Wall Street and started trading from Broker's office. He soon found that he was falling pray to Wall Street Traders behaviour. He totally abandoned the method that got him so much of profit. He forgot stop loss, started buying on tips, started selling the winners early and keeping the losers.

And soon his entire profit was wiped out.

He realized that by trading in Wall Street, he had forgotten the method that made him rich by half a million. He realized that he has lost his capacity to 'See' patterns. He immediately took action. He left NY and moved to Paris with a strict instruction to his brokers not to call him at all and only send him the day end cables showing the price movement and the market movement. With this information, he started working at night when market was sleeping. While he was sleeping and the market was working, his agent, the Trailing Stop Loss, was working on his behalf to handle any market reversal.

Slowly his 'Touch' returned.

By remaining invested in a few companies like Universal Controls, Thiokol and Texas Instruments, Diners Club and other stock the author reached a market value of $2.02 Million somewhere in July 1959, almost six and half years after he transacted his first trade.

What are the lessons that I have learned after reading this book?

1. Use trailing stop loss. I have seen my holdings go up in prices significantly and then coming down and I have not been able to get any profit out of it. For example, I purchased IDFC at 50, it went up to 300 and then again came down to 70. I held on without selling. I could have exited at a profit if I had used Trailing Stop Loss. 'Small Loss, Big Profit' should always be my Mantra.

2. Do not love a stock. It is very easy to get attached to a stock if you buy it based on some assumption and the assumption works. For example, I purchased TISCO at 250 because its P/E was low and in about 6 months, the stock has more than doubled. Now, I feel that I and TISCO are 'partners' in my success. A stock is like Cyborg in the movie 'Terminator'. It may help you to make money, but it has no emotional attachment to you.

3. Buy when prices are going up. Not when they are going down. 'Averaging' is a strict no.

4. Do not hate a stock: You might have purchased it at the wrong price and made loss on that. That doesn't mean that I can't make profit out of that in future.

5. Do not look at rear view mirror when buying a stock: You would have seen that a stock doubling in three months. That doesn't mean that it is overpriced. Always try to look at the future potential of the stock. An example is my purchase of HDIL. I see that I had purchased it when it was 250, again when it came down to 120, again when it came down to 50 and it finally reversed when it touched 15. Currently it is trading at 85. That doesn't mean that it is overpriced. It only means that the price has moved up from 15 to 85.

The main message in his book can be summarized in a few sentences. Start buying when market starts to rebound, buy stocks of quality companies with future profit potential, regular review and keep Stop Loss. There are three main lessons that one can learn from this book. First one is about regular personal reflection. You have to analyses your losses and identify the behavioural patterns that led to those losses. Reflection is the path through which one can become a better person and a better investor. The second lesson is about continuous learning. Every time the author identified a flaw in his approach, he want back to the drawing board and read up and understood why that flaw happened and that helped him take corrective action. The third and the main lesson is that you don't have to be a professional in the market to make money in it, a point which Mr.Peter Lynch makes HERE and HERE

Both Mr.Livermore and author makes a very important point about the importance of timing the purchase of a stock. As per them, it is important that the price of the stock starts rising immediately after you buy the stock. While Mr.Livermore do not stress a lot on Stop Loss (after all, he is a Stock Operator), the author of this book is very particular that one should always maintain a Trailing Stop Loss for every stock that one owns.

One of the flaws (if you can call it such) of this method is that Mr.Darvas made money in the middle of a major bull market. It will be fascinating to see if this method will work in all kinds of markets. 

Monday, July 28, 2014

First Milestone for this blog....

Just now, this blog achieved the first milestone. 1000 Visitors....

Next milestone 10000 Visitors.....

Wednesday, July 23, 2014

Book Review #8: Beating the street: Author: Peter Lynch

While his earlier book 'One up on wall street' focused on the concepts of Equity Investing, the focus of this book is on the application of those concepts for picking the right stock to invest. 

In the introduction to the chapter, Mr.Lynch rues the fact that over a period of time Americans are investing less in equity and more in bonds. He demonstrates through data that over the decades from 1930 through 80's, Equity investments have outperformed all other asset classes. Author emphasizes that only way to make money is to invest consistently in equity over a period of time. As pointed out in One up on Wall Street retail invest. ors tend to enter and exit the market at precisely the wrong time. 

One of the main points made in 'One up..' was that amateur investors have more opportunities to outperform the professionals provided they use their power of observation and common sense. In Chapter 1, 'Miracle at St.Agnes', author digs in to this point. He points the example of a group of school kids at St.Agnes school who followed fundamental rules of investing and over a two year period achieved a portfolio return of about 70%, the kind of returns that are the envy of professional investors. 

Some of the rules followed by the children (7th Graders All !) are:
  • A good company usually increases its dividend every year
  • You can lose money in a very short time but it takes a long time to make money.
  • You have to research the company before you put money into it.
  • Never fall in love with a stock
  • Just because a stock goes down doesn't mean it can't go lower
  • Over the long-term it is better to buy stocks in small companies....
NAIC (National Association of Investors Corporation), a Michigan based organization formed with the objective of teaching individuals become successful long-term investors, has come out with an Investor's Manual which contain the following points.
  • Hold no more stocks than you can remain informed on
  • Invest regularly
  • You want to see that sales and earnings per share are moving forward at an acceptable rate and that you can buy the stock at a reasonable rate.
  • It is well to consider the financial strength and debt structure to see how the company can withstand a few bad years
  • Buy the stock based on whether if the growth meets your objectives and whether the price is reasonable
  • Understanding the reasons for past sales growth will help you form a good judgement as to the likelihood of past growth rates continuing.
Another point that he makes in this chapter is the benefits of forming investment clubs. Properly designed and executed, Investment clubs formed by a group of investors can bring in the much needed analytic rigor to the process of stock picking and selling. 

Chapter 2, 'Weekend Worrier', cautions the reader against making too much out of the negative news coming out in the news media. Through examples, the author convincingly proves the dichotomy between a stream of negative news that appeared in the news media and the significant out-performance of the market. The main message from this chapter for retail investors is to develop a dispassionate attitude to the negative news and to the occasional market downturns and continue investing in companies with strong fundamentals. Buying and selling stock is a game of the head while staying invested and having courage of your convictions is a mind game. 

Being a book written by a Mutual Fund Manager, Chapter 3 focuses on investing in Mutual Funds. The chapter starts off by discussing that eternal investor's question, 'Stocks or Bonds?'. The book is very clear that Stocks are the way to go. Even for a retirement portfolio, the author suggests a full stock portfolio of companies with regular dividend payouts and dividend increases. The chapter also discusses various types of funds like Value Funds, Growth Funds, Income Funds, Special Situation Funds, Country Funds, Bond Funds and Sector Funds. The recommendation is to have equal allocation of your portfolio in Value, Growth, Special Situation and Bond funds. When it comes to sector funds, the recommendation is to invest in sectors that are down currently. 

There is a tendency among investors to rotate their money among mutual funds which have produced high level of returns from a 3 year and 5 year perspective. The author disapproves this tendency. His recommendation is to identify some good funds and invest in them regularly.

Chapter 4, 5 and 6 cover author's stint at as the Fund Manager of Fidelity Magellan Fund. When he took over in 1977 the fund size was about 18 Million Dollars, which increased to 100 Million by 1981. Two points stick out while reviewing the fund performance during this period. One, there was a phenomenal turnover of stocks in the portfolio. Rather than sticking to a specific portfolio strategy, Mr.Lynch went about buying any stock that convinced him of its potential to be a multi-bagger. The second point was that in 1978 and 1979, the Dow Jones was at its lows and he was able to purchase some very good stocks at a P/E of about 5-6. As he mentions, you can't lose in any market if you get good companies at very low valuations.

Author mentions that he never invested in businesses that he never understood. That is a good lesson for all those Indian Investors who don't know the difference between 'ANDA (Abbreviated New Drug Application)' and 'Anda (Egg)' but still invest in companies in the Pharma sector!!

During the 'Middle Years', covering the period from 1981 to mid of 1983, the fund rose from 100 Million to 1 Billion. Some of the valuable points made in this Chapter 5 are about buying companies with Strong Balance Sheets and buying companies in Retail Chains and Restaurant Chains where the success in one market can be easily replicated in other markets. During the first half of 1982, markets were in doldrums and Interest Rates were at their highs. When he found that the Interest Rates on Bonds were over 6% higher than the dividend yield on Index Stocks, author moved out of stocks and invested in Bonds (probably his first and the last big purchase in Bonds).

Somewhere in the mid of 1982, author purchased Chrysler at a price of $2 per share. This was the beginning of his slow transition into buying shares in the auto sector during the later years from 1983 till 1990 when he retired. Till '83 through '88, his portfolio was stacked with Financials (Banks and Savings & Loans) and Autos. He played auto for about 5 years and in 1988 and made a lot of money for the customers of Magellan. The strategy was to identify potential growth sectors and buy good stocks in that sector, which paid off handsomely.

I observed two points while reading his earlier book (One up on Wall Street) and this book. The author has a thing against big companies like IBM and GM. Any mention of these stocks is to demonstrate his mistakes or to proclaim that he was constrained into buying these stocks since the public expected all the mutual funds to have exposure to these shares.

Mr.Lynch makes an interesting observation. Many individuals are smart enough to identify potential multi-baggers and initiate coverage on the same. However, where they fails is in continuing to track the stocks as it moves from $2 to $5 to $10 to $20 and so on...

By the time Mr.Lynch left Magellan, the fund size was 14 Billion Dollars !!!.

In Chapter 7 the author addresses the habit of some people to keep on buying new stocks all the time. Once they lose money in some stock, they go in search of new stocks. They never invest in the same company again. This habit do not find favour with the author. He feels that if an individual has invested in some stocks, he has gained some knowledge of the company, the industry, the growth drivers, business challenges etc. Once they have spent time collecting this information, they have an advantage with reference to these stocks and industries and hence should closely monitor these companies at a regular intervals and again buy the shares of these companies if their analysis shows these stocks to be worth buying. The author follows a good habit of documenting all his observations with reference to a specific stock and continuously updates the same.

That is a good habit that all investor should follow.

While reading this chapter, I was thinking as to how relevant this was for me. I can site countless times when I have bought good stocks, sold them off at a minor profit or loss and then never followed them again. Later I am surprised (unpleasantly) when I see that the stock that I sold at a 30% profit has ended up as a 10 Bagger. Then there are very few occasions when I see that the stock that I sold at a loss has dipped further, giving me the sense of being a savvy investor who cuts his losses !.

The rest of the book, starting Chapter 8 through Chapter 21 is a detailed description of Lynch process in action. He explains, lucidly and with a lot of wit, the process he followed while he went about investing in companies in different sectors. The sectors covered include Retail - focusing on 'The Body Shop', Real Estate - focusing on secondary sectors interior decoration (Pier 1) and gardening (Sunbelt Nursery), Consumption -  'Supercuts', Great companies in low growth industries, Savings & Loans (two boring Chapters -12 and 13 focus on S&Ls), Master Limited Partnerships (MLPs), Cyclicals, Energy, Government Owned Companies (Public Sector Companies), One entire chapter on Author's experience with Fannie Mae, Mutual Fund Industry and Restaurant Stocks (Chapter 20).

Chapter 21 completes this section by discussing how the investor should do a regular check and update his portfolio.

While reading the above section, I was fascinated by the amount of wisdom and experience that was packed in these chapters. While talking of investing in the Retail Sector (Chapter 8) author makes the following points. One, the companies in this sector should have expansion potential since they can only grow through expansion - by replicating in another market the lessons learned in the current market. Two, Debt is a strict no, no for retail. Three, the key parameter to look for is the growth in same store sales, which should grow by at least 5-6% year on year.

The key concept that one learns in Chapter 9 is about 'Quite Facts'. These are facts that are counter to the prevailing market thinking. For example, there are three quite facts that are relevant to Housing Market. One, price of a median house, Two, Affordability and Three, percentage of mortgage loans in default. Towards the end of a realty downturn, these Quite Facts begin to move in a positive direction and market takes some time to react to the reversal of the 'Quite Facts'. Another lesson that one learns is about 'year end anomalies', where the price of a stock could drop drastically in a short time and could rebound equally rapidly. To capitalize on this situation, speed is of essence (and liquidity, of course !).

When it comes to the financial analysis of companies, author recommends the following. Are the inventories increasing? If they are increasing, it may be a sign that management is trying to hide falling sales. Another check is about the book value. One has to analyse if the book value is 'Real'. Some times, unscrupulous companies will hide obsolete inventory and inflate the assets (like the story of the Software Seller who had room full of Windows 95 OS, when the technology had moved to NT) to make the book value look good. Another question to ask is whether the competition will be interested in buying out the company. If there is a strong case for competition to be interested in the company, it is a good sign for the investor. Other factors to consider are decrease in inventory (good). low Debt / Equity (good), type of debt - Bank debt (bad), funded debt (good), low goodwill (good) and good growth potential.

I was really frustrated while reading Chapter 15 on Cyclicals. Throughout this book and also in the previous book by the same author that I reviewed the key message was that one should buy companies with Low P/Es and with good earnings potential. This was an intuitive message that one could understand. Suddenly, while discussing Cyclicals, the author says that low P/E may be a 'Sell' signal when it comes to Cyclicals and high P/E may be a 'Buy' signal. The logic is that at the peak of the business cycles, the earnings would have run up and market will start selling the Cyclicals leading to lowering of P/E. While this could be applicable to stocks in other industry, the key difference between other industries and Cyclicals is that for other Industries the P/E will start falling when the 'Market' starts correcting, while for Cyclicals P/E will start falling when the Business Cycles start reversing, which could happen even when the market momentum is upwards.

While discussing the energy sector, the author talks of 'Troubled Utility Cycle'. In the first phase, disaster strikes and earnings take a severe downturn. Earning downturn could be due to high costs that cannot be passed on to customers or some huge assets that should be mothballed. In phase two, known as the 'Crisis Management', the Utility tries to respond to the disaster by cutting capital spending and by implementing austerity measures. In the third stage, 'Financial Stabilization', the costs are cut to the point where the Utility can operate on the cash that is received from the bill paying customers. In stage four, 'Recovery', the Utility is capable of earning for the shareholders. From here, the Utility will require the support from Capital Market and the Regulatory Agencies to progress.

Author is a big fan of Privatization initiatives undertaken by various governments. Every time it privatizes a business, government ensures that the shareholders benefit in a major way. Author advises the investors to follow suit and invest in all the government stock offerings.

Mutual funds and Restaurants are two industries with high cashflow potential that author covers towards the end of the book. He convincingly argues that these industries can significantly reward the investors, even doubling in two years, if invested wisely.

When it comes to the continuous monitoring, author suggests asking the following questions. One, is the stock attractively priced relating to the earnings and Two, How can the earnings grow? If the earnings are expected to grow, your decision is to stick with it and add more to your portfolio. If the earnings are expected to fall, the decision is to sell it off and buy other better opportunities.

What if the story is unchanged? In that case you could stick with the stock or sell it off and move into attractively priced options available in the market.

'One up on Wall Street' along with this book gives an excellent conceptual and process overview for the Amateur investor to venture into the Stock Market.

Sunday, July 20, 2014

Book Review #7: One up on Wall Street: Author: Peter Lynch

The one overriding message in the delightful book One up on Wall Street (author: Peter Lynch) is this.

An amateur investor (like you and me) are better at identifying winning stocks than a professional !

It comes out clearly in every page in this book that Mr.Lynch wants common people to become extra ordinary investors. The introduction to the book (which starts with the primary rule in investing 'Never listen to a professional') is dotted with anecdotes of how ordinary people were able to identify potential multi-baggers (a stock whose price increase multifold) much before professional investors became aware of the same. Be it author's wife Carolyn who identified Hanes as a  potential multi-bagger after witnessing the market popularity of the company's product (based on this input Mr.Lynch purchased Hanes stock and it turned out to be a six-bagger), or the local fireman who observed that a local company was expanding and went and purchased the stock which went on to become a multi-bagger. Or the imaginary Mrs.Houndstooth who identified 'The Limited' as a potential winner after experiencing the mad rush in their stores (The stock went on to become a 40 bagger)....

The stories abound emphasizing the point that ordinary people can identify potential multi-baggers through simple observation and use of common sense.

In addition, ordinary folks have another advantage. They are experts in some areas. They can easily identify potential opportunities in their areas of expertise. For example, a doctor may be the first to know that a new drug is a potential blockbuster. Insurance salesmen are the first to see that the insurance rates are going up which could mean better times ahead for the insurance industry. A person working in an IT Company could notice that bench strength is coming down which could mean rising demand for the industry. And so on...

The author bemoans the fact that the ordinary folks do not use this advantage when it comes to investing. Common people follow the motto that more obscure the industry, more money they invest in the companies in that industry. The doctor in the example above will invest in the shares of Oil companies without knowing the difference between a block, drill or a rig. The insurance salesperson will invest in Pharma companies without any insight into ANDA, Molecules or Generic Drugs. 

The IT guy? He will invest in everything other than IT.

This book is divided into three parts. Part 1, from Chapter 1 through 5, titled 'Preparing to Invest', aims to help an individual prepare to become a better investor. Part 2, Chapter 6 through 15, titled 'Picking the winners', cover the execution aspects of trading in Stocks. This section deals with how to identify opportunities, what to look for in a company, how to use the information available to your advantage, and a brief explanation of various numbers that one comes up during the analysis. Part 3, Chapters 16 through 20, titled 'Long Term View', deals with how to design a portfolio, how to keeps tabs on the companies, when to buy and when to sell and some general observations on Corporate America.

Before becoming an investor in Stock Market, one has to make some basic decisions about her attitudes towards the market. As the author says, it is personal preparation, as much as knowledge and research, that distinguishes a successful stockpicker from a chronic loser. 

So what are these personal preparations that one has to make before investing in the Stock Market?

First of all, one has to have trust on the market and on the ability of Corporate India to weather the occasional storms and make progress. One has to be clear in the mind that despite occasional hiccups, the Corporate India has persisted in its quest for long term progress and has significantly achieved that. BSE Sensex which was trading at 100 in 1979 is trading today at 25000. A 2500% return in about 35 years. This is despite the crashes in 1988, end of 2000 and in 2008. If one do not have this basic trust, one will end up in investing in the market when it has run up and selling it when it has come down significantly, ending up in significant losses. 

Second decision is regarding the available options. Is one ready to invest in stocks?, if yes, how much amount? and for how long to stay invested?. Stock market is not for the short term investors or the faint-hearted. There will be occasional sharp declines in the share prices. Will one be able to handle the fall and stay invested? 

Third decision is about the risk profile. If one is highly risk averse, Stock Market is not for her. She is better off remaining invested in low-risk investment avenues like money market investments or bank deposits. 

There is a perception that stock market investing is for the nerds. That it is for those savvy, mathematically inclined Whizkids who roam around looking into their Tablets and making 'Buy' and 'Sell' calls on the go. This perception leads ordinary folks to decide that they can't understand how the Stock Market works and hence they end up staying away from the Stock Market.

Chapter 1 aims to debunk this perception through the story of Mr.Lynch himself. Since his family lived through the great recession of 1929, discussing about and investing in stocks was a strict no, no in his house. Mr.Lynch got initiated into the world of stocks while caddying for some of the leading business men in his local golf course. The conversations that he listened to in the golf course, made Mr.Lynch realize that substantial money can be made in Stocks if they are selected after a thorough research and one kept with it as long as the company was growing. 

Mr.Lynch proves the point that one do not have to be a mathematical wizard to become a successful investor by pointing to his background. He majored in Arts including History, Psychology, Political Science, Metaphysics, Epistemology, Logic, Religion and Philosophy of ancient Greeks.

No math, no accounting, no quants...

Shouldn't I know all the latest theoretical concepts when it comes to investing in Stocks, one may ask. What about Efficient Market Hypothesis and Random Walk theory that I have heard about a lot in the TV, I have no clue about them, one may wonder. Mr.Lynch displays a healthy skepticism to these theories. The only expectation for one to become a successful investor is that one identifies good stories and do rigorous analysis based on simple tools that the second part of this book covers, buy the stock, and stick with it till the basic story is in tact. 

It is that simple...

Earlier in this article I mentioned that amateur investors have an edge over professionals when it comes picking winners in the stock market. Chapter 2 elaborates this point. There are multiple factors that hamper the ability of professionals to pick multi-baggers. First one is what is called a 'Street Lag'. By the time a stock appears in the Radar of the professionals, it is already a multi-bagger. However an amateur can identify and invest a potential multi-bagger much earlier in the cycle. 

Sometimes a professional cannot invest in a potential multi-bagger since the company do not fall into any specific industry classifications and the professional is duty bound to invest in certain industries. An ordinary investor do not have this constraint to hamper his investment style. 

Another mistake that a professional makes is what is known as 'Camp-following'. Any stock purchase or sell decision that he makes have to be vetted by multiple stakeholders. This means that there is an incentive for the professional to follow the herd and invest in companies that others invest in. This helps him overcome the vetting process. Due to this thorough vetting process, a professional has a disincentive in investing in off-beat stock which may become potential multi-baggers. An amateur do not have this constraint. 

The other constraints that a professional faces which an amateur do not face are: Constraints of rules and regulations of the Organization that she works for, Having to spent considerable time convincing potential customers on the logic of his investment picks, huge size of the assets to handle etc.

Isn't investing in stocks a gamble? Isn't it risky? Am I not better off investing in Debt Instruments? These are some of the questions addressed in Chapter 3. The author makes multiple points relating to the above questions. First, stocks have significantly outperformed most of the other investment avenues over the long-term. Second, as to the question whether stocks are a gamble, author points out that retail investors enter the market when it is high and exit the market when it is low and this is precisely what makes it a gamble. (Check out this story of Mrs.Preeti Malhotra) Third, amateur investors invest in the stocks without doing the proper due diligence. Author points out that we tend to spend more time evaluating our decision to purchase a piece of clothing than we spend in deciding which stocks to invest in. Fourth, with regard to the point whether Debt Instruments are less risky, author points out multiple instances when runaway inflation made the investment in debt almost worthless. Another related point is that if you focus on curtailing the risk, you will end up getting lower returns on your investment.

Read my related post on this topic

Ok, I understand your point, you say. I plan to get into investing in stocks. Are there some steps that I have to take before I start investing in stocks? As per Chapter 4 of the book, there are three things to consider before investing in stocks. One is to purchase a House before investing in stock market. There are many advantages to buying a house. One is that you get almost 80% loan from the bank and your investment is only 20%. Another is that there are many tax benefits to buying a house. Historically houses have been an appreciating asset. One key point that is made in this chapter is that people tend to buy and hold houses over a long-term unlike stocks which are purchased and sold over a very short term. Another point is that we do a lot of analysis and evaluation before we buy a house and no analysis before buying a stock. 

Second thing to consider before investing in stocks is whether you need money in the short term. Stock investing should not be done to meet short term financial goals. Those should be handled through debt instruments and money market instruments. 

Third aspect to consider is whether you have the personal qualities required to become a successful stock investor. Some of the personal characteristics include patience, self-reliance, common sense, open-mindedness, detachment, persistence, humility, flexibility, a willingness to do independent research and ability to ignore general panic. In addition, you should develop the capability to take decisions without complete or perfect information. Author also emphasizes against going by 'Gut Feelings' and wants the investors to do thorough research and stand by the stock as long as the story is in tact.

Many people wait for the right time to invest in market. Most of them finally invest exactly at the wrong moment. This is the focus of Chapter 5. Author says that when it comes to being prepared for stock market mishaps, we are always preparing for the last disaster that occurred and not anticipating and planning the potential disasters. This is known as 'Penultimate Preparedness'. Author also talks about 'Cocktail Theory'. As per this theory (coined by the author himself), if many people in a Cocktail party are more interested in talking to the Dentist than to the mutual fund manager, the market is due for a rebound. And when many people in the cocktail party (including the dentist) start giving stock tips to the mutual fund manager, the market is due for a correction / fall. 

The key advise to potential investors is never to try to time the market. Identify potential multi-baggers with great stories, buy them and keep them all the way till the story remains intact. 

Chapter 6 through 15 takes the reader through the next section 'Picking the Winners'. Chapter 6 presents two different types of advantages that an average investor will have. First one is the Professional Edge, which involves having a deep understanding of the industry and the other is the Consumer Edge, knowledge of small retail companies that are doing good business in the market. One main advantage of having a professional edge is that it will help you decide when to buy or sell a stock in your familiar industry. The chapter ends with a story of how the author totally missed the entire boom in the Financial Services Industry which he is a part of !

Talk about missed opportunities...

Once you identify a stock, the next step is to do the analysis. That is the focus of Chapter 7. The first step in the analysis is to identify the type of the company that one is planning to invest in. Depending on the pace of growth or the timing of business cycle, companies can be grouped into 6 categories. They are:
  • Slow Growers: Big companies that grow at a very minimal rate. The only reason to keep them is for the regular dividends that they pay out.
  • Stalwarts: Big companies that grow faster than a Slow Grower but not as rapidly as a Fast Grower. They are less volatile and can act as a defensive play in times of market downturn. 
  • Fast Growers: These are small companies that grow at a high rate. You make money in stock market if you are able to identify a Fast Grower early in the growth cycle. Once the growth peaks, a Fast Grower either turns to a Stalwart or fizzle out.
  • Turnarounds: These are companies that have gone through a series of negative events and which are bouncing back from their lows. Once they turn around, they make up lost ground very quickly. In addition the ups and downs of these companies are totally unrelated to the market conditions. There are different types of turnarounds. Mr.Lynch gives them quaint names like.
  1. Bail-us-out-or-else 
  2. Who-would-have-thought ('Who would have thought that this company can go down so rapidly and who would have thought it will bounce off so dramatically')
  3. Little-problem-we-didn't-anticipate (As in a natural disaster)
  4. Perfectly-good-company-inside-a-bankrupt-company
  5. Restructuring-to-maximize-shareholder-value
  • Cyclicals: The fortunes of these companies go through regular ups and downs. Some of these cyclicals may be big companies and could easily be confused with Stalwarts. However what differentiate cyclicals is regularity in their upturns and downturns. In Indian conditions, companies like TISCO, Auto makers, Banks, Infra companies like L&T and most of the Industrials like Crompton Greaves, Voltas etc fall into this category. It is very important to know when to get in to these stocks and when to get out of them. 
  • Asset Plays: These are companies holding significant assets in their books of which the market is not aware of. Some of the assets could include Real Estate held at book value, Carry forward losses which provide tax benefits to the company, Investments in the shares of other companies, huge customer base etc.
Identifying the category to which a stock falls is the first step in developing your story. Next step is to fill in the details to help you see how your story is going to pan out. To further develop the story you have to understand the basic business of the company. In Chapter 8, Mr.Lynch has identified a set of 13 Criteria to help identify potential multi-baggers. Some of these criteria include: 
  • It sounds dull or ridiculous: If you identify such company early, you could get a few rupees benefit simply because the name is dull. 
  • It does something dull or boring: Money is made in doing dull or boring stuff repeatedly. For example, Payroll Processing.
  • It does something disagreeable
  • It is a spinoff: These are companies that are spun off from large companies as independent entities. Normally spinoffs have strong balance sheets and are well prepared for success. In Indian context 'Marico Kaya' is a recent example of a spinoff. 
  • Institutions do not own it and the analysts do not follow it
  • There are a lot of rumors about the company
  • There is something depressing about it
  • It is in a no-growth industry: This is a bit counter intuitive. The logic is that in a no-growth industry there will be hardly any competitors and a good company has the market all to itself.
  • It has got a niche: The niche could be market, patents, brand names etc. In business parlance a niche is also called a 'Barrier to Entry'.
  • People have to keep buying the product: If you are in the business of selling inhalers for Asthma, the patient will keep buying your product. Same is the case with Insulin drugs, Printer Cartridges, Food items etc. 
  • It is a user of technology: As an ERP Consultant, I can relate to this point. Over and over I have observed that market pays a premium for the companies that implement ERP. 
  • Insiders are buying: A high level of promoter stake is a signal of the strength of the company. A side advantage is that when insiders have high level of stake, rewarding investors become high priority for the company
  • The company is buying back shares: This increases P/E and hence the market price of the share. This is the best way to reward a shareholder other than paying dividends. 
Having identified the category of the company from Chapter 7 and grouped the company into one of the above criteria, there is one more lesson that one has to learn. This relates to the type of companies that one should avoid. 

Part of the answer to that is that one should avoid those companies that do not fall into any of the criteria defined in Chapter 8. Chapter 9 further elaborates on this and lists down a few types of stocks that Mr.Lynch would avoid. These include:
  • The 'Next' something
  • Excessive diversificationMr.Lynch calls them 'Diworsefications'. Some companies cannot stand prosperity and go into an acquisition mode into unrelated industries. The only way an investor should play this game is to buy the shares of the company being acquired. However there are exceptions to the rule. Asian Paints has grown through acquisitions in the last decade, but the point to be noted is that all these were in the related industry (Paints).
  • Whisper stocks: These are much touted stocks with no earnings history. You can make money in these only during IPO
  • Middlemen: These are companies with one or two significant customers. They are always at the mercy of their customers.
  • Stocks with Exciting Names: If the names include words like 'Advanced', 'Leading', 'Micro' etc, it is better to avoid the stocks. There is an amusing anecdote about an Indian Textile company named 'Soft Wear Industries', which was into manufacturing undergarments. Its IPO came during the IT boom and the shares were lapped up mistaking the name for 'Software'.
Ok. Let us say that you have identified the company. You have categorized it into 'Fast Growth' as discussed in Chapter 7. The name of the company is boring (Lets say 'Motherson Sumi' for example) as per the points discussed in Chapter 8 and it doesn't fall into any of the groups to be avoided as discussed in Chapter 9.

Now what?

Chapter 10 initiate the detailed analysis of the company. The questions to ask are, what makes the company valuable and will it continue to be valuable in the future. The analysis focuses on Earnings and Assets. One should evaluate the rate at which the earnings have grown in the past and expected growth rate of earnings. The company which has strong earnings growth will grow in value whatever may be the market conditions. The chapter also focuses on the importance of P/E ratio and cautions the investors to avoid the companies with excessively high P/Es. The chapter also contains a brief discussion on Market P/E. 

The chapter explains that there are five basic ways in which a company can increase earnings. It can cut costs, raise prices, expand into new markets, sell more of its products in the current market, or revitalize, close or otherwise dispose off a losing operation. As you analyze the company you may want to evaluate how the company propose to increase its earnings. 

Now that you have identified your company and classified it into a specific category, you might want to see if your story logically fits together. In Chapter 11, Mr.Lynch suggests what is known as a 'Two minute drill'. Take two minutes of your time and make a case as to why you are interested in the company and what you think are its future prospects. The drill should make a sound case for investing in the specific stock. The author recommends us to follow this process even for the stocks that we currently own. 

Chapter 12 talks about various sources from which one can get information to analyze the company. There are research reports available dime a dozen. One could directly call the company and talk to the investor relations team. One could also seek information from one's broker. Company financial statements are another great source for information regarding the company and industry in general. 

Chapter 13 covers some of the most important numbers to consider while analyzing. The numbers should not be looked at in isolation but as a part of an overall story. 'Percent of Sales' tells you how much percentage a specific product is contributing to the overall revenue of the company. We have already discussed the 'P/E Ratio'. Another important number is the 'Cash Position', more importantly do the company have the cash to cover the short term debt. The cash position also tells you the floor to which the stock price could fall. When it comes to Cash Position, it is also important to know what the company is proposing to do with the cash that it has got. Another number is the 'Debt / Equity Ratio', which shows the Long Term Debt as a proportion to the Equity of the company. Higher this ratio, higher is the risk to the investor. There are two debts, one is called the Bank Debt (more risky since it is callable) and Funded Debt (Less risky since it is not callable). Yet another number is the 'Dividend Payout', both in terms of the amount and the consistency of payments. Other numbers to look for include the Cash Flow (Positive, Operating), Inventories (depleting), Growth Rate and the Bottom Line. 

While you may have done all the due diligence before purchasing the stock, as Mr.Lynch mentions in Chapter 14, it is very important to recheck the story to ensure that the story line has not changed. The company's prospects should progress as you had anticipated

Chapter 15 closes Part 2 by running a quick summary of all the points covered from Chapter 6 through 14.

Chapter 16 covers the designing of your portfolio. It answers the following questions. One, how many stocks should be in my portfolio? What is the advantage of having a larger number of stocks in my portfolio? What is the proportion of various categories (portfolio diversification) that I should carry in my portfolio? and How frequently should I rotate my portfolio?

As per Mr.Lynch the ideal number of stocks to be had in a portfolio is between 3 and 10. It is another matter that Mr.Lynch's portfolio contains about 1400 stocks !. There are two advantages to having more stocks in your portfolio. First, higher the number of stocks in the portfolio, higher your chances are of having a couple of multi-baggers. Second, more number of stocks give you more flexibility for portfolio rotation. 

As to the question what proportion of stocks of various categories should I have in my portfolio, it is an individual choice. Ideally one should have a part of the portfolio in Stalwarts and (probably Slow Growers, esp. for their dividend) and the rest should be divided over the other categories. If you follow the main theme of this book, you will have a major portion in Fast Growers followed by Turnarounds and Cyclicals and a few Asset Plays.

Regarding frequency of rotation, it depends on market condition. Generally you rotate Stalwarts more than others (once a Stalwart attains about 50% profit, get out of it and move to another). You move in and out of Cyclicals based on the economic environment. You move out of a fast grower as soon as the story begins to change for the worse. When it comes to Asset Plays, you wait for the market raider to appear.

Are there some opportune moments when I can buy or sell a stock? This very important question is discussed in Chapter 17. As to the question of when one should buy a stock, there are two particular periods when great bargains are likely to be found in the market. One is during the annual, year-end tax filing. This is when many funds do a portfolio cleanup and this provides a buy opportunity. Another is during market downturns when prices of all the companies are dragged down to ridiculous levels.

The chapter also addresses the question of 'when to sell' in a bit of a detail. In summary, you must sell a stock when either your story has fully played out or when the actuals have turned worse from what the story had anticipated. Other times to sell are when the company moves into unrelated diversifications.

Remember, never sell based on Quant based targets. For example, never decide that 'I will sell when I get 30% profit or 10% loss'. (I did). The chances are that you will always meet your 10% loss targets. Check this out.

Chapter 18 discusses 12 of the silliest things that people say about stock prices. These include:
  1. It has gone this much down, it can't go much lower. I can relate to that. I had seen a stock trading at 500, I purchased it at 200 thinking is a bargain, again at 100 thinking it has hit bottom, again at 50 thinking it can't go further down. The stock stopped at 15 !.
  2. You can always tell when a stock has hit bottom. No you can't.
  3. It has gone so high, how can it go higher?
  4. It is only 8 rupees a share. What can I lose?. You can lose your investment
  5. Eventually they all come back: No they don't. I purchased a share in 1996 for 20, again for 13, for 6 and for 4. The company declared bankruptcy and became a BIFR case. 
  6. It is always darkest before the dawn
  7. When it rebounds to 100, I will sell.
  8. Conservative stocks do not fluctuate much
  9. It is taking too long for anything to ever happen: Currently I am experiencing this with HLL. I have been holding it from 2005 when it was trading at 140. Today, 10 years hence it is at around 600. Nothing seem to be happening in this stock. I am getting impatient. 
  10. If only I had bought the stock / not sold it quickly, I would be a millionaire by now.
  11. I missed that one, I will catch the next one: Looking back, I can see the opportunities that I missed in the bull run of 2003 - 2008. I am determined not to repeat those mistakes in the current bull run. 
  12. Stock is gone up, so I must be right (and vice versa) 
Chapter 19 talks about risks of investing in Futures and Options and other derivative products. Mr.Lynch does not believe in playing this segment. Chapter 20 is a recap of various events that have happened over the years in the Wall Street and how, despite all the negative news, the market have been going up. The central theme of Chapter 20 is about hope. How things eventually pan out for the best when it comes to the economy. The chapter ends with a summary of the points learned in this section. 

This ends the review of the book. It has been a difficult book to review since each page of the book contains some gems or other. Also, one has to really strive hard to ferret out the main points of a chapter from all the noise about individual stocks and their performance. 

But the effort is worth it. I will say that this book is an essential primer for anyone who plans to invest in stock market. If not for the concepts, you should read it for the inherent positiveness and the confidence that this book gives to an amateur investor to venture into the market.

Saturday, July 12, 2014

Thieves who steal your wealth...

If you are person who earns regular income and has some hope of establishing a nest egg for your retirement, you should be careful of two thieves who can steal your wealth away from you.

The two thieves are taxes and inflation.

If you are a salaried employee, you might know the impact of taxes on your income. You may not feel the impact since tax is deducted by your employer before the money reaches your bank. If you are in the 30% tax bracket, over the year you will pay about 30% of your salary as tax, which is like working about 4 months in a year free for the government.

Taxes are one of the main reasons why there is a significant mismatch between salary perceptions between an employee and the company. Company has to pay the salary as per the contract whether it is paying you or to the government. Employees, on the other hand, get much lower pay than they were expecting.

No wonder. A salaried employee in the highest tax bracket is working without pay for almost 4 months in a year.

Also remember, Personal Income Taxes are not the only taxes that we pay. In addition to the Personal Income Taxes, we feed the additional appetite of the government for our money by way of what are known as 'Indirect Taxes'. Every time we purchase a good, we pay sales tax and every time you purchase a service, you end up paying Service Tax. 

If the purchase involves both a good and a service, for example buying a Television and Installation Services, we end up paying both the taxes. 

When it comes to direct taxes, like Personal Income Tax, government offers at least some way of minimizing the burden. Tax laws in most of the countries provide for either deductions from personal income or a few exemptions to the taxable income. We can lower our effective tax by creatively using the deductions and exemptions. 

(Some people say that Personal Income Tax on salary income is a form of double taxation. The company already pays taxes on its earnings. Charging Personal Income Tax on Salaried Employees is like taxing the same income twice, once from the Company and other from the employee)

Left unplanned, taxes can create havoc on your retirement planning. 

Now we come to 'Inflation'. This is a real silent thief. Insidious and unobtrusive are the adjectives that I am looking for to describe Inflation. This thief is totally unknown to most of us. Like rust eating iron, Inflation continuously and consistently eats into our wealth. It is omnipresent like air and is invisible and dangerous like electricity. 

What is inflation? It is defined as the 'Rate at which the general prices are rising and the purchasing power is falling'. Inflation leads to fall in purchasing power, which means that if you are spending 100 rupees today to buy one Kg of Onion (!), tomorrow (one year later) you will get less than a Kg of Onion for 100 rupees. 

Normally Inflation is measured in terms of Whole Sale Price Index, what is known as WPI Inflation. In addition to WPI Inflation, there are six other types of inflation that can hurt the common man. These are:

  1. Consumer Price Inflation (CPI) also known as Retail Inflation
  2. Food Price Inflation
  3. Educational Cost Inflation
  4. Medical Cost Inflation
  5. Housing Inflation
  6. Lifestyle Inflation

Most of the current savings mechanisms available to us do not protect us from Inflation. Many of us invest a lot (most) of our savings in Bank Fixed Deposits. This is the choice of investment for many seniors. When it comes to Bank FD, both these thieves lead a co-ordinated attack on the returns. Interest Income is taxed, so there goes down your return. What is left of the interest and the capital is impacted by inflation. 

Is there any weapon that we can use to attack both these villains? Is there an Investment 'Brahmastra' or an Investment 'Thunderbolt' that can help a common man defeat and destroy these nefarious personalities?

Yes. Fortunately for us, the answer is that such a weapon exists.

It is called Investment in Equities. In most of the countries Long Term Capital Gain is taxed at much lower rates than the return on any other investment mechanisms. In India Long Team Capital Gain is Zero. Over the past several years, Equities have provided significant 'Inflation Adjusted' positive returns to the investor. In Indian context, the value of Sensex in 1979 was 100 while today it is at 25000, a 2500% jump over the last 35 years, which means a return of 17% per year over the last 35 years. If you subtract an average inflation of about 10% over the same period, your effective return (also called the 'Real Return' ) is about 7%. 

By the same standard, the Real Return from an FD paying 10% Interest is negative 3.5 percent, which means that your wealth is depleting. 

Next question is, how do I invest in Equities. The best way to do that is using Systematic Purchase Plans. 

As I explain in this article, you can follow Systematic Equity Plan whereby a specified amount invested in a regular frequency to purchase shares of a few companies. Since the investment takes place through a mandate that you place with your bank, the investment becomes regular and mechanical. This removes the main equity investment killers out there which are Fear and Greed

Investing in stocks takes some expertise. If you think that you do not have the knowledge to choose good stocks to invest or to time the purchases, you can opt for investing in Mutual Funds. Mutual Funds are managed by experts who do the investing on your behalf. Here also you can do Systematic Investment through what is known as SIPs (Systematic Investment Plans). In SIP, a specific amount is invested in a product of a mutual fund company to buy the units of a specific fund over regular frequency. 

By following SIP or more demanding SEP route, you are making regular investments in equity. This means that you are using the Investment Brahmastra to slay the two thieves who want to steal your wealth Vis. Taxes and Inflation. 

Remember, In India only two incomes are totally exempt from Tax. Agricultural Income and Income from Capital Gains from investments in Equity. Why not capitalize on this situation?

(PS: In this article, I am only looking at the impact of Taxes on your Wealth. I am not looking into the philosophical argument whether Taxes are good or not. I have my own views on that)

(One could say that investment in Real Estate also provide similar returns. But one is forgetting the regular annual maintenance costs of maintaining your real estate and the annual property taxes that you pay government to maintain the property. Also purchasing and selling real estate involves a lot of transaction costs to the investor. This is the subject of another post)

To learn more about investing in general and investing in equity in particular, you can read my Book Review Series on Reviewing 50 Finance Books. In particular, I will recommend THIS and THIS

Book Review #6: The Millionaire Mind: Author: Thomas J Stanley

The Millionaire Mind is a book written by Dr.Thomas Stanley who co-authored the wildly successful book 'The Millionaire Next Door' (TMND).

This book follows TMND and discusses the mind of the millionaire. The author send questionnaires to about 1000 odd individuals out of which about 733 millionaires responded to the questionnaire. The survey covered various aspects of decision making and Dr.Stanley wanted to know if there is a common pattern of thinking that makes a person a potential millionaire. The questions covered various aspects of decision making like How they think when exposed to particular situation? How they make life decisions? Which decision factors they emphasize and which of the factors they De-emphasize? What they learned in their school? How they choose their vocations?

In the first 20 odd pages of the book Dr.Stanley gives a very good introduction to the entire contents of the book. The introduction is a synopsis of the rest of the book. The introduction thoroughly covers the contents of the book and the rest of the chapters are elaboration of the points covered in the introduction.

The introduction is followed by a chapter devoted to each of the following.

1. Success Factors
2. School Days
3. The relationship between courage and wealth
4. Choice of Vocation
5. Choice of Spouse
6. The economically productive household
7. The Home
8. The lifestyles

The book rounds off by summarizing the points made about each of the above points. 

In the next chapter, the author covers the various success factors that help an individual become millionaire. The success factors are divided into major groups. The groups include:

a. Social Skills (Getting along with people, Having strong leadership qualities, Having an ability to sell my ideas and products and Having good mentors)
b. Integrity and Moral Values (Being honest with all people, Having a supportive spouse and Having a strong religious faith)
c. Creative intelligence (Seeing opportunities others do not see, Finding a profitable niche, Specializing, Loving my career or business)
d. Investing (Investing in equities, Having good investment advisers, Making wise investments, Investing in my business, Willing to take financial risk given the right expected returns, Living below the means)
e. Self Discipline (Being well disciplined, Being well organized, Working harder than other people)
f. Intellectual Orientation (Having high IQ, Attending a top-rated college, Graduating near / at the top of my class)

As you read these success factors, it is gratifying to note that 9 out of the top ten success factors (out of the 30 Success Factors listed) are within behavioral factors which are under individual control. This gives the hope that with the right thought processes any one can aspire to become a millionaire !.

The top 10 success factors identified by Millionaires are:

1. Being honest with people
2. Being well disciplined
3. Getting along with people
4. Having a supportive spouse (This is one factor not totally in an individual control)
5. Working harder than most people
6. Loving my career / business
7. Having strong leadership qualities
8. Having a very competitive personality
9. Being well organized
10. Ability to sell my ideas / products

As you can see, except point 4 above, all the rest are factors that can be controlled by the individuals.

Are High IQ, High Test Scores and Graduating at the top of the class important factors to become a millionaire? The chapter on School Days addresses this question. As per the author, while test scores may be important for some type of vocations like Doctors, Attorneys etc, people with Millionaire traits get more out of schools and colleges than non-millionaires do. For example, by interacting with people, they learn to get along with people, by being active participants in sports they get keen competitive spirit and by participating in various events in school, they learn leadership skills. In addition, since schools focus a lot on test scores, some of the millionaires get a lot of negative feedback from the teachers for their poor performance in tests. These negative feedback in turn elicits a burning desire in their minds to prove the teachers wrong. The summary of the chapter is that yes, test scores are important, but other factors are equally, if not more, important. 

Out of the 733 millionaires studied, almost 60% run their own business. Running own business is a risky proposition. There are 10 failures for every 1 successful business out there. How do millionaires handle this risk? Are they scared? How do they handle their fears? The chapter on the Relationship between courage and wealth addresses this question. The author points out that millionaires and not above feeling the fear. However they have conviction in their ideas and faith in their ability to execute those ideas. 

What are the approaches adopted by millionaires to handle fear? Some of them follow positive thinking and removes negative thoughts from the mind. Some of them work extra harder to remove all the 'Fear Inducing Aspects' of running a business. Some of them call upon their religious faith to overcome their fear. Some of them do regular exercises to keep the mind and body sharp to handle the challenges. 

The importance of choosing the right Vocation is the subject of the next chapter. How do millionaires choose their vocation? Do they hit it right the first time? How do they identify the right vocation? Most of the millionaires do not identify their vocation the first time. They try different vocations, some successfully some not so, before they identify the right vocation. Most of them identify a market niche where others have not gone. They build specialized skills that can help them tap that specific niche. A lot of emphasis is given in this book on the power of specialization and identifying the niche to capitalize on. One characteristic of the vocation should be that you should be able to love it. In fact most of the millionaires featured in the book claim to love their vocations. Once you love your vocation, it no longer is work, it is more of a vacation!! (copy right mine)

Studies have found that there is a high correlation between durability and stability of the marriage and wealth generation. This book proves the point. Most of the millionaires profiled in the book are married to the same woman for more than 20 years. And almost all of them say that their spouses play a significant role in their economic success. This leads to the question, are there any specific criteria that millionaires use when searching for their spouses? This is the focus on the next chapter on 'Choice of a Spouse'. As the chapter points out, millionaires look for the following specific characters in their spouses. At the beginning, during courtship, the factors that attracted the millionaires to their spouses included Spouses' Intelligence, Sincerity, Cheerfulness, Reliability, and Love & Affection. While these factors may lead to initial interest, the factors that help in the durability of marriage include Honesty, Responsibility, Love & Affection, Capability and Supportiveness. 

There is some unproductive discussion in this chapter about where you can find the best spouse that meets your criteria. This part could have been avoided in my opinion.

How do the millionaires run their households? How do they handle the day-to-day expenses of running a household? What separates them from the non-millionaires when it comes to running a household? Millionaires are frugal. When it comes to spending there is nothing called impulsive purchases for millionaires. The spouses of the millionaires also share this trait. Their purchases are well planned. They do not enter a store without a shopping list. They know what they want before they enter the store. This saves both money ( a less valued resource) and time (a highly values resource). Given a choice between repairing and buying new, most millionaires believe in repair and reuse. 

There are four major patterns to the way millionaires run their households. These patterns are:

1. Extending Life Cycle: This is done by repairing instead of buying new, be it getting shoes resoled or clothes altered or mended and using.
2. Reducing monthly burdens: By reducing the monthly payout, be it the electricity cost by resetting the thermostat during summer or paying off the mortgages or by switching off long distance phone companies. The objective is to reduce regular monthly payouts as much as possible.
3. Planning Purchases: No 'Impulsive Purchases' for millionaires. They achieve this by preparing a shopping list before entering a store, or never purchasing online or through telephone solicitations, or using discount coupons, or by reviewing consumer reports before making a purchase or by leaving the store as soon as purchase is made
4. Patronizing Discount Institutions: Buying from Discount stores like Sam's Club or by doing business with a discount brokerage firm.

And finally, Economically Productive Households always lives below their means.

One of the major purchases in the life of an individual is the purchase of a Home. Do millionaires approach this differently from non-millionaires? Millionaires for one buy older homes in classy neighborhoods as against non-millionaires who buy expensive, new homes in classy neighborhoods. Millionaires hardly have any mortgage balances on their homes as against non-millionaires who pile up hefty mortgages (Read my post on this aspect). In addition there are certain behavioral characteristics displayed by millionaires when it comes to buying home. Millionaires are:

1. More proactive when searching for a home to buy. For instance, they may put up classified ads in papers expressing their interest in buying a property in a specific locality
2. They take their time in searching for and reviewing options. They are not impulsive when it comes to Home buying
3. They are prepared to walk away from a negotiation
4. They don't pay the initial asking price. They always ask for and get a discount.
5. They almost never borrow long-term to buy a home with short-term income. In other words, they build a corpus of funds before making a buy decision. 
6. They do a thorough research of the property on sale before starting the negotiations. The research include researching the prices of recent home sales in the neighbourhood.
7. They negotiate better before purchasing. 
8. They always consider life cycle costs when it comes to buying a home.

The last point is worth elaborating. There are two concepts of costs, one is known as 'First Cost' and the other is the 'Life Cycle Cost'. The first cost is the purchase cost of the property. Millionaires focus on the Life Cycle Costs while Non-millionaires focus on the First Costs. For example given an option to buy a house costing $700000 Vs $ One Million, people with First Cost Focus will choose the former. However a person with the 'Life Cycle Cost' Focus will look at running costs including maintenance costs, electricity costs, property taxes, cost of services in the area etc. This may lead to the conclusion that it may be better to pay a little bit more now and pay a lower running costs later thereby lowering the total Life Cycle Costs.

One would assume that with all their wealth, millionaires would be leading a lavish lifestyle. As the next chapter on Lifestyles of the Millionaires tells us, there nothing farther from the truth. The number one activity for most of the millionaires is Consulting Tax Expert. Other activities include watching their children and grand children play, regular physical exercise, DIY tasks like Gardening and being involved in civic activities. 

Of course, they do visit Paris albeit not as the first priority!

The final chapter summarizes the entire book by pointing out that the millionaires think differently from others. That is the focus of the entire book. Each chapter in the book tells us how millionaires think differently from non-millionaires. The lesson is that if you want to become a millionaire, you must learn to think like a millionaire. (That is kind of paradox because millionaires are original thinkers !)

What are my key learnings from the book.?

One is the concept of First Cost Vs Life Cycle Cost. Another is the concept of Balance Sheet Affluent Vs. Income Statement Affluent (BA Vs. IA, most millionaires fall into BA Category). Third is the fact that if you want to be successful you have to think about your customer. As the top salesman says 'Me, me, me, dull, dull, dull'. You have to think less of 'Me' and more of 'You'. 

Will I recommend this book?

This book is not an easy read. The structure of this book is not intuitive. There is scope for improvement when it comes to the structure. You cannot, for example, look at the major headings of a chapter and come up with a big picture idea about the contents of the chapter. In addition, and very annoyingly, some of the topics are underlined where as some others of the same level are not. (For example, in the section Introduction, heading VOCATION, VOCATION, VOCATION is not underlined, whereas THE HOME is. Since both are names of chapters in the book, either both should be underlined or both should not be). But the ideas are simple and elegantly explained with a lot of examples. Between TMND and this book, I will recommend the former. 

Good read if you are a fan of Thomas Stanley.