Phil Town: Companies Are On Sale Right Now!

His Life

Interesting, since most people just get killed on Wall Street.

In return for saving the life of a VIP who was on that almost fateful raft trip, he was taught the foundation of Rule #1 investing. Phil Town has taken that knowledge and authored the bestseller Rule #1 Investing. I have seen him speak and read his book.

Phil Town's message is simple. Find a great business you understand and buy it at a 50% discount. Yes, you will have to incorporate some number crunching to find these businesses, but his book explains it all very nicely. He even has a web site to help you do any calculations.

Before Phil Town discovered his Rule #1 method of investing, I had more money than him. Now, he has more money than me. And that’s the first requirement to get a profile.

His lessons

Ok. Now that I got the tagline out of the way, how does Phil Town do it? As a Rule #1 investor your goal is to find a business that dominates its industry, determine its worth, and then buy it at 50% off. Repeat as necessary or as often as you can afford it.

This principle is slightly ingenious because that’s how you make money on Wall Street.

Since the 1980’s approximately 95% of all fund managers could not beat the S&P Index; and investing in government bonds yields about 4%. Rule #1 is looking for gains of at least 15%. Now that’s a business.

Well, where do you start? There are several thousand stocks out there. Begin with industries you know and love. Know pharmaceuticals ? Then you probably know who the leaders are and who is on the cutting edge.

You want to pick a business that you can see yourself owning for at least 10 years. Your want to see yourself as an owner of this business....not a speculator who holds it for two weeks then dumps it like a old worn greasy t-shirt. Your approach to investing will totally change when you purchase stocks this way.

Your goal is to find great but temporarily undervalued stocks, and bring home at least a 15% return compounded annually when you sell them.

Phil Town says ignore the noise around you. You want to buy great companies that the stock market has put on sale. Don’t worry about what everyone else is buying or whether the Fed plans on raising rates. These have no effect on you. How do you know you found a stock on sale? When the market price is below the sticker price.

Established companies or new growth companies? Go with well known established stocks. Why? Because history repeats. If a firm is undervalued and has good fundamentals, the chances are it will return to the heights it once had. New companies have limited history. As usual, it’s about putting the odds in your favor.

When you’ve identified some companies (businesses) you’d like to buy, make sure they exhibit the 4 M’s.

The Moat These companies have powerful barriers to entry from the competition. These barriers include a popular brand name. For example, the local pizza place might have 8 brands of coca-cola in the fridge. However, most people go for the real thing. Coke.

The company may have a hold on you. How easy would it be for a salesperson to convince you to replace all your Microsoft software and purchase something else? Sure…I have plenty of time to relearn a new suite of software. Hang on, let me uninsatll Microsoft and then re-intstall all your stuff. Paaaaarty!

Price. Not everyone can compete with Target. They’re known for low prices. But many stores have low prices. But Target sells quality goods. All my socks, underwear and undershirts? Yep.....Target.

Meaning Does this company represent your values and interests. Maybe it's a company logo you want to be associated with. Love sports? Maybe Nike would be a business to buy.

Management Some firms have CEO’s that are just in it for the private jet and getting photographed with Bono. Some CEO’s like Steve Jobs are in it for the true passion of growing their business and making sure the customer is satisfied.

You want a business whose CEO face epitomizes the company's goals and aspirations.

Margin of Safety Whether you love crunching numbers or not, this an important component of Phil Town’s system. Don’t worry. The good news is Rule #1 makes it easy to understand the financials. Most other investors ignore it. Here is what we like to see.

Each category should have growth of at least 10% per year over the past 10 years. The nominees are:

Begin with ROIC (Return On Investment Capital): This number shows how well management is able to invest the capital it plows into its operations. Look for at least 10% per year and growing.

Sales: Is the company selling enough product or service to grow at least 10% per year.

Earnings Per Share: What profitably are current shareholders receiving by owning a share of stock.

Equity or Bok Value: What value is left if all assets were sold and all liabilities were paid.

Free Cash Flow: The cash that a company is able to generate after laying out the money required to maintain or expand its operations. This allows a company to pursue opportunities that enhance shareholder value. Without cash, it's tough to develop new products, make acquisitions, pay dividends and reduce debt.

I’m sure you know this already but many financial web sites provide these numbers. No need to whip out a slide rule and annual report.

Moment of Truth Now we determine the sticker price and determine if its below the current stock price.

To arrive at the sticker price we need:

1. Current EPS 2. Estimated (future) EPS growth rate 3. Estimated future PE ratio 4. Minimum acceptable rate of return. 15%

Phil Town’s web site www.RuleOneInvestor.com provides a free calculator that does the work for you. The answer you get after plugging in the numbers will be the sticker price.

The Margin of Safety will be 50% off the sticker price. The sticker price is what the company should be worth according to our analysis of the numbers. We want to buy it at 50% below. Once we determine the sticker price of the stock we compare it to the current market price.

If the market price of the stock is below what we calculated as the sticker by at least 50%....we got a bargain. We buy. The stock should yield us a minimum 15% rate of return year after year for 10 years.

The calculator provided at RuleOneInvestor.com will take care of all the financial stuff. We just need to find a company that passes the 4 M’s and compare the stock prices.

Since stock market prices fluctuate, a 50% MOS should give us protection on our return.

The next question begging to be asked is when do you sell? That has two conditions. When the business you own is not so “wonderful” to own any more. When the market price of the stock is above the sticker. Sell and cash out.

The Three Tools To the happiness of chartists everywhere, Phil Town uses three technical indicators to help determine when to jump in & when to sell. These tools give you insight into the recent buying and selling activity of the stock. In other words, keeping tabs on what the smart money is doing.

The tools he uses are MACD, Moving Averages and Stochastic. When all three tools say buy….you have confirmation.

We will review technical indicators and how to use them in another section of this site I have aptly called Technical Indicators.

When I first started trading I went by the charts exclusively. I used the technical tools that Phil Town recommends and tried experimenting with others. My results greatly improved when I started to introduce good financials into the mix. When I buy and sell is determined by the charts. But the companies I trade are determined by the earnings.

Has it helped? It certainly hasn't hurt.

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