15 Tips for Successful Investing
When we opened the doors of McRae Capital Management, I believed we could help individuals and small to medium-sized institutions invest their money successfully. Our company was founded on several principles that had worked for me over my years as an investment adviser. In the years since then, these principles have remained very much the same; if anything, the past 35 years have served to confirm their validity.
On the occasion of our 15th anniversary back in 1996, I decided to share those principles with our clients, identifying 15 tenets of successful investing. The number could be 12 or it could be 16…the exact count doesn’t matter. What does matter is consistency. Here are Rod McRae’s 15 Fundamentals.
I. Think long term
II. Invest in growth
III. Buy the best companies
IV. Prize strong balance sheets
V. Focus on intrinsic value
VI. Benefit from compounding
VII. Minimize the impact of taxes
VIII. Concentrate your investments
IX. Buy only what you understand
X. Be wary of companies that stray
XI. Follow the big trends
XII. Watch money flows
XIII. Stocks outperform bonds
XIV. Control spending
XV. Remain calm
Readers of Commentary will recognize most, if not all, of them. Those who are new to our newsletter may be disappointed that I’m not revealing my “top secret, insider’s sure-fire formula.” Sorry, but there’s no such thing. Have other investment professionals developed their own successful approaches? Of course. Wall Street can be as complex and arcane as you want to make it. And, I’m not sure I’d call a lot of them investors, given their trader’s penchant for playing the fad du jour. The 15 you’ll read about here have worked, and they’re not at all difficult to understand.
These 15 have been rewarding for me. More important, they’ve been rewarding for McRae clients. I’d like to take this opportunity to thank our clients for the opportunity to be of service. We pledge to continue our very best efforts going forward.
—Rod McRae
I. Think long term
The major fortunes in this country have been made by holding equity positions in growing companies for significant periods of time. This is how the vast majority of wealthy families around the world accumulated their fortunes. Many try to trade the market, but they are not as successful as those who own growth companies that compound earnings and dividends over the long term. The chances of picking the right stocks and being right on both buy and sell timing are very slender.
II. Invest in growth
I’ve said it before and I’ll say it again: The single consideration that most influences the price of a company’s stock is growth in earnings per share. Right alongside is dividend growth. Above any other factor, Wall Street rewards growth— and this is the key criteria in our investment philosophy. Even when the market is not doing well, earnings of solid growth companies continue to increase. It’s like a coiled spring. What’s making it coil is earnings growth. When it pops, the stock’s price jumps higher and higher.
III. Buy the best companies
This is the stock market corollary to the old real estate adage that the only three things that count are “location, location and location.” Paraphrasing that thought for common stocks, we’d say the only three things that matter are “quality, quality and quality.” This means you not only want to buy growth, but you want to buy the best growth company in a given industry— not the second, third or fourth ranked company. Quality means strong balance sheets, high returns on equity, consistent growth, and proven, honest management.
IV. Prize strong balance sheets
One of the measures of quality is a company’s financial strength. I like self-financing companies with low debt, positive cash flow and high rates of return on equity that can afford to invest in R&D, expand into global markets and build new plants. They also have the ability to create shareholder value by increasing dividends and buying back shares.
V. Focus on intrinsic value
The high concentration of money in the hands of mutual fund managers who tend to focus on the short term has increased the volatility of the market and individual stocks. The indiscriminate buying and selling of short-term thinkers creates price swings that move far away from the company’s intrinsic value in both directions. In the long term, value will be dependent on the growth of the basic business, and the short-term price movements will only be “noise.”
VI. Benefit from compounding
Investors should focus on the total return of their portfolio. Total return is the combination of income (dividends) plus the increasing value of capital. After all, as we mentioned before, it’s the total dollar return that is important. This is why stocks that combine dividends and price appreciation outperform bonds over the long term.
VII. Minimize the impact of taxes
People who buy and sell frequently, even if they’ve made good money on their investments, pay higher taxes far more often than the long-term investor. Taxes on long-term gains are usually much less than taxes on short-term gains.
The single consideration that most influences the price of a company’s stock is growth in earnings per share
VIII. Concentrate your investments
Andrew Carnegie is credited with having said, “Put all your eggs in one basket—and watch that basket.” I don’t go quite that far, but I do believe in running fairly concentrated portfolios. Today’s most notable practitioner of this approach is Warren Buffett, who concentrates his assets in about a dozen issues. Generally, the portfolios we manage have about 20 to 25 stocks in them. To us, this approach offers the best way to take advantage of opportunities, yet enough diversification to dampen normal market fluctuations and limit risk.
IX. Buy only what you understand
To mention Warren Buffett again, he likens investing to a baseball game. He gets a lot of pitches, but he doesn’t have to swing at any until he gets one he really likes. The same with me. Recently, there have been a couple of highly-touted stocks that I didn’t go near because I didn’t like their accounting methods. There’s a certain intuitive factor at work here—once the homework is done, you have to be comfortable with a stock and your understanding of it. Otherwise, your emotions take over and you don’t make sound judgments.
X. Be wary of companies that stray
Successful companies stick to their knitting. Watch out if a company buys another company in an unrelated industry or in some other way expands outside of its expertise. The most successful investments I’ve been involved with are very focused, they concentrate their efforts and resources in one area— the one they know the best. There are very, very few successful multi-industry companies.
XII. Watch money flows
Why swim upstream when you can be carried along by a good downstream current? In other words, you want to invest in companies benefiting from big trends. We choose leading companies in rapidly growing industries and ride the trend until we think it has run its course.
XI.Follow the big trends
You’ve probably heard of Federal Reserve watchers. Well, I admit to being one. Most of the time, my focus is on individual stocks, not the overall stock market. This is an exception. I believe the number one “macro-factor” affecting the stock market is ease or tightness of money and related money flows. If money is flowing into our economy and interest rates are level or falling, the stock market usually can be expected to rise. If the Fed is pulling money out or capital is becoming tight around the world, money is flowing out and the market is likely to go down. A key factor behind the long-term bull market we’ve been in since 1982 has been a decline in interest rates.
XIII. Stocks outperform bonds
The long-term return from common stocks is far ahead of bonds. Balanced portfolios need bonds, and the proportion of a portfolio devoted to bonds should depend on an individual’s specific circumstances. In general, however, people usually err on the side of holding too much in bonds and not enough in stocks—particularly when they are retired. The risk is inflation. Stocks offer inflation protection and bonds do not. Recently, we have experienced relatively benign rates of inflation. But, with people living so much longer, after five or so years of moderate inflation, retirees are going to have to reduce their standard of living if they don’t have the inflation protection afforded by common stocks.
XIV. Control spending
Retirees and others living on their portfolios need to watch the amount they take out or they, too, will suffer the decline in living standards I just spoke of. People can take out 5 or 6 percent a year and live very well, even in years when the stock market declines. Why? Because there will be other years when they’re ahead 10, 15 or maybe 20 percent. People who take out 10 or 15 percent won’t prosper because they will have depleted too much of the principal.
XV. Remain calm
When I say calm, I mean that I’ve never been in this business when there isn’t something to worry about, and it’s usually something that has enough intellectual significance to get people’s attention. You can’t get too caught up in wars, recessions and “the world’s coming to an end” books. Remember, all crises, large and small, are temporary. Throughout history people have continued to want to improve their standard of living—it’s human nature. Growth companies thrive on satisfying this innate human need. Our entrepreneurial, capitalistic society makes it possible for good companies to grow and make money. I am a believer—this is where I want my investment dollars to be!
McRae Capital can help you understand a host of topics, like the risks of market volatility, how to live off retirement savings, and why taking the long view as an investor is so very important.
Connect your finances to what matters most
This article can provide only a general understanding of sometimes difficult financial concepts. For for a more thorough explanation, or if you have questions about your own portfolio, please feel free to reach out to us here at McRae at (973) 387-1080.
I. Think long term