Not long ago, MagicDiligence reviewed Mary Buffett and David
Clark''s Warren Buffett and the Interpretation of Financial
Statem...... and concluded that, while possibly useful for
beginners, experienced stock investors would dismiss the book as
simplistic and adding nothing new. The review also mentioned that a
good alternative for more experienced investors looking to add to
their knowledge is Pat Dorsey''s The Five Rules for Successful
Stock Investing.
Today we''ll take a look at that book. The author, Pat Dorsey,
is currently the Director of Equity Research for Morningstar.
Morningstar has historically been known for their 5-star scale of
mutual fund ratings, but several years ago began applying the same
scale to individual stocks. Since Morningstar''s focus is on
durable competitive advantage, the firm''s investing philosophy
correlates very well with that of the Magic Formula and of
MagicDiligence. That makes the book particularly relevant and much
of my stock analysis is based on techniques outlined in it. The
Five Rules... is more or less a two part book. The first half deals
covers the title, laying out the five rules for successful
investing and then proceeding to expand on each of them. Without
spoiling too much of the book, Dorsey''s five rules are:
1) Do your homework.
2) Find economic moats.
3) Have a margin of safety.
4) Hold for the long haul.
5) Know when to sell.
This first section then continues on to introduce the investor
to the techniques of stock analysis. Topics covered include
detailed explanations of each financial statement, the points of
emphasis to look for in a good investment (such as growth potential
and financial health), how to spot accounting blowups before they
happen, how to value a stock, and so forth. For everyone interested
in stock analysis, from 10 year pros to those just beginning to dip
their toes in the market, these chapters contain invaluable and
vital information. Nearly every investor will learn something new
about evaluating companies and valuing stocks. One particularly
valuable chapter is titled "The 10-Minute Test", which will help
you quickly throw out stocks that are not worth your time, while
highlighting investment opportunities that warrant additional
research.
The second half of the book is equally useful. In this section,
Dorsey calls upon Morningstar''s sector analysts to lay out the
intrinsic moat qualities and the factors that separate good and bad
companies in a variety of sectors, including Health Care, Consumer
Services, Media, Banks, and so on. It''s no secret to
MagicDiligence Members that some industries are inherently better
investment hunting grounds than others, and this book explains why.
For example, retail is generally a difficult place to invest -
there are no customer switching costs, tons of competition, and
constantly changing consumer trends. On the other hand, most
medical device makers have very high switching costs, as surgeons
are trained on one company''s products and are loathe to learn the
intricacies of a competing product, unless there is a very good
reason to do so.
To close this review, a personal observation. Most investors
routinely cite classic investing books like Ben Graham''s The
Intelligent Investor as the place to start for novice investors. I
respectfully disagree. I''ve read many of those great classics, but
no one book has explained the details of company and equity
analysis as directly or relevantly as this book. This is one of the
most overlooked investing books out there, and comes highly
recommended to all investors. -The Motley Fool